[Federal Register Volume 61, Number 112 (Monday, June 10, 1996)]
[Notices]
[Pages 29438-29444]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-14590]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37273; File No. SR-NYSE-95-47]
Self-Regulatory Organizations; New York Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change Relating to the
Exclusion of Competing Market Maker Orders From Trading at No Charge
June 4, 1996.
I. Introduction
On December 29, 1995, the New York Stock Exchange, Inc. (``NYSE''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to exclude orders of nonmember
competing market makers from the NYSE's no charge provision for system
orders of 100 to 2,099 shares.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in the Federal
Register on January 5, 1996.\3\ The Commission initially received a
total of four comment letters opposing the proposal.\4\ On April 26,
1996, the NYSE submitted its response to these comment letters.\5\
After receiving the NYSE's response, the Commission received four
additional comment letters.\6\ For the reasons discussed below, the
Commission, after careful consideration, has decided to approve the
NYSE's proposal.
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\3\ Securities Exchange Act Release No. 36658 (Dec. 29, 1995),
61 FR 436.
\4\ See letter from John I. Fitzgerald, Executive Vice
President, Legal Affairs and Trading Services, Boston Stock
Exchange, Inc. (``BSE''), to Jonathan G. Katz, Secretary, SEC, dated
February 21, 1996 (``BSE February 21, 1996 Letter''); letter from
George T. Simon, Foley & Lardner, on behalf of the Chicago Stock
Exchange, Incorporated (``CHX''), to Jonathan G. Katz, Secretary,
SEC, dated March 4, 1996 (``CHX March 4, 1996 Letter''); letter from
William W. Uchimoto, First Vice President and General Counsel,
Philadelphia Stock Exchange, Inc. (``Phlx''), to Jonathan G. Katz,
Secretary, SEC, dated February 23, 1996 (``Phlx February 23, 1996
Letter''); letter from David P. Semak, Vice President, Regulation,
Pacific Stock Exchange Incorporate (``PSE''), to Jonathan G. Katz,
Secretary, SEC, dated March 4, 1996 (``PSE March 4, 1996 Letter'').
\5\ See letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Jonathan Katz, Secretary, SEC, dated April 25,
1996 (``NYSE April 25, 1996 Letter''). Previously, the NYSE had
granted the Commission an extension of 30 days after the date of the
Commission's receipt of the Exchange's response within which to act
on the NYSE's proposal. See letter from James E. Buck, Senior Vice
President and Secretary, NYSE, to Glen Barrentine, SEC, dated March
13, 1996.
\6\ See letter from George W. Mann, Jr., Senior Vice President
and General Counsel, BSE, to Jonathan G. Katz, Secretary, SEC, dated
April 23, 1996 (``BSE April 23, 1996 Letter''); letter from John I.
Fitzgerald, Executive Vice President, Legal Affairs and Trading
Services, BSE, to Jonathan G. Katz, Secretary, SEC, dated May 6,
1996 (``BSE May 6, 1996 Letter''); letter from J. Craig Long, Foley
& Lardner, on behalf of the CHX, to Jonathan G. Katz, Secretary,
SEC, dated May 6, 1996 (``CHX May 6, 1996 Letter''); letter from
William W. Uchimoto, First Vice President and General Counsel, Phlx,
to Jonathan G. Katz, Secretary, SEC, dated May 3, 1996 (``Phlx May
3, 1996 Letter'').
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II. Background and Description of the Proposal
A. Transaction Credits
On November 7, 1995, the NYSE, pursuant to Section 19(b)(3)(A) of
the Act,\7\ filed a rule change with the Commission that made a series
of revisions to the Exchange's equity \8\ transaction fee schedule,
including the exclusion of nonmember competing market makers from the
NYSE's no charge provision for system orders of 100 to 2,099 shares.\9\
Prior to such filing, the NYSE's transaction fee schedule imposed on
all public agency,\10\ equity transactions the following charges:
\7\ 15 U.S.C. 78s(b)(3)(A). Pursuant to Section 19(b)(3)(A), a
proposed rule change may take effect upon filing with the Commission
if designated by the self-regulatory organization as, among other
matters, establishing or changing a due, fee, or other charge
imposed by the self-regulatory organization.
\8\ The NYSE's transaction fee schedule defines the term
``equity'' to include shares, rights, and warrants.
\9\ Securities Exchange Act Release No. 36465 (Nov. 8, 1995), 60
FR 57473 (publishing SR-NYSE-95-38.
\10\ Equity public agency transaction fees and credits do not
apply to principal transactions by NYSE members for their own
accounts. See NYSE Transaction Fee Schedule n.1.
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$0.00265 per share for the first 5,000 shares;
$0.00010 per share for 5,001 to 672,500 shares; and no charge for all
shares in excess of 672,500.
The NYSE's transaction fee schedule also provided for a credit of
$0.30 per order for all orders of 100 to 2,099 shares that were placed
through the NYSE's Common Message Switch (``CMS'')\11\ and an
additional credit of $1.30 for all Individual \12\ or Agency \13\
market orders of 100 to 2,099 shares placed through the NYSE's CMS.
Orders executed by members and member organizations for the account of
a competing market maker,\14\ however, were not eligible for the
additional system credit. This additional system credit was applied on
a monthly basis against the member or member organization's total
transaction charges.
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\11\ The Common Message Switch is a data communications
application that accommodates a wide variety of member firm computer
and technical connections, enabling a member firm to send orders
directly to the appropriate floor booth for execution by the firm's
floor broker or by SuperDot to the appropriate specialist post.
Accordingly, the NYSE's transaction fee schedule provided credits
for SuperDot orders. See Securities Exchange Act Release No. 28655
(Nov. 29, 1990), 55 FR 50260, at n.1 (publishing SR-NYSE-90-54).
\12\ An Individual order is an order for the account of any
customer who is an individual as defined by NYSE Rule 80A. See
Securities Exchange Act Release No. 29866 (Oct. 28, 1991), 56 FR
56432. That rule, in turn, cites Section 11(a)(1)(E) of the Act,
which defines an individual investor as a natural person. See
Securities Exchange Act Release No. 32377 (May 27, 1993), 58 FR
31568, at n.7 (approving NYSE's limitation on the additional system
credit concerning nonmember competing market makers).
\13\ An Agency order is an order for the account of any
customer, other than a natural person, who is a nonmember of
nonmember organization. Id. at n.8.
\14\ The proposed rule change defines a competing market maker
as ``a specialist or market maker registered as such on a registered
stock exchange (other than the NYSE), or a market maker bidding and
offering over-the-counter in a New York Stock Exchange-traded
security.''
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B. Payment for Order Flow
On October 27, 1994, the Commission adopted Rule 11Ac1-3 \15\ and
amendments to Rule 10b-10 \16\ under the Act concerning payment for
order flow practices.\17\ These provisions were designed to improve the
information available to investors about their broker-dealer's order
routing practices and disclose to investors whether the broker-dealer
received market center \18\ inducements for routing unspecified order
flow to a particular market.\19\ In defining payment for order flow,
the Commission took a very broad approach so that all forms or
arrangements whereby a broker-dealer received compensation for
directing order flow to a particular market were included.
Specifically, payment for order flow was designed to include any
credit, rebate, or discount against execution fees that exceeds the fee
charged for executing the order.\20\ As a result, credits received by
NYSE members under the NYSE's transaction fee schedule constituted
[[Page 29439]]
payment for order flow where such credit exceeded the transaction
charged associated with such order.\21\ In response to these new
disclosure requirements, the NYSE decided to revise its transaction fee
schedule so that its members would not be required to comply with Rule
11Ac1-3 \22\ and Rule 10b-10 \23\ regarding disclosure of the receipt
of payment for order flow.\24\
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\15\ 17 CFR 240.11Ac1-3.
\16\ 17 CFR 240.10b-10.
\17\ See Securities Exchange Act Release No. 34902 (Oct. 27,
1994), 59 FR 55006 [hereinafter Payment for Order Flow Release].
\18\ See 17 CFR 240.11Ac1-2(a)(14) (defining ``reporting market
center'').
\19\ See Payment for Order Flow Release, supra note 17.
\20\ See Payment for Order Flow Release, supra note 17.
\21\ For example, under the NYSE's transaction fee schedule,
NYSE members and member organizations were receiving payment for
order flow for certain system orders of 100 to 603 shares. For
orders greater than 603 shares, the NYSE equity transaction charges
exceeded the $1.60 credit granted.
\22\ 17 CFR 240.11Ac1-3.
\23\ 17 CFR 240.10b-10.
\24\ On October 13, 1995, the Commission issued a letter to the
Securities Industry Association granting all registered broker-
dealers a temporary exemption from the confirmation disclosure
requirements of Rule 10b-10(a)(2)(C) and a no-action position
regarding the account opening provisions of Rule 11Ac1-3. This
exemption and no-action position expired on November 5, 1995.
Subsequently, the Commission issued another similar letter to the
NYSE effective from November 6, 1995 to December 31, 1995. See
letter from Brandon Becker, (then) Director, Division of Market
Regulation, SEC, to Edward A. Kwalwasser, Group Executive Vice
President, Regulation, NYSE, dated November 8, 1995.
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C. SR-NYSE-95-38
On November 7, 1995, the NYSE submitted a rule filing pursuant to
Section 19(b)(3)(A) of the Act \25\ that revised its equity transaction
charges, effective January 2, 1996.\26\ Among other things, this
filing: (1) eliminated all SuperDot system credits, (2) reduced the
equity transaction fees on orders for 5,000 shares and under from
$0.00265 per share to $0.0019 per share,\27\ (3) eliminated the equity
transaction charges for SuperDot system orders of 100 to 2,099 shares,
except for orders of competing market makers, and (4) capped monthly
equity transaction fees at $400,000. The Commission published the
notice of filing and immediate effectiveness of this rule change on
November 8, 1995.\28\ Subsequently, the Commission received three
comment letters regarding this rule change.\29\
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\25\ 15 U.S.C. 78s(b)(3)(A). See supra note 7 (detailing which
rule filings may be submitted pursuant to this section for immediate
effectiveness).
\26\ Securities Exchange Act Release No. 36465 (Nov. 8, 1995),
60 FR 57473 (publishing the notice and immediate effectiveness of
SR-NYSE-95-38).
\27\ See supra note 10 (noting that the fees and credits
concerning equity public agency transactions do not apply to
principal transactions by members for their own accounts).
\28\ Securities Exchange Act Release No. 36465 (Nov. 8, 1995),
60 FR 57473.
\29\ See letter from Samuel F. Lek, Chief Executive Officer,
Lek, Schoenau & Company, Inc., to Secretary, SEC, dated November 14,
1995 (opposing the monthly equity transaction fee cap); letter from
William W. Uchimoto, First Vice President and General Counsel, Phlx,
to Jonathan Katz, Secretary, SEC, dated November 27, 1995 (opposing
the disparate treatment of competing market maker orders and
requesting that the NYSE withdraw that portion of the filing and
refile it for notice and action pursuant to Section 19(b)(2) of the
Act); letter from David P. Semak, Vice President of Regulation, PSE,
to Jonathan Katz, Secretary, SEC, dated December 7, 1995 (opposing
the disparate treatment of competing market maker orders and
requesting that the NYSE withdraw that portion of the filing and
refile it for notice and action pursuant to section 19(b)(2) of the
Act).
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D. SR-NYSE-95-46
In response to these comment letters, the Commission requested that
the NYSE withdraw that portion of the filing concerning the exclusion
of competing market maker orders from the NYSE's no charge policy and
resubmit it pursuant to Section 19(b)(1) \30\ for notice and action
pursuant to Section 19(b)(2).\31\ This would provide sufficient time
for the Commission to consider, and interested parties to comment on,
that portion of the filing.\32\ In complying with the Commission's
request, on December 29, 1995, the NYSE submitted two related rule
filings: SR-NYSE-95-46 and the current proposal, SR-NYSE-95-47.
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\30\ 15 U.S.C. 78s(b)(1).
\31\ 15 U.S.C. 78s(b)(2).
\32\ Section 19(b)(2) requires that a notice be published in the
Federal Register for the statutory comment period and provides that
changes pursuant to this section are not effective until the
Commission issues an approval order.
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In SR-NYSE-95-46, the NYSE revised its equity transaction charges,
effective January 2, 1996,\33\ to eliminate the exclusion of competing
market maker orders from the no charge provision for SuperDot system
orders of 100 to 2,099 shares. The Exchange, however, also reserved the
right to collect, retroactive to January 2, 1996, the fees on such
trading in the event the Commission approved SR-NYSE-95-47.\34\ The
Commission published the notice of filing and immediate effectiveness
of this rule change on December 29, 1995.\35\
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\33\ This rule change became effective upon filing with the
Commission pursuant to Section 19(b)(3)(A) of the Act.
\34\ The effect of this rule change was to require members and
member organizations to report competing market maker system orders
of 100 to 2,099 shares to the Exchange. The amount of fees due would
be $0.0019 per share for all such competing market maker orders
executed by NYSE members on the Exchange from January 2, 1996 to the
present.
\35\ Securities Exchange Act Release No. 36659 (Dec. 29, 1995),
61 FR 432.
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E. The Current Proposal
The Exchange now proposes to amend its fee schedule to re-institute
the exclusion of competing market maker SuperDot system orders of 100
to 2,099 shares from the NYSE's no charge policy. This change, in
effect, would impose a charge of $0.0019 per share on competing market
maker SuperDot system orders of 100 to 2,099 shares and, furthermore,
allow the Exchange to collect equity transaction charges on all such
orders that have been executed on the NYSE since January 2, 1996.\36\
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\36\ Currently, the NYSE waives the equity transaction fees for
all SuperDot system orders of 100 to 2,099 shares.
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III. Summary of Comments
The Commission received a total of eight comment letters from the
BSE, the CHX, the PHlx, and the PSE (collectively referred to herein as
the ``commenters'') regarding the exclusion of competing market maker
system orders from the Exchange's no charge provision.\37\ In its
response, the NYSE supports its proposal and responds to the first four
comment letters.\38\ The issues raised by the commenters are discussed
below.
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\37\ See supra notes 4 and 6.
\38\ See supra note 5.
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A. Equitable Allocation of a Reasonable Fee
The commenters believe that the proposal is inconsistent with
Section 6(b)(4) of the Act \39\ because it constitutes an inequitable
allocation of fees \40\ and further assert that the proposal is
inconsistent with Section 6(b)(5)\41\ because it unfairly discriminates
among certain brokers, dealers, and customers,\42\ as well as
compromises the existence of a free and open market.\43\
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\39\ 15 U.S.C. 78f(b)(4). Section 6(b)(4) requires that the
rules of an exchange provide for the equitable allocation of
reasonable dues, fees, and other charges among its members and
issuers and other persons using its facilities.
\40\ See BSE February 21, 1996 Letter, supra note 4; PSE March
4, 1996 Letter, supra note 4.
\41\ 15 U.S.C. 78f(b)(5). Among other things, Section 6(b)(5)
requires that the rules of an exchange be designed to promote just
and equitable principles of trade, to perfect the mechanism of a
free and open market and a national market system, and, in general,
to protect investors and the public interest. Section 6(b)(5) also
requires that the rules of an exchange not be designed to permit
unfair discrimination between customers, issuers, brokers, or
dealers.
\42\ See BSE February 21, 1996 Letter, supra note 4; BSE April
23, 1996 Letter, supra note 6; CHX March 4, 1996 Letter, supra note
4; Phlx February 23, 1996 Letter, supra note 4; PSE March 4, 1996
Letter, supra note 4.
\43\ See BSE February 21, 1996 Letter, supra note 4.
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To support its opposition to the proposal, the CHX explains that
nonmember competing market makers do not receive any trading advantage
on the NYSE Floor that justifies this disparate treatment, and that
this proposal does not provide any benefit to
[[Page 29440]]
the public.\44\ Therefore, the CHX argues, there is no valid
justification or legally sufficient rational basis why nonmember
competing market makers should pay more than all other nonmembers for
such orders.\45\
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\44\ See CHX March 4, 1996 Letter, supra note 4.
\45\ See CHX March 4, 1996 Letter, supra note 4.
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Separately, the Phlx contends that competing market makers will be
required to subsidize all of the NYSE's other system orders of this
size and, therefore, this fee should be cost based.\46\
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\46\ SEE Phlx February 23, 1996 Letter, supra note 4.
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In its response, the NYSE charges that the commenters fundamentally
misread the provisions of the Act dealing with competition in the
national market system (``NMS''). The NYSE argues that the proposal
does not constitute either an inequitable allocation of fees or unfair
discrimination among brokers and dealers because the affected parties
are in direct competition with each other. This competition, the
Exchange asserts, justifies the disparate treatment in this instance
because to require otherwise would obligate the NYSE to subsidize its
competitors.
The CHX characterizes the NYSE's logic as specious. The CHX asserts
that the proposal does not achieve one of its stated purposes, to avoid
subsidizing the NYSE's competitors, because proprietary orders of
regional exchange specialists and third market makers that are
affiliated with a NYSE member are included in the NYSE's no charge
policy. Therefore, the CHX argues that the NYSE's justification is
inadequate because the proposal does subsidize some NYSE
competitors.\47\
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\47\ See CHX May 6, 1996 Letter, supra note 6.
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B. Burden on Competition
The commenters also argue that the proposal is inconsistent with
Section 6(b)(8) \48\ and Section 11A(a)(1)(C) \49\ of the Act because
it raises the costs of competing market makers without sufficient
justification and, therefore, places an unnecessary and inappropriate
burden on competition.\50\ The commenters contend that raising the
costs of competing market makers in this case will harm the depth and
liquidity of the market.\51\ One commenter also believes that it will
reduce price improvement opportunities, impair the ability of competing
market makers to perform their required market making functions, and,
in general, disrupt the equilibrium of the NMS.\52\
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\48\ See BSE February 21, 1996 Letter, supra note 4; BSE April
23, 1996 Letter, supra note 6; CHX March 4, 1996 Letter, supra note
4; CHX May 6, 1996 Letter, supra note 6; Phlx February 23, 1996
Letter, supra note 4; PSE March 4, 1996 Letter, supra note 4.
\49\ See BSE February 21, 1996 Letter, supra note 4; BSE April
23, 1996 Letter, supra note 6; PSE March 4, 1996 Letter, supra note
4.
\50\ See 15 U.S.C. 78f(b)(8) and 78k-1(a)(1)(C). Section 6(b)(8)
prohibits the rules of a national securities exchange from imposing
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act. In Section 11A(a)(1)(C),
Congress found that, among other things, it is in the public
interest and appropriate for the protection of investors and the
maintenance of fair and orderly markets to ensure fair competition
among brokers and dealers, among exchange markets, and between
exchange markets and markets other than exchange markets.
\51\ See CHX March 4, 1996 Letter, supra note 4; PSE March 4,
1996 Letter, supra note 4.
\52\ See PSE March 4, 1996 Letter, supra note 4.
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Several commenters also claim the impetus for this filing is
similar to a prior American Stock Exchange, Inc. (``Amex'') competing
dealer rule proposal that was eventually withdrawn. In analogizing the
NYSE proposal to the prior Amex proposal, the commenters claim the NYSE
is seeking to implement rules that disadvantage its competition for
purely competitive reasons.\53\
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\53\ See BSE February 21, 1996 Letter, supra note 4; CHX March
4, 1996 Letter, supra note 4; Phlx February 23, 1996 Letter, supra
note 4; Phlx May 3, 1996 Letter, supra note 6. In its competing
dealer filing, the Amex proposed that orders for a competing dealer
would: (1) yield priority and parity to all other off-floor orders,
(2) accept parity with orders for an account of an Amex specialist,
and (3) be excluded from the Amex's order routing system, the Post
Execution Reporting System (``PER''). The Amex subsequently amended
this proposal in December 1991, among other things, to: (1) provide
that orders for the account of a competing dealer that better the
existing market do not have to yield priority and parity to off-
floor orders, (2) withdraw the portion of the proposal that would
have placed orders for the account of a competing dealer on parity
with orders for the account of an Amex specialist, and (3) request
that the Commission temporarily defer its consideration of the
proposed prohibition of competing dealer access to PER. See
Securities Exchange Act Release No. 30161 (Jan. 7, 1992), 57 FR 1502
(File No. SR-Amex-90-29). The Amex thereafter withdrew this filing
at the request of Commission staff. See Division of Market
Regulation, SEC, Market 2000, An Examination of Current Equity
Market Developments Study III-11 (Jan. 1994) [hereinafter Market
2000] (recommending that the Amex amend or withdraw SR-Amex-90-29).
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The NYSE argues that the proposal does not impose an inappropriate
burden on competition because competing market makers already have
cost-free access to the NYSE through the Intermarket Trading System
(``ITS'').\54\ The NYSE characterizes ITS as a carefully-constructed
\55\ market linkage that has evolved over the past twenty years to
successfully balance the goals enumerated in Section 11A(a)(1)(D) of
the Act.\56\
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\54\ ITS provides facilities and procedures for: (1) the display
of composite quotation information at each participant market so
that brokers can readily determine the best available price for a
particular security, (2) the execution of orders between broker-
dealers at respective ITS market centers, and (3) the coordination
of market openings among the linked markets.
Brokers may execute orders in other ITS market centers by
entering a ``commitment to trade'' into their ITS computer terminal.
Currently, the Amex, the BSE, the Chicago Board Options Exchange,
Incorporated, the CHX, The Cincinnati Stock Exchange, the National
Association of Securities Dealers, Inc., the NYSE, the Phlx, and the
PSE are all ITS participants. See Market 2000, supra note 53, at
Appendix II (providing the history of ITS).
\55\ The NYSE notes that, in addition to itself and other
markets, all of the commenters were involved in the development of
ITS and that this development was supervised by the Commission. See
also Market 2000, supra note 53, at Appendix II.
\56\ 15 U.S.C. 78k-1(a)(1)(D) (finding that the linking of all
markets will foster efficiency, enhance competition, increase the
information available to brokers, dealers, and investors, facilitate
the offsetting of investors' orders, and contribute to the best
execution of such orders).
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By utilizing ITS, the NYSE explains, competing market makers still
can lay off their excess positions and interact with trading interest
on the NYSE. In support of this argument, the NYSE states that the
commenters' ITS commitments executed on the Exchange during the first
three months of 1996 accounted for over twenty-one percent of the total
share volume reported by the commenters during this time period.
As further support that the filing does not impose an inappropriate
burden on competition, the NYSE notes that this proposal seeks to
maintain the prior relationship between member proprietary and
nonmember competing market maker activities in Exchange-listed
securities.\57\ The Exchange asserts that although the proposal
replaces the credit system with a discount system, it maintains the
status quo because the economic effect is unchanged.
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\57\ According to the prior fee schedule, neither order type was
eligible for the NYSE's additional system credit. See supra note 10.
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Finally, the NYSE argues that the proposed fee for competing market
maker orders is lower than the fee structure previously in effect and,
therefore, does not impose an inappropriate burden on competition. The
NYSE emphasizes that the proposal lowers the fee charged from $0.00265
per share to $0.0019 per share \58\ and, in any event, the amount
charged is nominal.\59\
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\58\ Without adjusting for the lost system credit, the NYSE
represents this as a reduction of 28%. See NYSE April 25, 1996
Letter, supra note 5.
\59\ The greatest differential exists between a nonmember
competing market maker system order of 2,099 shares and another
system order of 2,099 shares that qualifies for the NYSE's no charge
policy. Under these circumstances, the competing market maker order
would incur a charge of $3.99 (2,099 shares * $0.0019 per share),
while the other order would incur no fees at all. In underscoring
its argument that this fee is nominal, the NYSE points out that for
a $30 stock the $3.99 fee would represent .006% of the $62,970 value
of the trade. See NYSE April 25, 1996 Letter, supra note 5.
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[[Page 29441]]
In commenting further on the proposal, the BSE, the CHX, and the
Phlx refute the NYSE's claim that ITS provides adequate access to the
NYSE's market.\60\ They claim that ITS is too limited in its
capabilities. The CHX adds that its specialists choose to ignore free
ITS access and pay for access to the NYSE's SuperDot system simply
because SuperDot is better; \61\ while the BSE asserts that its
specialists are forced to use SuperDot because ITS commitments do not
have the same status as orders on the NYSE and do not have any standing
in the trading crowd.\62\
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\60\ See BSE May 6, 1996 Letter, supra note 6; CHX May 6, 1996
Letter, supra note 6; Phlx May 3, 1996 Letter, supra note 6.
\61\ See CHX May 6, 1996 Letter, supra note 6.
\62\ See BSE May 6, 1996 Letter, supra note 6.
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C. Proposed Order Handling Rules \63\
Finally, the BSE urges the Commission to consider the possible
impact this proposal will have in conjunction with the Commission's
``Proposed Limit Order Rule'' \64\ and ``Proposed Price Improvement
Rule.'' \65\ The BSE is concerned that a NYSE specialist availing
itself of the proposed rules' exceptions concerning the immediate
delivery of an Order to another market maker or system would be charged
a different fee than a BSE specialist doing likewise.
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\63\ On October 10, 1995, the Commission proposed two rules and
amendments to a rule to improve the handling and execution of
customer orders. The Proposed Limit Order Rule, Proposed Rule 11Ac1-
4, would require covered market makers to immediately reflect in
their bid or offer the price and size of each customer limit order
they hold in a covered security at a price that would improve their
bid or offer in the security unless an exception applies. The
Proposed Price Improvement Rule, Proposed Rule 11Ac1-5, would
require each specialist or OTC market maker in a covered security
that accepts a customer market order to provide that order with an
opportunity for price improvement unless an exception applies. Both
of these rules contain an exception for orders that are delivered
immediately to a market maker or system that complies with the
requirements of the applicable rule with respect to that order. See
Securities Exchange Act Release No. 36310 (Oct. 10, 1995), 60 FR
52792 (publishing File No. S7-30-95 for comment); Proposed 11Ac1-
4(c)(5); Proposed 11Ac1-5(e)(4).
\64\ See BSE February 21, 1996 Letter, supra note 4.
\65\ See BSE April 23, 1996 Letter, supra note 6.
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The NYSE did not address this issue in its response.
D. Antitrust Considerations \66\
The Phlx also requests the Commission to consider the possible
antitrust implications this proposal presents.\67\ The Phlx contends
that the NYSE enjoys a ``strategic dominance'' and that the antitrust
law's ``essential facility'' doctrine is germane to the Commission's
analysis of this proposal. In support of this argument, the Phlx claims
the proposal effectively and inappropriately excludes competing market
makers equal access to the primary market simply because they are
competitors.
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\66\ See infra notes 101, 102 (discussing the applicability of
the antitrust laws and the essential facility doctrine).
\67\ See Phlx February 23, 1996 Letter, supra note 4.
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The NYSE disputes the Phlx's premise that the NYSE is an essential
facility. The NYSE supports its position by asserting that: (1) the
NYSE is not a monopoly (as evidenced by the existence of multiple other
securities markets in the United States) and (2) competing market
makers will continue to have two forms of access to the NYSE's market--
``one free and another at near-zero price.'' \68\
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\68\ See NYSE April 25, 1996 Letter, supra note 5.
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IV. Discussion
Under Section 19(b)(2) of the Act,\69\ the Commission must approve
the NYSE's proposed rule change if it finds that the proposed rule
change is consistent with the requirements of the Act and the rules
thereunder applicable to a national securities exchange. If the
Commission is unable to make that finding, it must institute
proceedings to consider whether to disapprove the proposed rule change.
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\69\ 15 U.S.C. 78s(b)(2).
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The statutory requirements relevant to such a determination are
found, for the most part, in Section 6(b) of the Act.\70\ That section
delineates the purposes the NYSE's rules should be designed to achieve.
Those purposes or objectives, which take the form of positive goals,
such as investor protection, or prohibitions, such as those against
unfair discrimination or inappropriate burdens on competition, are
stated in the form of broad and elastic concepts. They afford the
Commission considerable discretion to use its judgment and knowledge in
determining whether a proposed rule complies with the requirements of
the Act.\71\ Furthermore, the subsections of Section 6(b) \72\ must be
read with reference to one another and to other provisions of the
Act.\73\ Within this legal framework, the Commission must weigh and
balance the strengths and weaknesses of a proposed rule, assess the
views and arguments of others, and make predictive judgments about the
consequences of approving the proposed rule.\74\
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\70\ 15 U.S.C. 78f(b).
\71\ Bradford National Clearing Corp. v. Securities and Exchange
Commission, 590 F.2d 1085 (D.C. Cir. 1978).
\72\ 15 U.S.C. 78f(b).
\73\ See Securities Exchange Act Release No. 17371 (Dec. 12,
1980), 45 FR 83707, 83715-19 (interpreting identical provisions of
Section 15A(b)).
\74\ Id.
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With this in mind, and after careful consideration of all of the
comments received, the Commission has determined to approve the
proposed rule change. For the reasons discussed below, the Commission
finds that the proposed rule change is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to a
national securities exchange.
In particular, the Commission finds that the proposal is consistent
with the Section 6(b)(4) requirement that the rules of an exchange
provide for the equitable allocation of reasonable fees among its
members; \75\ the Section 6(b)(5) \76\ requirements that the rules of
an exchange be designed to perfect the national market system, and, in
general, to protect investors and the public interest; and not designed
to permit unfair discrimination between brokers, dealers, and
customers; as well as the Section 6(b)(8) \77\ requirement that the
rules of an exchange not impose any burden on competition that is not
necessary or appropriate in furtherance of the purposes of the Act.
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\75\ 15 U.S.C. 78f(b)(4).
\76\ 15 U.S.C. 78f(b)(5).
\77\ 15 U.S.C. 78f(b)(8).
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A. The Proposal
The NYSE's original proposal, SR-NYSE-95-38, instituted a discount
fee system that excluded orders of nonmember competing market makers
from the NYSE's no charge provision for system orders of 100 to 2,099
shares. Instead, these orders would have been subject to a fee of
$0.0019 per share.
This modified the NYSE's previous system--a credit fee system. The
credit system imposed a charge of $0.00265 per share for the first
5,000 shares on all equity public agency transactions.\78\ If such an
order was for 100 to 2,099 shares and was placed through the NYSE's
CMS, it earned the NYSE member a credit of $0.30 per order. If this
also was an Individual or Agency market order, the NYSE member was
granted an additional credit of $1.30.\79\ Orders executed by members
and member organizations for the account of
[[Page 29442]]
a competing market maker, however, were not eligible for the additional
system credit.
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\78\ See supra note 10 (noting that the fees and credits
concerning equity public agency transactions do not apply to
principal transactions by members for their own accounts).
\79\ See supra notes 12 and 13 (defining Individual and Agency
orders).
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Prior to the effective date of the discount system, the NYSE
suspended the effectiveness of the exclusion concerning competing
market maker orders.\80\ Publication of the exclusion for public
comment provided additional time for the Commission to consider, and
interested parties to comment on, that portion of the filing. With this
filing, the NYSE seeks approval to implement the discount system as
originally filed.
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\80\ See (publishing the notice and immediate effectiveness of
SR-NYSE-95-46).
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B. Section 6(b)(4) \81\
Several commenters have argued that the proposal violates section
6(b)(4).\82\ The Commission disagrees and finds that the proposal
constitutes an equitable allocation of a reasonable fee.
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\81\ See surpa note 39 (listing the requirements of Section
6(b)(4)).
\82\ 15 U.S.C. 78f(b)(4).
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The Commission believes the proposed fee is reasonable because it
generally is a fee reduction. The Commission notes that the NTSE's new
discount system generally grants competing market maker orders a cost
savings over the prior credit system.\83\ The Commission believes the
fee is an equitable allocation within the meaning of Section 6(b)(4)
because, although the fee distinguishes between the orders of nonmember
competing market makers and all other orders executed on the NYSE, it
does not do so in a manner that imposes a significant cost burden on
the nonmember competing market maker orders. In addition, the
Commission is unable to conclude that the fee is not reasonable because
nonmember competing market makers will be able to continue the same
level of trading activity on the NYSE as before this fee was
implemented, except that it now will be at a lower cost.
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\83\ Under most circumstances, the fee imposed on competing
market maker orders has been reduced.
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The following illustrates this fact:
------------------------------------------------------------------------
Credit Discount
Shares System System Savings
------------------------------------------------------------------------
100................................ $(0.04) $0.19 $-0.23
400................................ 0.76 0.76 0.00
500................................ 1.03 0.95 0.08
1,000.............................. 2.35 1.90 0.45
1,500.............................. 3.68 2.85 0.83
2,099.............................. 5.26 3.99 1.27
------------------------------------------------------------------------
The Commission emphasizes, however, that whether a proposed fee can
be deemed an equitable allocation of a reasonable fee depends on the
facts and circumstances under which the proposal is being made. In
evaluating such a proposal, the Commission necessarily would weigh and
balance all of the relevant factors. These may include, among others,
whether the proposed fee is an increase or a decrease, who is subject
to the fee, the basis for any classification being drawn, the potential
impact on competition, and how any disparate treatment will impact the
goals of the Act.\84\
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\84\ Of course, any fee proposal must be found to meet all
applicable statutory standards.
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C. Section 6(b)(5) \85\ and Section 6(b)(8) \86\
The commenters also argue that it is inappropriate for the NYSE to
exclude competing market maker orders from the NYSE's no charge policy
because it will deny the Exchange's competitors effective access to the
NYSE's market, harm the depth and liquidity of the market, disrupt the
balance of competition in the NMS, and hamper competing market makers'
ability to compete.
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\85\ See supra note 41 (listing the requirements of Section
6(b)(5)).
\86\ See supra note 50 (listing the requirements of Section
6(b)(8)).
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1. National Market System
The commenters allege that ITS, although providing them with free
access to the NYSE, is not an effective substitute for access to
SuperDot. In evaluating the role of ITS in the NMS, the Commission
recognizes that the design of ITS is limited in scope. ITS is not a
complete intermarket linkage.\87\ ITS does not provide order-by-order
routing of customer orders, a consolidated limit order book, or
automated or default based execution systems; it does not guarantee
price and time priority. Rather, ITS utilizes communications and
technological components of other NMS facilities so that trading
interest in various market centers can be identified and accessed. It
also provides uniform trading rules governing transactions in exchange-
listed securities.\88\ These functionalities benefit the markets,
broker-dealers, and investors by reducing fragmentation, increasing
opportunities to secure the best execution of customer orders, ensuring
effective competition among qualified markets, and, in general,
furthering the purposes of the NMS established by Congress in Section
11A of the Act.\89\
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\87\ See Market 2000, supra note 53, at Appendix II-12. The
Commission previously has encouraged all ITS participants to
continue to improve the system.
\88\ See 15 U.S.C. 78k-1(a)(1)(D) (finding that the linkage of
all markets will foster efficiency, enhance competition, increase
the information available to brokers, dealers, and investors,
facilitate the offsetting of investors' orders, and contribute to
the best execution of such orders).
\89\ See Market 2000, supra note 53, at Appendix II-11.
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ITS provides an avenue for competing market makers to lay off their
excess positions and interact with trading interest on the NYSE, fee-
free. The Commission believes that ITS will continue to provide an
alternative means by which competing market makers can access the NYSE.
In addition, competing market makers will continue to have access to
the NYSE through SuperDot.
Because access to the NYSE will not be more restrictive under the
proposed rule change, and because competing market makers can avail
themselves of ITS, the Commission does not believe the proposal will
harm the depth and liquidity of the market. Moreover, the Commission
notes that the depth and liquidity of any particular security is
dependent on numerous variables, such as the degree of customer buying
and selling interest in the security and the quality and capitalization
of the issuer.\90\ Hence, the Commission believes it is unlikely that
the cost imposed on competing market makers under the NYSE fee schedule
will have
[[Page 29443]]
a significant impact on the willingness of these market makers to
contribute to the depth and liquidity of NYSE listed securities.
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\90\ See Market 2000 supra note 53, at Study II 8-10 (discussing
quote competition between the regional exchanges and the NYSE). See
also Market 2000, supra note 53, at Study II-8 (finding that in 1992
over 92% of the regional exchanges' volume derived from issues
traded pursuant to unlisted trading privileges, rather than in
issues where the regional exchanges are the primary market).
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2. Disparate Treatment of Competing Market Maker Orders \91\
In determining that disparate treatment of competing market makers
is not inconsistent with the Act in this instance, the Commission
believes three aspects of the proposal are particularly significant.
First, the new fee schedule generally represents a fee reduction.
Second, the NYSE is attempting to maintain the status quo that existed
under the previous fee structure. Third, the parties are competitors in
the NMS.
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\91\ The Commission does not intend this proposal to establish a
precedent to permit a primary market to make distinctions in the
treatment of orders on its Floor as a means to discriminate unfairly
against its competitors. Orders for the account of nonmember
competing market makers will continue to be treated in the same way
as other Agency orders. See supra note 13 (defining Agency order).
For example, the proposal does not effect any change in routing to
the NYSE market; in the priority such orders receive on the Floor;
or in surveillance by the NYSE. Therefore, this proposal is
distinguishable from the one proposed by the Amex in SR-Amex-90-29.
See Securities Exchange Act Release No. 32377 (May 27, 1993), 58 FR
31568 (utilizing similar reasons for distinguishing SR-Amex-90-29
from the NYSE's limitation of its additional system credit).
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First, as noted previously, this proposal generally reduces the fee
heretofore imposed on competing market maker orders.\92\ The Commission
is unable to conclude that reducing competing market makers' fees on
most of their SuperDot system orders will have a significant, negative
impact on the competitors' ability to perform their market making
functions.
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\92\ See supra note 83.
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Second, the Commission has due regard for the NYSE's proffered
intent to maintain the status quo. The Exchange decided to change from
a credit system to a discount system in response to the Commission's
regulatory initiatives addressing the practice of payment for order
flow, and the NYSE has stated that excluding orders of competing market
makers from its no charge policy is intended ``to maintain the current
relationship between member proprietary and nonmember market maker
activities in Exchange-listed securities.'' \93\ Orders of competing
market makers were not entitled to the same fee treatment as other
orders in the prior fee schedule. This proposal does not alter this
result.\94\
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\93\ See NYSE April 25, 1996 Letter, supra note 5.
\94\ Given that the fee imposed on competing market maker orders
is being reduced from its prior level in most instances, the
Commission does not believe that a predatory motive is the impetus
for this filing. Contra Phlx February 23, 1996 Letter, supra note 4.
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Finally, the Commission does not believe that this fee change
imposes an unnecessary burden on competition. Fair competition in the
NMS does not require free access in all instances to a competitor's
systems.\95\ Fair competition must take into consideration all of the
relevant facts and circumstances. To find otherwise would negate the
benefits of belonging to a membership organization. Also, it is
important to note that membership carries with it certain duties,
responsibilities, and costs not applicable to nonmembers.\96\ Thus, in
the circumstances presented by this filing, it is not inconsistent with
fair competition for the NYSE to charge competing market maker orders a
reasonable fee when utilizing systems whose development has been
financed by NYSE members.
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\95\ This is especially true in light of the fact that other
means of access to the NYSE market exist.
\96\ See Securities Exchange Act Release No. 32377 (May 27,
1993), 58 FR 31568 (noting that the NYSE Specialist System Charge
was used to partially fund the NYSE's credit system).
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For all of the above reasons, the Commission finds that the NYSE
proposal is consistent with Section 6(b)(5) \97\ and Section 6(b)(8)
\98\ of the Act.
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\97\ 15 U.S.C. 78f(b)(5).
\98\ 15 U.S.C. 78f(b)(8).
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D. Proposed Order Handling Rules \99\
The BSE is concerned that BSE specialists availing themselves of
exceptions in the Proposed Limit Order Rule and in the Proposed Price
Improvement Rule concerning the immediate delivery of an order to a
market maker or system complying with the applicable rule would be
charged a different fee than a NYSE member complying with the same
exception.\100\
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\99\ See supra note 63 (describing the Commission's proposed
order handling rules).
\100\ The fifth exception to the Proposed Limit Order Rule
applies to any customer limit order ``that is delivered immediately
to an exchange or association sponsored system that displays limit
orders and complies with the requirements of [the Proposed Limit
Order Rule] with respect to that order.'' The fourth exception to
the Proposed Price Improvement Rule applies to any customer market
order ``that is delivered immediately to another specialist or OTC
market maker that complies with the display requirements of [the
Proposed Price Improvement Rule] with respect to that order.'' See
Securities Exchange Act Release No. 36310 (Oct. 10, 1995), 60 FR
52792 (publishing File No. S7-30-95 for comment).
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The BSE's comments in this connection are premature inasmuch as the
Commission has not taken final action on the proposed rules referred to
by the BSE. The Commission notes, however, that the Proposed Limit
Order Rule would allow a specialist or market maker to display the
limit order in its own quote; execute the limit order; or send the
order to another market maker or system that would display the order in
conformity with the rule. Thus, a competing market maker would have two
alternatives to sending the order to another market or system.
Similarly, the Proposed Price Improvement Rule provides market makers
with an alternative to sending their orders to another market center.
E. Antitrust Law's Essential Facility Doctrine \101\
The Phlx urges the Commission to apply the antitrust law's
essential facility doctrine because, in the Phlx's opinion, the NYSE is
an essential facility.\102\ The Commission declines to do so in this
case because, as noted previously, the NYSE is not denying the use of
its facilities to its competitors.\103\ Competing market makers still
have two forms of access to the NYSE--one free (ITS) and the order at a
reduced rate (SuperDot).
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\101\ In Silver v. New York Stock Exchange, the Supreme Court
ruled that certain instances of self-regulation that fall within the
scope and purposes of the Act could protect an exchange against an
antitrust claim. Silver, 373 U.S. 341, 360-61 (1963). In Thill
Securities Corporation v. New York Stock Exchange, the U.S. Court of
Appeals for the Seventh Circuit interpreted this ruling to allow the
securities laws to act as an implied repealer of the antitrust laws,
but only to the minimum extent necessary to make the securities laws
work. Thill, 433 F.2d 264, 268 (7th Cir. 1970), cert. denied, 401
U.S. 994 (1971). In determining when such antitrust immunity is
applicable, one court explained, ``Where the concededly self-
regulatory rule or practice complained of is within the explicit
mandate of the Exchange Act and also is actively reviewed by the
Commission, that body may and appropriately should itself consider
the policies of both the antitrust and the securities laws.'' Jacobi
v. Bache & Co., Inc., 377 F. Supp. 86, 92 (S.D.N.Y. 1974), aff'd,
520 F.2d 1231 (2d Cir. 1975), cert. denied, 423 U.S. 1053 (1976).
\102\ The essential facility doctrine, also called the
``bottleneck principle,'' requires the owner of a facility that
cannot practicably be duplicated by would-be competitors to share
this facility on fair terms. Hecht v. Pro-Football, Inc., 570 F.2d
982, 992 (D.C. Cir. 1977), cert. denied, 436 U.S. 956 (1978). In
determining if a facility is ``essential'' under the Sherman Act,
courts look to whether ``duplication of the facility would be
economically infeasible'' and if ``denial of its use inflicts a
severe handicap on potential [or current] market entrants.'' Twin
Laboratories, Inc. v. Weider Health & Fitness, 900 F. 2d 566, 568-69
(2d Cir. 1990) (citing Hecht); MCI Communications Corp. v. American
Telephone & Telegraph Co., 708 F.2d 1081, 1132-33 (7th Cir.)
(requiring ``(1) control of the essential facility by a monopolist;
(2) a competitor's inability practically or reasonably to duplicate
the essential facility; (3) the denial of the use of the facility to
a competitor; and (4) the feasibility of providing the facility''),
cert. denied, 464 U.S. 891 (1983).
\103\ In finding that the NYSE is not denying the use of its
facilities to its competitors, the Commission does not reach the
issue of whether the NYSE is, in fact, an essential facility.
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In addition, the Commission notes the competitive environment in
which
[[Page 29444]]
today's market makers operate.\104\ For example, the NYSE faces
significant competition for orders in NYSE stocks from the regional
stock exchanges,\105\ third market makers,\106\ proprietary trading
systems (``PTSs''),\107\ and foreign markets.\108\ Modern technology
has facilitated this competition and should continue to do so in the
future.\109\
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\104\ See Market 2000, supra note 53, at 6-12 (providing an
overview of the intense competition that exists in the U.S. equity
market); Market 2000, supra note 53, at Exhibit 18 (charting the
NYSE's percentage of Consolidated Tape trades in NYSE stocks from
1976 to 1992).
\105\ The regional stock exchanges captured 20% of the orders in
NYSE stocks during the first six months of 1993. Market 2000, supra
note 53, at 8.
\106\ OTC trading of exchange-listed securities is commonly
known as the ``third market.'' In 1989, the third market garnered
3.2% of reported NYSE share volume and 5% of reported trade volume.
By 1993, third market volume had more than doubled to 7.4% of
reported NYSE reported share volume and 9.3% of reported trade
volume. Market 2000, supra note 53, at 9.
\107\ A PTS is a type of automated trading system that typically
is a screen-based system sponsored by broker-dealers. PTSs are not
operated as or affiliated with self-regulatory organizations but
instead are operated as independent businesses. Participation in
these systems may be limited to institutional investors, broker-
dealers, specialists, and other market professionals.
Although most PTS volume is in Nasdaq securities, PTSs handled
about 1.4% of the volume in NYSE stocks in the first six months of
1993. Market 2000, supra note 53, at 8, Study II 12-13.
\108\ Although exact numbers are not available, the Commission
estimates that foreign market trading in NYSE stocks amounts to
approximately seven million shares per day. See Market 2000, supra
note 53, at 10-11.
\109\ See Market 2000, supra note 53, at 8-10 (noting that
automated systems allow the regional stock exchanges, third market
makers, and PTSs to compete for order flow with the primary
markets).
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\110\ that the proposed rule change (SR-NYSE-95-47) is approved.
\110\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\111\
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\111\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland
Deputy Secretary
[FR Doc. 96-14590 Filed 6-7-96; 8:45 am]
BILLING CODE 8010-01-M
