[Federal Register Volume 59, Number 137 (Tuesday, July 19, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17430]
[[Page Unknown]]
[Federal Register: July 19, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34363; File No. SR-NYSE-93-40]
Self-Regulatory Organizations; New York Stock Exchange, Inc.;
Order Approving Proposing Rule Change To Amend Exchange Rule 95 to Add
New Intra-Day Trading Provisions
July 13, 1994.
I. Introduction
On October 28, 1993, 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 amend Rule 95 (``Discretionary
Transactions'') to add new intra-day trading provisions.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1991).
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The proposed rule change was published for comment in Securities
Exchange Act Release No. 33372 (December 23, 1993), 58 FR 69430
(December 30, 1993). Two comment letters were received on the
proposal.\3\ This order approves the proposed rule change.
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\3\See letter from Daniel P. Barry to Diana Luka-Hopson, Branch
Chief, Division of Market Regulation, SEC, dated November 10, 1993
(``Barry comment letter''); and anonymous letter to Diana Luka-
Hopson, Branch Chief, Division of Market Regulation, SEC, received
on November 18, 1993 (``anonymous comment letter'').
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II. Description of the Proposal
Under Exchange Rule 95, and NYSE Floor broker cannot effect a
transaction if that broker has discretion regarding the choice of
security to be bought or sold; the total amount of the security to be
bought or sold; or whether the transaction shall be a purchase or a
sale. Currently, there are no provisions, in Rule 95 or otherwise,
specifically governing the practice of intra-day trading. The term
``intra-day trading'' refers to the practice whereby a market
participant places orders on both sides of the market and attempts to
garner the spread by buying at the bid and selling at the offer.
The NYSE proposes to amend Rule 95 to add new intra-day trading
provisions. These provisions, as discussed below, will apply only when
a Floor broker simultaneously represents, for the same account,\4\
market or limit orders on both sides (i.e., a buy order and a sell
order) of a minimum variation market.\5\
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\4\For purposes of Rule 95, the NYSE will define the term
``account'' to include any account in which the same person or
persons is directly or indirectly interested. The NYSE has indicated
that the Rule 95 amendments will not apply to a Floor broker who
simultaneously represents an agency order on one side of a minimum
variation market and a principal order (or an agency order for a
different ``account,'' as defined above) on the other side of the
market. Telephone conversation between Donald Siemer, Director,
Market Surveillance, NYSE, and Beth Stekler, Attorney, Division of
Market Regulation, SEC, on March 9, 1994.
\5\NYSE Rule 62 sets forth the minimum variation permitted for
securities traded on the Exchange.
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Under the NYSE proposal, if a Floor broker acquires a position on
behalf of an intra-day trader's account, Rule 95(c) will place certain
restrictions on how the broker can liquidate or cover that position
during the same trading session. Specifically, the broker will be
required to obtain a new liquidating order (i.e., one entered
subsequent to the acquisition of the contra-side position) from his or
her customer.\6\ Thereafter, proposed Rule 95(d) will require that the
Floor broker must execute the liquidating order entered pursuant to
Rule 95(c) before he or she can execute any other order for the same
account on the same side of the market as that liquidating order.\7\
Neither provision of Rule 95, however, will apply to the execution of
an order to liquidate or cover a position carried over from a previous
trading session; a position assumed as part of a strategy relating to
bona fide arbitrage; or a position assumed in reliance on the exemption
for block positioners.\8\
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\6\To obtain a new order, the Floor broker must leave the
trading Crowd. The new liquidating order must be time-recorded
upstairs (if initially received there) and upon receipt on the
trading Floor. Telephone conversation between Donald Seimer,
Director, Market Surveillance, NYSE, and Beth Stekler, Attorney,
Division of Market Regulation, SEC, on March 9, 1994. The new order
must be marked ``BC'' for a buy order to cover a short position, or
``SLQ'' for a sell order to liquidate a long position.
\7\Paragraph 95.20 contains the following example:
In a minimum variation market, a Floor broker simultaneously
represents a 5,000 share buy order and a 5,000 share sell short
order for the same account. If the broker sells 2,000 shares short,
he or she must obtain a 2,000 share ``BC'' order to cover that
position that day. Until the ``BC'' order has been executed, and the
short position has been unwound, the broker cannot execute any part
of the original 5,000 share buy order.
For discussion of exceptions to the above requirements, see
infra, note 8 and accompanying text.
\8\Under the circumstances described above, see supra note 7,
the broker has carried a 2,000 share short position over from a
previous trading session. If the broker sells 3,000 shares short, he
or she still must obtain a 3,000 share ``BC'' order to cover that
position that day. However, in this case, 2,000 shares of the
original 5,000 share buy order may be executed to cover the carry-
over position. Thereafter, the ``BC'' order must be executed, and
the short position unwound, before the broker can execute the
balance of the original buy order.
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Finally, the Exchange proposes to clarify its existing rule
prohibiting members from handling discretionary transactions.\9\ In
particular, Paragraph 95.30 provides examples of what types of orders a
broker can handle simultaneously, without violating Rule 95's
prohibition against a broker choosing whether a transaction will be a
purchase or a sale.
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\9\Telephone conversation between Brian McNamara, Managing
Director, Market Surveillance, NYSE, and Beth Stekler, Attorney,
Division of Market Regulation, SEC, on November 19, 1993.
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The NYSE states that the amendments to Rule 95 are intended to
address trading situations where a Floor broker may be perceived as
having an advantage over other market participants in that he or she
may be able to trade for the same customer without leaving the Crowd.
According to the NYSE, by requiring the entry of a new liquidating
order, these amendments can be expected to minimize any such perceived
advantage. The Exchange states that the basis under the Act for the
proposed rule change is the requirement under Section 6(b)(5) that an
Exchange have rules that are designed to promote just and equitable
principles of trade, to remove impediments to, and perfect the
mechanism of, a free and open market and, in general, to protect
investors and the public interest.
III. Comments Received and NYSE Response
The Commission received two comment letters on the proposed rule
change, one from a public customer who trades stocks on the NYSE and
another from an anonymous NYSE employee.\10\ These letters raise
various issues and concerns with respect to the NYSE proposal.
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\10\See supra, note 3.
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In his letter, Mr. Barry, the public customer, recommends that the
proposed rule change be disapproved and argues that the amendments to
Rule 95 are anti-competitive. The commenter provides two examples in
support of his position. In the first scenario, an individual investor
places buy and sell orders at the minimum variation with a ``two-dollar
broker;'' there are no orders on the specialist's limit order book at
the best bid or offer. The Barry comment letter asserts that, under the
NYSE proposal, the specialist could freely buy and sell at the minimum
variation for his own account, but the individual investor could not do
so. According to the commenter, this is equivalent to allowing the
specialist to trade ahead of public orders on the book.
In the second scenario, the commenter begins from the premise that
NYSE limit order books (particularly for bond funds, which he contends
are the focus of the proposed amendments to Rule 95) are dominated by
large orders of other specialists. His letter states that, as a result,
the public must wait behind the professionals or use two-dollar
brokers. From the commenter's perspective, the NYSE proposal will allow
those market participants with the most resources to continue to engage
in minimum variation trading, but will force two-dollar brokers and
their retail customers out of the ``game'' through regulation.
The Barry comment letter also argues that, if there is a problem
with minimum variation trading, the practice should be restricted not
only for the NYSE, but also for the third market (i.e., over-the-
counter trading of listed stocks) and broker-dealers who internalize
their order flow. Above all, the commenter recommends that whatever
restriction is imposed not single out small public investors.
Finally, the commenter questions whether the NYSE has the authority
to prohibit him from entering buy and sell orders at the minimum
variation, or to dictate that such orders can be placed on the
specialist's book but not given to a two-dollar broker. In his opinion,
the NYSE's actions create the impression that the Exchange has been
influenced by political pressure from the specialist community. The
commenter predicts that approval of the proposed rule change will grant
specialists a monopoly on commission dollars from trades in their
specialty stocks, and will allow them to dominate the limit order book
in their non-specialty stocks.
The second commenter, an anonymous NYSE employee, states that the
purpose of his letter is to inform the Commission of the ``real story''
leading up to the proposed amendments to Rule 95. According to the
commenter, this story casts doubt on the effectiveness of self-
regulation and Commission oversight of the self-regulatory
organizations. In brief, the letter alleges that certain Exchange
constituencies (e.g., specialists) pressured NYSE staff and a committee
of the Exchange's Board of Directors (``Board'') to find a way to stop
intra-day trading. The commenter suggests, among other things, that
this practice has become so controversial because the specialist
community is losing trading opportunities to public customers who
participate when there is a market disparity, and losing commission
dollars to the two-dollar brokers who execute their orders.
The anonymous comment letter notes that the Exchange staff
initially drafted rules similar to the proposal before the Commission
which, in the commenter's opinion, would have eliminated the two-dollar
broker's (and thus the small public customer's) ability to engage in
minimum variation trading, allegedly to protect the specialists'
business. According to the anonymous comment letter, membership outrage
forced the Exchange to withdraw its initial proposal; thereafter, NYSE
staff drafted these amendments to Rule 95 and submitted them to the
Commission without seeking comment from the Floor.
The NYSE responded to the issues raised by the two comment
letters.\11\ First, in response to Mr. Barry's concerns about the
proposal's effect on public customers, the NYSE contends that the
amendments to Rule 95 are not intended to preclude individual
investors, or anyone else, from engaging in the practice of minimum
variation trading. In this regard, the NYSE notes that no distinction
is made between orders entered by individuals and those entered by so-
called professionals.
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\11\See letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Sandra Sciole, Special Counsel, Division of
Market Regulation, SEC, dated March 16, 1994 (``NYSE response
letter'').
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According to the NYSE response letter, the proposed amendments are
intended to address the perception that a Floor broker, who
simultaneously represents buy and sell orders at the minimum variation
for the same customer, may have an advantage over other market
participants, such as individual investors, because that broker can
trade on both sides of the market without leaving the Crowd. The NYSE
argues that, by requiring the broker to obtain a new liquidating order,
the proposed rule change should minimize any such possible advantage
from the intra-day trading strategy, and thus should enhance investors'
confidence in the fairness and orderliness of the Exchange market.
The NYSE letter also responds to the anonymous commentator's
concerns about its internal rule development process. The NYSE states
that the amendments to Rule 95 were developed by an advisory committee
to the Exchange Board that included representatives from all major
constituent groups. That panel's recommendations were reviewed by the
Floor trading community and the appropriate constituent committees,
before being approved by the Board and authorized for filing with the
Commission. In the NYSE's opinion, all major constituent groups had the
opportunity to contribute to the rule development process, and the
proposal that was submitted to the Commission reflects a consensus
among their views.
IV. Discussion
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, and, in
particular, with the requirements of Section 6(b).\12\ In particular,
the Commission believes the proposal is consistent with the Section
6(b)(5) requirements that the rules of an exchange be designed to
promote just and equitable principles of trade, to prevent fraudulent
and manipulative acts, and, in general, to protect investors and the
public interest.
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\12\15 U.S.C. Sec. 78f(b) (1988).
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The Commission previously has recognized that it is not
inconsistent with the Act for a self-regulatory organization (``SRO'')
to limit certain types of trading activity in order to minimize
interference with the execution of public customer orders and preserve
the quality of its market.\13\ The NYSE believes that intra-day trading
constitutes activity that can interfere with public customer orders and
present the perception of an unfairness trading advantage to larger
market participants. Under current NYSE rules, orders for the account
of intra-day traders can compete, often on equal footing, with orders
for the account of retail investors.\14\ To the extent that the public
may have to share incoming order flow with intra-day traders, customer
orders may, on the whole, be allotted fewer shares than they otherwise
would receive.
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\13\See, e.g., Securities Exchange Act Releases Nos. 33678
(February 24, 1994), 59 FR 10192 (March 3, 1994) (File No. SR-NYSE-
92-13) (approving NYSE proposal to identify and preclude the use of
certain odd-lot trading practices, including intra-day trading, that
the NYSE believes are inconsistent with the purpose of its odd-lot
order execution system); and 25842 (June 23, 1988), 53 FR 24539
(June 29, 1988) (File No. SR-NYSE-87-18) (approving NYSE telephone
policy which, among other things, prohibits members from using
portable telephones on the Exchange floor, on the grounds that such
a large time and place advantage for relatively few large investors
could create a perception of unfairness or inequality).
\14\NYSE Rule 72 provides for the manner in which bids and
offers at the same price will be sequenced for execution. A member
who makes the first bid or offer at a particular price has
``priority'' at that price, which means that the member is the first
one in the market entitled to receive an execution at that price. If
no member can claim priority, all members who are bidding or
offering at a particular price are deemed to be on ``parity'' with
each other, or equivalent in status. When members are on parity, a
member whose bid or offer is larger than other bids or offers may
claim ``precedence based on size'' and thereby be entitled to the
next execution at that price.
Accordingly, if size precedence is not invoked, orders for the
account of intra-day traders (except for those orders required to
yield pursuant to Section 11(a)(1)(G) of the Act and the rules
thereunder) may be on parity with public customer orders.
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The Commission believes that it is not unreasonable for the NYSE to
be concerned about the impact of such trading on public participation
in its market. Intra-day traders place orders on both sides of the
market; by executing one order immediately after the other, their floor
broker can garner the spread for them without ever leaving the trading
crowd. The NYSE argues, and the Commission agrees, that such
``instantaneous representation'' may create a perception that intra-day
traders have a time and place advantage over other market participants.
Such a time and place advantage has, in the past, led the Commission to
place restrictions on members' floor trading.\15\
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\15\See, e.g., SEC Rule 11a1-1(T).
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After careful review, the Commission has concluded that the NYSE
proposal could minimize intra-day traders' perceived time and place
advantage, thereby enhancing investors' confidence in the fairness and
orderliness of the Exchange market. Under the proposed amendments to
Rule 95, market participants whose conduct reasonably suggests that
they are engaged in intra-day trading activity will be subject to
certain new requirements. Specifically, a floor broker who acquires a
position for an account, while simultaneously representing orders at
the minimum variation for that same account, will be required to obtain
a new order to liquidate or cover that position during that trading
session. This, in effect, forces the broker to leave the trading Crowd
and re-establish contact with the customer, thus ending the broker's
continuous representation of orders at the trading post. This extra
responsibility will dampen the ability of floor brokers to represent
two-sided orders of intra-day traders.
The Commission agrees with the NYSE that this restriction will
lessen the perception that professionals or institutional participants
have a large time and place advantage over small public customers.
Intra-day trading in a strategy employed by professionals or
sophisticared traders. Intra-day orders can crowd-out small customer
limit orders and delay or prevent their execution. This provides the
perception that public customer orders are being disadvantaged by the
time and place advantage of intra-day traders. By lessening this
advantage, the NYSE proposal should increase public confidence in the
market.
The Commission also notes that the NYSE proposal is very limited in
scope. It does not prohibit any market participant from engaging in
minimum variation trading. Rather, the amendments to Rule 95 are
narrowly drafted to ensure that market participants are not receiving
an undue advantage from the method in which they engage in such trading
activity.
Moreover, in the Commission's opinion, the NYSE proposal contains
sufficient safeguards to ensure that the new requirements will not
impinge upon bona fide short-term trading strategies. In this regard,
the Commission notes that these provisions of Rule 95 will not apply in
certain situation where orders have been placed on both sides of a
minimum variation market for purposes unrelated to intra-day
trading.\16\
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\16\See, e.g., note 8 and accompanying test.
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Similarly, the Commission believes that Paragraph 95.30, by
providing specific examples of the types of orders a Floor broker may,
and may not, represent simultaneously, will clarify the NYSE's policy
regarding discretionary transactions. In the Commission's opinion, this
should facilitate the Exchange's efforts to detect and deter violations
of Rule 95.
Finally, the Commission does not agree with the commenters'
arguments in opposition to the proposed rule change. As part of its
review of the NYSE proposal, the Commission specifically evaluated the
possible effects on small public customer orders. The Commission is not
persuaded that the amendments to Rule 95 were intended to disadvantage
public customers. In fact, the opposite is the case. As a practical
matter, public customers will be a main beneficiary if the Rule 95
amendments successfully enhances the perception of fairness of the
Exchange market and the ability of public customer limit orders to be
executed.
In regard to the comment letters' allegations about the influence
certain Exchange constituencies may have exerted on the rule
development process, the Commission is satisfied with the NYSE's
response.\17\ In light of the Exchange's representations and all
available facts, the Commission has no basis to conclude that the NYSE
did not follow proper procedures in the development, approval and
submission of the proposed rule change.
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\17\In particular, the Commission has not been persuaded by the
commenters' allegations regarding the NYSE's motives for allowing
specialists to continue to garner the bid-ask spread. Specialists
differ from intra-day traders in two respects. First, specialists
are under a continuous obligation to maintain fair and orderly
markets and are subject to affirmative and negative market making
responsibilities. Their ability to quote a two-sided market is
integral to their market making function. Second, they are required
to yield to public customer orders in all circumstances.
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In sum, although the Commission recognizes that there may be a
variety of approaches to address the concerns raised by intraday
trading, the Commission believes that the proposed rule change
adequately balances the needs of market participants to effectuate
their trading strategies unhampered, with concerns about the potential
for certain market participants to have unfair time and place
advantages by using Floor brokers to garner the spread in minimum
variation markets. For these reasons, as discussed more fully above,
the Commission finds that the new intra-day trading provisions of Rule
95 are consistent with the Act in that they will further the protection
of investors and the public interest and will remove impediments to and
perfect the mechanism of a free and open market.
V. Conclusion
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\18\ that the proposed rule change (SR-NYSE-93-40) is approved.
\18\15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\19\
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\19\17 CFR 200.30-3(a)(12) (1991).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-17430 Filed 7-18-94; 8:45 am]
BILLING CODE 8010-01-M
