[Federal Register Volume 63, Number 146 (Thursday, July 30, 1998)]
[Notices]
[Pages 40748-40759]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-20313]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40260; File No. 4-208]
RIN 3235-AH49
Intermarket Trading System (``ITS'') Plan; Proposed Amendments to
Expand the ITS/Computer Assisted Execution System Linkage to all Listed
Securities and to Eliminate the Unanimous Vote Provision
AGENCY: Securities and Exchange Commission.
ACTION: Proposed amendments to national market system plan.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing amendments to the plan governing the operation of the
Intermarket Trading System (``ITS Plan'' or ``Plan'') that was approved
pursuant to Rule 11Aa3-2 under the Securities Exchange Act of 1934, as
amended (``Exchange Act'' or ``Act''). The proposed amendments expand
the ITS/Computer Assisted Execution System (``CAES'') linkage to all
listed securities, including non-Rule 19c-3 securities. The amendments
to the Plan also eliminate the requirement that amendments to the ITS
Plan be approved by a unanimous vote of all Participants; instead, a
two-thirds supermajority of the Participants would be required for
amendments.
DATES: Comments should be submitted by August 31, 1998.
ADDRESSES: All comments should be submitted in triplicate and addressed
to Jonathan G. Katz, Secretary, Securities and Exchange Commission,
Mail Stop 6-9, 450 Fifth Street, NW., Washington, DC 20549. Comments
also may be submitted electronically at the following E-mail address:
rule-comments@sec.gov. All comments should refer to File No. 4-208;
this file number should be included in the subject line if E-mail is
used. Comment letters will be available for public inspection and
copying at the Commission's Public Reference Room at the same address.
Electronically submitted comment letters will be posted on the
Commission's web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT:
Katherine A. England, Assistant Director at (202) 942-0154; Elizabeth
Prout Lefler, Special Counsel at (202) 942-0170; Heather A. Seidel,
Attorney at (202) 942-4165; or Christine Richardson, Attorney at (202)
942-0748, Office of Market Supervision, Division of Market Regulation,
Securities and Exchange Commission, Mail Stop 10-1, 450 Fifth Street,
NW., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing amendments to
the ITS Plan \1\ to expand the NASD's ITS/CAES linkage to all listed
securities. The Commission is also proposing amendments to the Plan to
eliminate the unanimous vote requirement for amendments to the ITS
Plan. The amendments, published by the Commission on its own initiative
pursuant to Rule 11Aa3-2 under the Exchange Act,\2\ are necessary to
[[Page 40749]]
encourage the statutory goals of efficient execution of securities
transactions and opportunities for best execution of customer orders.
They also address features of governance requirements of the ITS Plan
that discourage intermarket competition. The Commission is proposing
these amendments only after the ITS Participants have been unable to
take action in these areas. The Commission is publishing this proposal
for comment from interested persons.
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\1\ ITS is a communications and order-routing network linking
eight national securities exchanges and the electronic over-the-
counter (``OTC'') market operated by the National Association of
Securities Dealers, Inc. (``NASD''). ITS was designed to facilitate
intermarket trading in exchange-listed equity securities based on
current quotation information emanating from the linked markets.
Participants to the ITS Plan are the American Stock Exchange, Inc.
(``Amex''), the Boston Stock Exchange, Inc. (``BSE''), the Chicago
Board Options Exchange, Inc. (``CBOE''), the Chicago Stock Exchange,
Inc. (``CHX''), the Cincinnati Stock Exchange, Inc. (``CSE''), the
NASD, the New York Stock Exchange, Inc. (``NYSE''), the Pacific
Exchange, Inc. (``PCX''), and the Philadelphia Stock Exchange, Inc.
(``Phlx'').
\2\ Rule 11Aa3-2 (17 CFR 240.11Aa3-2) establishes procedures for
initiating or approving amendments to national market system plans
such as the ITS Plan. Paragraph (b)(2) of Rule 11Aa3-2 states that
the Commission may propose amendments to an effective national
market system plan by publishing the text thereof together with a
statement of purpose of the amendments. Paragraph (c)(2) requires
the Commission to publish notice of any amendments initiated by the
Commission and provide interested parties an opportunity to submit
written comments. Further, Paragraph (c)(2) of Rule 11Aa3-2 requires
that promulgation of an amendment to an effective national market
system plan initiated by the Commission be by rule.
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I. Background
A. ITS/CAES Interface
Section 11A(a)(2) of the Exchange Act, adopted by the Securities
Acts Amendments of 1975 (``1975 Amendments''),\3\ directs the
Commission, having due regard for the public interest, the protection
of investors and the maintenance of fair and orderly markets, to use
its authority under the Act to facilitate the establishment of a
National Market System for securities in accordance with the
Congressional findings and objectives set forth in Section 11A(a)(1) of
the Act. Among those findings and objectives is the ``linking of all
markets for qualified securities through communication and data
processing facilities.'' \4\
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\3\ Pub. L. 94-29 (June 4, 1975).
\4\ Section 11A(a)(1)(D) of the Act, 15 U.S.C. 78k-1(a)(1)(D).
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On January 26, 1978, the Commission issued a statement on the
national market system calling for, among other things, the prompt
development of comprehensive market linkage and order routing systems
to permit the efficient transmission of orders among the various
markets for qualified securities, whether on an exchange or over-the-
counter.\5\ In particular, the Commission stated that an intermarket
order routing system was necessary to ``permit orders for the purchase
and sale of multiple-traded securities to be sent directly from any
qualified market to another such market promptly and efficiently.'' \6\
The Commission further stated that ``[t]he need to develop and
implement a new intermarket order routing system to link all qualified
markets could be obviated if participation in the ITS market linkage
currently under development were made available on a reasonable basis
to all qualified markets and if all qualified markets joined that
linkage.'' \7\
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\5\ Securities Exchange Act Release No. 14416 (January 26, 1978)
(``1978 Statement''), at 26, 43 FR 4354, 4358. Previously, on June
23, 1977, the Commission had indicated that a national market system
would include those ``regulatory and technological steps [necessary]
to achieve a nationwide interactive market system.'' See Securities
Exchange Act Release No. 13662 (June 23, 1977), at 20, 42 FR 33510,
33512.
\6\ 1978 Statement, supra note 5, at 4358.
\7\ In this connection, the Commission specifically indicated
that ``qualified markets'' would include not only exchanges but OTC
market makers as well. Id.
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As requested by the Commission, in March 1978, various exchanges
\8\ filed jointly with the Commission a ``Plan for the Purpose of
Creating and Operating an Intermarket Communications Linkage,'' now
known as the ITS Plan.\9\ On April 14, 1978, the Commission, noting
that ITS might provide the basis for an appropriate market linkage
facility in a national market system, issued a provisional order,
pursuant to Section 11A(a)(3)(B) of the Act,\10\ authorizing the filing
exchanges (and any other self-regulatory organization (``SRO'') which
agreed to become a participant in the ITS Plan) to act jointly in
planning, developing, operating and regulating the ITS in accordance
with the terms of the ITS Plan for a period of 120 days.\11\
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\8\ The exchanges involved were Amex, BSE, NYSE, PCX (than
called the ``PSE''), and Phlx.
\9\ The ITS Plan is contained in File No. 4-208.
\10\ 15 U.S.C. 78k-1(a)(3)(B).
\11\ Securities Exchange Act Release No. 14661 (April 14, 1978),
43 FR 17419. In authorizing the implementation of ITS, the
Commission urged those SROs not yet ITS participants to participate
in ITS. Id. at 7 n. 15, 43 FR 17421. On August 11, 1978, the
Commission extended ITS authority for an additional period of one
year. Securities Exchange Act Release No. 15058 (August 11, 1978),
43 FR 36732. In the interim the ITS Plan had been amended to include
the Midwest Stock Exchange (``MSE'') as a participant. The MSE is
now the CHX.
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In 1979, during the Commission's hearings regarding proposed Rule
19c-3 under the Act,\12\ the NASD announced plans to enhance its Nasdaq
System to include, among other things, a computer assisted execution
system which would enable participating firms to route their orders for
listed securities through the system to obtain automatic executions
against quotations of ``third market makers'' participating in the
enhanced Nasdaq,\13\ later known as the NASD's Computer Assisted
Execution System (``CAES''). The NASD also contemplated an automated
interface between the ITS and CAES (``ITS/CAES interface'') to permit
automated execution of commitments sent from participating exchanges
and to permit market makers participating in the enhanced Nasdaq to
route commitments efficiently to exchange markets for execution.\14\
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\12\ Securities Exchange Act Release No. 15769 (April 26, 1979),
44 FR 26688. Rule 19c-3 precludes exchange off-board trading
restrictions from applying to most securities listed after April 26,
1979.
\13\ The term ``third market makers'' refers to OTC market
makers in listed securities.
\14\ In its discussions with the ITS Participants, the NASD
indicated that the enhanced Nasdaq would encompass trading of listed
securities and that it intended to pursue an automated interface.
See In re Off-Board Trading Restrictions, File No. 4-220, at 9-10,
23-34.
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The Commission later extended its authorization for the joint
operation of the ITS \15\ but indicated several concerns with respect
to the ITS that would require the attention of the ITS participants
during the extension period. In particular, the Commission indicated
that, in order for ITS to serve as a means to achieve price protection
on an intermarket basis, the ITS Participants should implement ``a
linkage between the ITS and over-the-counter market makers regulated by
the NASD. * * * '' \16\ The Commission further indicated its
expectation that the NASD would become an ITS participant before
October 1980, and stated that if the contemplated ITS/NASD interface
was not implemented promptly, the Commission was prepared to review
whether the temporary approval granted in the order should continue and
to take appropriate steps to require the inclusion of those market
centers.\17\
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\15\ The authorization for the joint operation was extended
until January 31, 1983. See Securities Exchange Act Release No.
16214 (September 21, 1979), 44 FR 56069.
\16\ Id. at 12, 44 FR 56072. The Commission also called for a
linkage between the ITS and the Cincinnati Stock Exchange's
(``CSE'') National Securities Trading System (``NSTS'').
\17\ Id. at 14-15, 44 FR 56072. The Commission substantially
reiterated these views in a letter to Congress shortly thereafter.
See letter from Harold M. Williams, Chairman, SEC, to the Honorable
Bob Eckhardt, Chairman, Subcommittee on Oversight and Investigations
and the Honorable James Scheuer, Chairman, Subcommittee on Oversight
and Investigations and the Subcommittee on Consumer Protection and
Finance, House Committee on Interstate and Foreign Commerce, dated
November 9, 1979, included in Progress Toward the Development of a
National Market System, Joint Hearings before the Subcommittee on
Consumer Protection and Finance of the Committee on Interstate and
Foreign Commerce, House of Representatives, 90th Cong., 1st Sess.,
Serial 96-89.
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On June 11, 1980, the Commission adopted Rule 19c-3 under the Act,
which eliminated off-board trading restrictions with respect to most
newly-listed securities and thereby permitted member firms of the NYSE
and Amex to make markets over-the-counter in what was then a small
number of NYSE and Amex-listed securities.\18\ Although the
[[Page 40750]]
Commission recognized many potential concerns regarding the rule, such
as internalization,\19\ the Commission determined that they were
outweighed by the benefits of the rule, including an opportunity for
competition between the OTC and exchange markets, with concomitant
benefits to investors. For example, the Commission stated that the
presence of additional market makers might (1) place competitive
pressure on primary market specialists, thereby possibly resulting in
narrower spreads in Rule 19c-3 securities; and (2) create incentives
for markets to disseminate quotations of greater size and add to the
depth, liquidity, and continuity of the markets for those
securities.\20\
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\18\ Securities Exchange Act Release No. 16888 (June 11, 1980),
45 FR 41125 (``Rule 19c-3 Adopting Release''). The rule, as adopted,
precludes exchange off-board trading restrictions from applying to
securities listed after April 26, 1979 (``Rule 19c-3 securities'').
\19\ The term ``internalization'' refers to ``the withholding of
retail orders from other market centers for the purpose of executing
them ``in-house,'' as principal, without exposing those orders to
buying and selling interest in those other market centers.'' Id. at
18 n.31, 45 FR 41128 n.31.
\20\ The Commission believed that off-board trading restrictions
had anti-competitive effects because they effectively confined
trading in listed securities to exchange markets by precluding
exchange members from trading as principal in the OTC market.
Adopting Rule 19c-3 limited the expansion of the anti-competitive
effects. The Commission also announced the development of a
monitoring program to study the issues raised by commentators,
determined to publish monitoring reports on a periodic basis and
committed to a reexamination of those issues as appropriate in light
of development in the markets. In connection with the adoption of
Rule 19c-3, the Commission noted the importance of the NASD's
completion of the Nasdaq enhancements in order to provide ``a more
efficient mechanism for over-the-counter market making in listed
securities.'' Id. at 14-15, 45 FR 41127. See Rule 19c-3 Adopting
Release, supra note 18, at 49-53, 45 FR 41134. The Commission notes
that it is not, at this time, proposing to amend or expand Rule 19c-
3.
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The Commission indicated that achieving efficient linkages between
traditional exchange trading floors and over-the-counter markets was
essential to obtaining maximum order interaction between the various
types of markets. The Commission therefore expected the NASD and the
ITS Participants to establish an automated linkage between the ITS and
Nasdaq system and to provide the Commission with formal status reports
on the ITS-Nasdaq linkage.\21\
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\21\ Id. at 15-16, 45 FR 41127.
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In September 1980, several Participants submitted identical letters
which indicated that they were not at that time willing to commit to
the development of an automated interface.\22\ The MSE, in a separate
letter, raised various regulatory concerns with respect to the
automated interface.\23\ In contrast, the NASD responded by reaffirming
its commitment to the automated interface \24\ and provided the
Commission and the ITS participants with a functional description of
the automated interface.\25\ On January 7, 1981, the NYSE Board of
Directors approved participation in a two-step ``test'' linkage between
ITS and the enhanced Nasdaq system.\26\ The Commission determined that
ITS, because of its ability to permit market participants to send
orders from one market to another, was consistent with national market
system goals and, if efficiently linked with all markets, could become
a permanent feature of a national market system. Nonetheless, the
Commission continued to believe that the absence of any established
linkage between the exchanges and OTC market makers preserved an
environment in which there were reduced opportunities to ameliorate
market fragmentation,\27\ to eliminate pricing inefficiencies, to
obtain best execution and to promote the type of competitive market
structure which a national market system was designed to achieve.\28\
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\22\ These Participants were the Amex, BSE, NYSE, Phlx and PCX.
See e.g, letter from John J. Phelan, Jr., President and Chief
Operating Officer, NYSE, to George A. Fitzsimmons, Secretary, SEC,
dated September 16, 1980. In addition, the Amex submitted a separate
letter in which it expressed its opposition to efforts to link
upstairs markets to exchange markets in the context of its
continuing opposition to Rule 19c-3. See letter from Robert J.
Birnbaum, President, Amex, to George A. Fitzsimmons, Secretary, SEC,
dated September 22, 1980, contained in File No. 4-208. See also
letter from Robert J. Birnbaum, President, Amex, to George A.
Fitzsimmons, Secretary, SEC, dated December 12, 1980, contained in
File No. 4-208.
\23\ See letter from John G. Weithers, President, MSE, to George
A. Fitzsimmons, Secretary, SEC, dated September 15, 1980
(``September MSE Letter''), contained in File No. 4-208. See also
letter from John G. Weithers, President, MSE, to John J. Phelan,
Jr., President, NYSE, dated July 31, 1980 (``July MSE Letter''),
contained in File No. 4-208.
\24\ See letter from Gordon S. Macklin, President, NASD, to
George A. Fitzsimmons, Secretary, SEC, dated September 12, 1980
(``NASD Letter''), contained in File No. 4-208. The NASD indicated
that there were no significant technical concerns in connection with
building the automated interface and estimated that the automated
interface could be implemented within six months of an agreement
among the parties to proceed.
\25\ See Description of NASD Market Services, Inc., Computer
Assisted Execution System, contained in File No. 4-208. In its
functional description, the NASD also committed to developing a
capability to provide the ITS participants with the best bid and
offer among all market makers participating in the enhanced Nasdaq.
\26\ With respect to the actual operation of the automated
interface, the NYSE plan contemplated an initial ``pilot'' phase in
which trading through the automated interface would be limited to
the 30 most active Rule 19c-3 securities. The other ITS participants
were in general agreement with the NYSE's position with respect to
the automated interface. During the pilot phase, the NYSE
anticipated that the ITS participants and the Commission would
evaluate trading under the Preliminary Rule and other policy
concerns which may have been raised by trading Rule 19c-3 securities
through the automated interface. The NYSE plan further anticipated
that in the subsequent phase the automated interface would be
expanded to include the trading of all Rule 19c-3 securities, but
only after the completion of the pilot phase evaluation and
agreement among the ITS participants and the NASD on any additional
measures to address policy concerns identified by that evaluation.
\27\ Fragmentation occurs when investor order flow is directed
to several markets that are not connected. Among other things,
fragmentation reduces the probability of matching customer buy and
sell orders because of the smaller number of orders in each market.
\28\ Indeed, in mandating that the Commission facilitate the
establishment of a national market system, the Congress found that
the linking of all markets for qualified securities through
communication and data processing facilities would foster
efficiency, enhance competition, increase the information available
to brokers, dealers, and investors, facilitate the offsetting of
investors' orders and contribute to best execution of such orders.
Section 11A (A)(1)(D) of the Act, 15 U.S.C. 78k-1(a)(1)(D).
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Therefore, on April 28, 1981, the Commission issued an order \29\
requiring the ITS Participants to implement an automated interface
between CAES and ITS by March 1, 1982, limited to Rule 19c-3
securities, and to submit proposed amendments to the ITS Plan
reflecting the inclusion of the NASD as an ITS Participant. On March
11, 1982 the Commission delayed the implementation date of the
interface until May 1, 1982 and published its own proposed amendments
to the ITS Plan.\30\ Consequently, due to the failure of the ITS
Participants to submit an amendment on May 12, 1982, the Commission
adopted its own amendments to the ITS Plan.\31\ The
[[Page 40751]]
Commission order applied to Rule 19c-3 securities initially because the
Commission believed that OTC trading would be more active in these
securities. The Commission fully intended the ITS/CAES linkage to
subsequently expand to all listed securities.\32\
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\29\ Securities Exchange Act Release No. 17744 (April 21, 1981),
46 FR 23856 (April 28, 1981).
\30\ Securities Exchange Act Release No. 18536 (March 11, 1982),
47 FR 10658. The Commission deferred the implementation date in part
because the Participants had failed to submit amendments to the
Plan.
\31\ A majority of the amendments were non-controversial and had
been agreed upon by the parties or reflected the parties' decision
to defer resolution of certain issues until after the pilot phase of
the interface. The areas where the parties could not reach agreement
were resolved by the Commission. See Securities Exchange Act Release
No. 18713 (May 12, 1982), 47 FR 20413. The amendments included
language requiring the NASD to apply trade-through safeguards to
provide for a sufficient assurance of consistency with the
exchanges' trade-through rules. A ``trade-through'' occurs when a
transaction is effected at a price below the best bid, or above the
best prevailing offer. The NASD submitted a proposed trade-through
rule on May 4, 1982, which the Commission approved on an accelerated
basis for six months. The Commission believed that the NASD rule was
adequate even through it was not identical to the exchangers' trade-
through rules. See Securities Exchange Act Release No. 18714 (May 6,
1982), 47 FR 20429 (May 12, 1982). The Commission had approved the
exchanges' trade-through rules on April 9, 1981. See Securities
Exchange Act Release No. 17704 (April 9, 1981), 46 FR 22520.
On January 27, 1983, the Commission granted permanent approval
to the ITS Plan. See Securities Exchange Act Release No. 19456
(January 27, 1983), 48 FR 4938 (February 3, 1983) (``Final Approval
Order''). On September 15, 1983 the pilot phase ended and all Rule
19c-3 securities became eligible for trading through the ITS/CAES
interface. See Securities Exchange Act Release Nos. 19825 (May 31,
1983), 48 FR 25043 (June 3, 1983); and 19970 (July 20, 1983), 48 FR
33103.
\32\ See Final Approval Order, supra note 31, at 4940 (``The
Commission also notes that in order to achieve fully the
Congressional goal that all markets for qualified securities be
linked (Section 11A(a)(1)(D) of the Act), it will be necessary in
the future for the ITS/CAES interface to be expanded to include all
stocks traded in the third market.'').
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On November 12, 1991, the NASD submitted an application to the
Commission, pursuant to Rule 11Aa3-2(e), to review the ITS Operating
Committee's failure to approve two NASD recommendations that would have
amended the ITS Plan to expand the ITS/CAES linkage to include non-Rule
19c-3 securities.\33\ Since that submission, the Division of Market
Regulation (``Division'') issued its Market 2000 Study,\34\ which
included the Division's findings that it was necessary to expand the
ITS/CAES linkage,\35\ as well as identifying several regulatory issues
that the Commission believed the NASD and Nasdaq needed to address
prior to any expansion of the ITS/CAES linkage.\36\
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\33\ In a July 8, 1997 letter, commenting on four issues
relating to ITS that the Commission preliminarily viewed as
``unreasonably impeding competition among the various markets,'' the
NASD reaffirmed its position originally made in its 1991
application. See letter from Robert E. Aber, Vice President and
General Counsel, Nasdaq, to Jonathan G. Katz, Secretary, Commission
(``NASD 1997 Letter''). However, the NASD has since withdrawn its
application submitted to the Commission pursuant to Exchange Act
Rule 11Aa3-2(e). See letter from Robert E. Aber, Senior Vice
President and General Counsel, Nasdaq, to Jonathan G. Katz,
Secretary, Commission, dated July 23, 1998.
\34\ Division Market Regulation, Market 2000: An Examination of
Current Equity Market Developments (January 1994) (``Market 2000
Study'').
\35\ Specifically, the Market 2000 Study noted that the
possibility of execution in the OTC market of a significant
percentage of the total volume in multiply traded securities
increased the need to enhance interaction of orders in all market
centers to eliminate trade throughs and to provide market makers in
those securities the ability to compete for order flow through their
displayed quotations. Id.
\36\ In February 1995, the NASD submitted a rule filing
addressing those recommendations but subsequently withdrew that
filing in light of the Commission's publication of its Order
Handling Rules (Securities Exchange Act Release No. 37619A
(September 6, 1996), 61 FR 48290 (September 12, 1996) (``Order
Execution Rules'' or ``Order Handling Rules'')), which addressed
many of the topics covered by the NASD's proposed rules. The NASD
has stated that it is prepared to submit remaining aspects of this
1995 filing, when appropriate, that the Commission believes are
necessary to achieve expansion of the ITS/CAES linkage. The NASD
also states it is prepared to present any other rule changes to its
Board that the Commission believes are necessary to achieve this
expansion. See NASD 1997 Letter, supra note 33. On June 22, 1998,
the NASD submitted a Petition for Rulemaking (``NASD Petition'') to
adopt rules necessary to remove the limitation on access to ITS with
respect to non-Rule 19c-3 securities. The NASD Petition adopts by
reference the substance of the NASD's 1991 appeal mentioned above.
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More recently, the Commission solicited comment on whether the ITS/
CAES linkage should be expanded to cover non-Rule 19c-3 securities in
the proposing release for the Order Execution Rules.\37\ In the
adopting release for those rules, the Commission deferred action on the
expansion of the ITS/CAES linkage, and instead encouraged the ITS
Participants to work jointly to expand the linkage.\38\
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\37\ See Securities Exchange Act Release No. 36310 (September
29, 1995), 60 FR 52792 (October 10, 1995).
\38\ See Order Execution Rules, supra note 36.
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B. Unanimous Vote Requirement
A unanimous vote of all the Participants is required for any
amendment to the ITS Plan. Section 4(c) of the ITS Plan states that any
proposed change in, addition to, or deletion from the ITS Plan may be
effected only by means of a written amendment to the Plan which is
executed on behalf of each Participant. In addition, Section 3(c),
regarding New Participants, states that any national securities
exchange or national securities association may subscribe to the ITS
Plan and become a participant by agreeing, in an amendment to the Plan
adopted in accordance with its provisions, to comply and enforce
compliance with the provisions of the Plan (as provided in Section
3(b)). This in effect requires a unanimous vote before a new
participant can be admitted to the Plan.
II. Discussion
In 1997, the Commission initiated a review concerning certain anti-
competitive aspects of ITS. The review was prompted by the significant
changes in the equity markets since the inception of ITS and the
slowness or inability of ITS to accommodate these changes. The
Commission believed that certain structural aspects of ITS impeded
innovation and competition in the national market system. Accordingly,
the Commission sent a letter to the ITS Participants on May 27, 1997
outlining four anti-competitive aspects of the ITS Plan and requesting
that they develop reasonable recommendations to the Commission in the
form of proposed ITS Plan amendments and proposed SRO rule changes.\39\
The Division followed up this letter with another letter to the
Participants on September 25, 1997, in which the Division reinforced
the Commission's concerns and provided specific examples of the anti-
competitive nature of the unanimous vote requirement.\40\ The responses
that the Commission received in reply to both of these letters
indicated that a number of the Participants will not agree to expand
the ITS/CAES interface or to eliminate the unanimous vote requirement.
Because of the unanimous vote requirement, these changes therefore
cannot be approved by the Participants. Accordingly, the Commission is
proposing rules to address the anti-competitive operation of these ITS
provisions.\41\
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\39\ Preliminarily, the Commission found four elements of the
current operation of ITS and the ITS Plan to be unreasonably
impeding competition among the various markets: (1) Minimum
increments for ITS commitments; (2) the lack of access to ITS for
OTC market makers; (3) the unanimous vote requirement for ITS Plan
amendments; and (4) the ITS Participants' special right of review
for CSE proposed rule changes. See letter from Jonathan G. Katz,
Secretary, Commission, to ITS Participants, dated May 27, 1997
(``May 27 Letter''). The Participants have voted to eliminate the
limitation on access to increments through ITS, and the review of
CSE rule changes.
\40\ See letter from Richard R. Lindsey, Director, Market
Regulation, Commission, to Allan A. Bretzer, Committee Chairman, ITS
Operating Committee (``ITSOC''), dated September 25, 1997
(``September 25 Letter'').
\41\ Section 11A(a)(3)(B) of the Act authorizes the Commission,
in furtherance of its statutory directive to facilitate the
development of a national market system, by rule or order, to
authorize or require self-regulatory organizations to act jointly
with respect to matters as to which they share authority under the
Act in planning, developing, operating or regulating a national
market system (or a subsystem thereof) or one or more facilities
thereof. 15 U.S.C. 78k-1(a)(3)(B). The language of Section
11A(a)(3)(B) states explicitly that the Commission not only may
approve national market system facilities in response to an
application by SROs, but also may require SROs to implement such
facilities on their own initiative. Moreover, the possible need for
Commission regulatory compulsion in connection with the development
of a national market system where necessary to supplement
competitive forces was specifically recognized by the Congress in
enacting the 1975 Amendments. For example, the Committee of
Conference of both Houses of Congress, in discussing the
implemention of a national market system stated: It is the intent of
the conferees that the national market system evolve through the
interplay of competitive forces as unnecessary regulatory
restrictions are removed. The conferees expect, however, in those
situations where competition may not be sufficient, such as the
creation of a composite quotation system or a consolidated
transaction reporting system, the Commission will use the power
granted to it in [1975 Amendments] to act promptly and efficiently
to ensure that the essential mechanisms of an integrated secondary
trading system are put into place as rapidly as possible.
Committee of Conference, Report To Accompany S 249, H.R. Rep.
No. 94-249, 94th Cong., 1st Sess., at 92, reprinted in [1975] U.S.
Code Cong. & Ad. News 321, 323. See also Securities Exchange Act
Release No. 16410 (December 7, 1979), at 13-14, 44 FR 72607, 72608-
09.
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[[Page 40752]]
A. Need for Expanded ITS/CAES Interface
In its permanent approval order for ITS, the Commission stated that
``in order to achieve fully the Congressional goal that all markets for
qualified securities be linked (Section 11A(a)(1)(D) of the Act), it
will be necessary in the future for the ITS/CAES interface to be
expanded to include all stocks traded in the third market.'' \42\ The
Commission continues to believe that it is necessary to expand the ITS/
CAES linkage to all listed securities in order to fully implement the
1975 Congressional mandate to create a national market system to link
the exchanges and the OTC market. Originally, the Commission realized
the need for an efficient lingage between ITS and the OTC market,
especially in light of the adoption of Rule 19c-3, but limited the ITS/
CAES linkage to Rule 19c-3 securities as an interim measure because it
could not predict how the linkage would work in practice.\43\ However,
the Commission explicitly stated that it intended this limitation to be
temporary and wanted it removed eventually through joint action by ITS
Participants.
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\42\ See Securities Exchange Act Release No. 19456 (January 27,
1983), 48 FR 4938 (February 3, 1983).
\43\ More recently, in its Market 2000 Study, the Division
stressed that ``the Commission limited its mandated link (in 1981)
to Rule 19c-3 securities because it concluded that the adoption of
Rule 19c-3 heightened the need for an efficient linkage between the
exchanges and the OTC market.'' See Market 2000 Study, supra note
34, at AII-12. Furthermore, the Commission already has encouraged
the ITS Participants to solve this issue, but with no results. See
Order Execution Rules, supra, note 36.
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The Commission now believes that the significant changes to the
third market that have occurred since 1982, when the Commission first
approved the ITS/CAES linkage for Rule 19c-3 securities, support the
expansion of the linkage. Any NASD member that acts in the capacity of
an OTC market maker must provide continuous two-sided quotations for
any exchange-listed security in which that member, during the most
recent calendar quarter, comprised more than 1% of the aggregate
trading volume for such security as reported in the consolidated system
(``1% Rule'').\44\ The NASD now requires all third market makers
registered as CQS market makers to register and participate in ITS/
CAES.\45\ Moreover, all specialists and OTC market makers must now
display the price and size of all customer limited orders that improve
their quote (``Limit Order Display Rule'').\46\ Thus, the significant
limitations in transparency that previously distinguished the OTC
market from the exchange market have been reduced.
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\44\ The 1% Rule applied only to Rule 19c-3 securities prior to
being expanded in the Order Execution Rules. See Securities Exchange
Act Release No. 39367 (November 26, 1997), 62 FR 64242 (December 4,
1997) (``Autoquote Order'').
\45\See Securities Exchange Act Release No. 34280 (June 29,
1994), 59 FR 34880 (July 7, 1994).
\46\ See Order Execution Rules, supra, note 36. In addition, if
a specialist or market maker enters an order into an electronic
communications network (``ECN'') that improves its quote, it has to
either (1) reflect that limit order in its quote, or (2) use an ECN
that is linked to the National Market System, displaying its
specialist and market maker top of book, and that top of book quote
must be accessible.
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The increase in transparency has been accompanied by a growth in
trading in the third market. In 1996, third market trading of NYSE
listed stocks accounted for 8.14% of the volume and 10.74% of the
trades reported to the consolidated tape. In 1981, however, 98.5% of
the consolidate tape volume in exchange-listed securities occurred on
exchange floors.\47\ The growth of third market activity makes it even
more important to expand the ITS/CAES linkage to all listed securities
in order to ensure that customers receive the best price regardless of
the market of execution. In addition, the Commission does not believe
there have been any substantial adverse effects of the ITS/CAES linkage
to date. There is no evidence that the linkage has led to poorer
executions in Rule 19c-3 stocks versus other listed stocks. On the
contrary, the linkage enables third market makers to make more
competitive markets and allows orders routed to exchanges to obtain
those prices. The lack of any adverse effects makes the ITS distinction
between Rule 19c-3 securities and non-Rule 19c-3 securities a
historical anachronism. Indeed, this distinction seems to create and
inappropriate barrier to trading. The Commission preliminarily cannot
identify convincing justification for maintaining an arbitrary barrier
which prevents the expansion of the ITS/CAES linkage to non-Rule 19c-3
securities. Moreover, the absence of an ITS/CAES linkage, in light of
growing trading in the third market and the presence at times of
superior quotes in that market, raises questions about whether best
execution can be obtained by default routing of customer orders to any
exchange or NASD market maker,\48\ rather than order-by-order routing
to exchange and market makers, based on the best available quotation.
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\47\ See NYSE 1996 Fact Book at 26 and 14.
\48\ The Commission has previously stated its belief that
broker-dealers automatically routing order flow to a particular
market center must regularly and rigorously examine execution
quality likely to be obtained from the different markets or market
makers trading a security, carefully examine the extent to which
directed order flow would be afforded better terms if executed in a
market or with a market maker offering price improvement
opportunities, and in the event that material differences exist
between the price improvement opportunities offered by markets or
market makers, the broker-dealer must take such differences into
account. See, e.g., Order Handling Rules, supra note 36.
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Consequently, the Commission believes that expansion of the ITS/
CAES linkage to all listed stocks is warranted. Such an expansion will
increase a broker-dealer's ability to obtain best execution for the
customer and promote competition in listed securities. It also will
help ensure more equivalent access to the markets, reduce market
fragmentation, and provide for additional liquidity and more efficient
executions. The Commission continues to believe that it is desirable
for the industry to take a lead in the development, implementation and
enhancement of national market system facilities and in the formulation
of solutions to national market system issues. Affected industry
participants should have every reasonable opportunity to advance
national market system goals without direct Commission intervention. In
this instance, however, the Commission believes that change will not
occur without Commission intervention.
In the Commission's view, the failure to achieve a linkage between
exchange and OTC markets in all listed securities inhibits a broker's
ability to ensure best execution of its customer orders.\49\ With
regard to non-Rule 19c-3 securities, orders routed to exchange floors
cannot be easily redirected to the OTC market in situations where more
favorable prices are offered by OTC market makers. Conversely, OTC
market makers are precluded from using an efficient means of achieving
rapid delivery of their orders to exchange floors when the exchange has
a more favorable price.\50\ Currently, an OTC market maker may be
trading a security at a better price than an exchange specialist (or
vice versa) and the exchange specialist (or OTC market maker) is not
able to access
[[Page 40753]]
directly the better quote for non-Rule 19c-3 securities. Expanding the
ITS/CAES linkage to non-Rule 19c-3 securities will enable the OTC
market maker and the exchange specialist to directly access those
superior priced quotes through ITS, rather than potentially executing
an order at an inferior price.
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\49\ The Commission indicated in the Rule 19c-3 Adopting Release
that intermarket exposure of orders in a national market system
should maximize competition between and among markets and market
participants, and further the efficiency and fairness of the
securities markets. See Rule 19c-3 Adopting Release, supra note 18,
at 10, 45 FR at 41126.
\50\ Non-exchange member OTC market makers presently are able to
access exchange floors only through correspondent relationships with
member firms.
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The Commission also believes that the failure to expand the ITS/
CAES linkage impedes ``fair competition among brokers and dealers * * *
and between exchange markets and markets other than exchange markets,''
\51\ and that competitive OTC markets cannot develop fully in the
absence of a linkage for all listed securities. Without an expanded
ITS/CAES linkage, OTC market makers in non-Rule 19c-3 securities have
little ability to interact with the vast majority of retail orders,
which presently are routed to the primary exchange markets, or to
attract additional order flow through their displayed quotations. The
expansion of the ITS/CAES linkage should promote competition in non-
Rule 19c-3 securities by encouraging market makers or specialists to
improve their quotes to match or better the bid or offer in another ITS
market, in order to attract order flow from those other markets. The
Commission also believes the expansion should help equalize access to
all the markets because OTC market makers and exchange specialists will
have an ability to access directly each other's markets for non-Rule
19c-3 securities.
---------------------------------------------------------------------------
\51\ See Section 11A(a)(1)(C)(ii) of the Act, 15 U.S.C. 78k-
1(a)(1)(C)(ii).
---------------------------------------------------------------------------
The expansion of the ITS/CAES linkage should also decrease market
fragmentation because all exchanges and the OTC market would be linked
directly through ITS for all listed securities. The failure to extend
the linkage between the OTC market and exchange markets to all listed
securities obviates trade-through protection for third market trades
and quotes, and inhibits efforts to achieve comprehensive nation-wide
price protection. Expanding the ITS/CAES linkage should make ITS a more
efficient and useful linkage by expanding the applicability of the ITS
trade-through rule because all market maker trades and quotes in listed
securities would be subject to the rule.\52\
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\52\ Currently, third market makers can trade non-Rule 19c-3
listed securities without complying with the ITS trade-through rule.
The NASD, however, has indicated its willingness to amend its rules
to conform with trade-through protection if the ITS/CAES link is
expanded. See NASD 1997 Letter, supra, note 33.
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Although an expansion of the ITS/CAES linkage should produce
significant benefits to the national market system, the Commission and
market participants have suggested in the past that certain
improvements to third market trading rules and NASD procedures should
be implemented before the expansion. As discussed below, the Commission
believes that most of these improvements have been implemented, and
that the rest could be completed during the pendency of this
rulemaking.
The Division, in its Market 2000 Study, identified several areas
where the NASD should amend its rules prior to an expansion of the ITS/
CAES linkage. Specifically, the Division recommended that the NASD
amend its rules to provide for: the display of customer limit orders
that improve the existing ITS best bid or offer (``BBO''); customer
limit order protection; fixed standards for queuing and executing
customer orders; crossing of customers' orders, if possible, without
dealer intervention; and compliance with ITS trade-through and block
trade policies. The Division also stated that the NASD should develop a
program specifically designed to enhance oversight examination of the
third market.\53\
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\53\ See Market 2000 Study, supra, note 34.
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In addition, in response to a Commission letter,\54\ the ITS
Participants recently submitted their views in writing to the Division
on the expansion of the ITS/CAES interface.\55\ Eight of the nine
Participants supported eliminating the ITS/CAES linkage restriction as
long as certain significant changes are made to the NASD's rules prior
to the expansion. Several Participants express concern about the
accessibility of all third market quotes in listed securities and the
application of the ITS Plan, including the trade-through rule, if the
linkage were expanded. One Participant believes that the NASD must
implement a trade-through rule that would apply to all third market
makers, even non-ITS/CAES market makers, who trade listed stocks.\56\
Several Participants believe the NASD should require all third market
makers and ``unregulated exchanges'' to participate in ITS,\57\ and
another believes all NASD members, both market makers and brokers, who
trade listed securities should be accessible through ITS and willing to
comply with the Order Handling Rules and all ITS rules, including the
trade-through rules.\58\ Another commenter suggested that all block
positioners and non-market makers (that trade listed stocks) linked
with the National Market System should also be required to comply with
the ITS trade-through rule. The Commission is soliciting comment on
whether this is necessary or appropriate, and how it could be
achieved.\59\
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\54\ See May 27 Letter, supra, note 39. In that letter, the
Commission commented on four aspects of the ITS Plan that it
believes are anti-competitive; the ITS/CAES limitation to Rule 19c-3
securities was one of those provisions.
\55\ See letter from Thomas F. Ryan, Jr., President and Chief
Operative Officer, Amex, to Jonathan B. Katz, Secretary, Commission,
dated June 26, 1997 (``Amex Letter''); letter from Charles J. Henry,
President and Chief Operating Officer, CBOE, to Jonathan G. Katz,
Secretary, Commission, dated June 26, 1997; letter from Robert H.
Forney, President and Chief Executive Officer, CHX, to Jonathan G.
Katz, Secretary, Commission, dated November 3, 1997 (``CHX
Letter''), letter from David Colker, Executive Vice President and
Chief Operating Officer, CSE, to Jonathan G. Katz, Secretary,
Commission, dated July 3, 1997 (``CSE Letter''); NASD 1997 letter,
supra, note 33; letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Jonathan G. Katz, Secretary, Commission, dated
June 25, 1997 (``NYSE Letter''); and letter from William G. Morton,
BSE, Robert H. Forney, CHX, Robert M. Greber, PCX, and Nicholas
Giordano, Phlx, to Jonathan G. Katz, Secretary, Commission, dated
June 23, 1997 (``Joint Letter'').
\56\See NYSE Letter, supra note 55.
\57\See Joint Letter, supra note 55.
\58\See CSE Letter, supra note 55.
\59\See Amex Letter, supra note 55.
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The Participants also expressed concerns regarding adequate trade-
reporting and surveillance of the third market. The Participants
believe additional oversight of the third market and third market
makers is necessary prior to any expansion of the ITS/CAES linkage. One
Participant believes that the third market must implement timely and
accurate trade reporting because the operation of ITS, especially the
operation of the trade-through and block trade policies, depends upon
timely trade reporting at the actual price of the transaction.\60\ The
Participant argues that currently, third market transactions can be
reported that at a price ``reasonably related to the prevailing
market,'' taking into consideration all relevant circumstances,
including the costs of executing transactions, market conditions, and
the number of shares involved.\61\ The Participants also states
[[Page 40754]]
that the Commission has cited its confirmation rule \62\ as resolving
the trade reporting issue, but the Participant does not think that this
addresses the issue because that rule merely requires the NASD member
to report the same price to the customer as they do to the tape.\63\
---------------------------------------------------------------------------
\60\ See NYSE Letter, supra note 55. If the transaction is not
reported accurately, there is no way of ascertaining if that
transaction would have traded-through a superior priced quotation in
another ITS market. See id. The Commission notes that the ITS block
trade policy requires anyone handling a block transaction to satisfy
all superior ITS quotes at the block price.
\61\ Prior to 1980, third market principal transactions were
reported to the consolidated system at a ``net'' price which
included the mark-up or mark-down charged to the customer on the
transaction. In 1980 the Commission approved an NASD proposed rule
change requiring third market reporting at a ``gross'' price,
excluding the mark-up or mark-down charged a customer. The rule
requires that the price reported to the consolidated system shall be
reasonably related to the prevailing market, taking into
consideration all relevant circumstances, including, but not limited
to, market conditions with respect to the security, the number of
shares involved in the transaction, the published bids and offers
with size at the time of execution (including the reporting firm's
own quotation), accessibility to market centers publishing bids and
offers with size, the cost of the execution, and the expenses
involved in clearing the transaction. See Securities Exchange Act
Release No. 18536 (March 11, 1982), 47 FR 10658, 10662 n.21 and NASD
Rule 6420(d)(3)(A). NASD Rule 5230 states that transactions in ITS
securities executed in CAES by ITS/CAES market makers or receive
through the ITS system and executed by an ITS/CAES market maker are
reported to the Consolidated Tape by the CAES system at the price
specified in the ITS commitment or, if executed at a better price,
the execution price.
\62\ See Rule 10b-10 under the Exchange Act, 17 CFR 240.10b-10.
This rule requires that when a NASD member is acting as an agent for
a customer, the member must confirm to the customer the gross trade
price, which is the price that was reported to the Consolidated
Tape, and the commission equivalent as well as the net price to the
customer. When an NASD member is acting as principal for its own
account, the member must include in the confirmation the price
reported to the Consolidated Tape, the net price to the customer,
and the difference.
\63\ In the original order adopting amendments to the ITS Plan
in 1982, the Commission discussed the trade-reporting issue. See
Final Approval Order, supra note 31. The ITS Participants had stated
that they believed it was necessary for the NASD to agree to require
market makers to report trades to the consolidated tape at the same
price they confirm transactions to their customers, believing that
such a requirement would impose, through customer monitoring of
trade confirmations, a discipline on market makers to ensure that
they reported trades as the true wholesale price. The Commission
responded that it believed that concerns about accurate trade
reporting could be effectively resolved through surveillance. The
Commission believes that its confirmation rule amendments help
enforce the trade reporting obligations by requiring disclosure of
the mark-up resulting from the actual reported price. See Securities
Exchange Act Release No. 18713 (May 6, 1982), 47 FR 20413, 20415
n.13 (May 12, 1982). The Commission notes that the NASD, in its
petition for rulemaking to expand the ITS/CAES linkage to non-Rule
19c-3 securities, has indicated that it intends to modify its last
trade reporting rules for exchange-listed securities in order to
address concerns relating to the ITS/CAES linkage expansion. See
NASD Petition, supra note 36.
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The Commission believes that most of these issues have already been
addressed and that the NASD could address the others prior to the
implementation of the expansion of the ITS/CAES linkage. The
Commission's adoption of the Limit Order Display Rule eliminates the
need for the NASD to implement a rule to require the display of
customer limit orders that improve the existing ITS/BBO, as recommended
in the Market 2000 Study.\64\ In addition, the Limit Order Display Rule
provides enhanced opportunity for public orders to interact with other
pubic orders without the intermediation of a specialist or market maker
by requiring certain customer limit orders to be displayed in the
quote.\65\ The Commission also notes that there is an NASD rule that
prohibits third market makers from trading ahead of their customer
limit orders.\66\
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\64\ The Limit Order Display Rule requires all specialist and
market makers to display customer limit orders that improve their
quotes. See Order Execution Rules, supra note 36.
\65\ Id.
\66\ The Commission notes that NASD's Rule 6440(f)(1)(2), which
applies to listed securities, states that no member shall buy (or
sell) (or initiate the purchase or sale of) any security at or above
(or below) the price at which it personally holds or has knowledge
that any person associated with it holds an unexpected limited price
order to buy (or sell) such security in the unit of trading for a
customer.
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In addition, the Commission believes that, for the most part, the
issue of timely and accurate trade reporting has already been
adequately addressed. The Commission notes that third market
transactions during regular market hours must be reported to the
consolidated tape within 90 seconds of execution; this is the same as
the reporting of transactions on all the exchanges. Moreover, the
Commission has enacted a rule requiring the third market to report
transactions to the consolidated tape at the same price as they report
the transactions to the customer.\67\ Although the Commission believes
that the rule relating to third market trade reporting could be
clarified, they are the same for Rule 19c-3 and non-Rule 19c-3
securities, and thus provide no basis for not extending the ITS/CAES
linkage to all securities. Nonetheless, the Commission believes that
the NASD must continue to ensure that it is actively and adequately
surveilling trade reporting in the third market.\68\
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\67\ See supra notes 61-62 and accompanying text.
\68\ In its Report Pursuant to Section 21(a) of the Securities
Exchange Act of 1935 Regarding the NASD and the Nasdaq Market, the
Commission noted that the NASD failed to monitor and enforce
rigorously trade reporting compliance by NASD members trading
exchange-listed securities in the OTC market, and that they were
many transactions that constituted trade-through. See U.S.
Securities and Exchange Commission, Report Pursuant to Section 21(a)
of the Securities Exchange Act of 1935 Regarding the NASD and the
Nasdaq Market (August 8, 1996) (``Section 21(a) Report'') at A-44.
Since that time, the NASD has taken various measures designed to
comply with the undertakings contained in its settlement of an
enforcement proceeding with the Commission. One of the undertakings
required the NASD to improve substantially the reliability of trade
reporting.
---------------------------------------------------------------------------
The Commission also believes that the NASD should provide for
trade-through and block trade policy rules that will apply to all third
market makers who trade in listed securities, prior to an expansion of
the ITS/CAES linkage. In addition, the NASD should consider developing
standards for queuing and executing customer orders. The Commission
invites the NASD to submit proposed rule changes to address these
concerns. However, while these standards are needed to better protect
OTC customers, they are not relevant to orders received via the
linkage, and so are not fundamentally the concern of other markets.
Finally, the Commission also wishes to emphasize that all ITS
Participants need to enforce strictly Rule 11Ac1-1 under the Exchange
Act (the ``Firm Quote Rule'') to ensure that investors receive best
execution and that the market receives reliable quotation information.
The Firm Quote Rule requires that every exchange specialist or OTC
market maker execute any order to buy or sell a security it receives at
a price at least at favorable as its published bid or offer in any
amount up to its published size, subject to two exceptions. The
Commission emphasizes that the Firm Quote Rule applies to ITS
commitments; where a specialist or market makers fails to honor its
quote by refusing to execute an ITS commitment received at its
published bid or offer, and neither of the exceptions contained in the
Firm Quote Rule apply, the specialist or market maker is in violation
of the Firm Quote Rule. A market maker or specialist who fails to meet
his or her quote obligations is said to have ``backed away.'' \69\
---------------------------------------------------------------------------
\69\ The Firm Quote Rule by its terms applies to ITS
commitments.
---------------------------------------------------------------------------
There are only two exceptions to the Firm Quote Rule. The first
exception occurs when, prior to the receipt of the order, the market
maker or specialist has communicated to its association of exchange a
revised quotation size or revised bid or offer. The second exception
applies when, prior to the receipt of an order, the market maker or
specialist is in the process of effecting a transaction in a security
when an order in the same security is presented, and immediately after
the completion of such transaction, the market maker or specialist
communicates to its association or exchange a revised quotation size or
revised bid or offer (the ``trade ahead'' exception). In its Section
21(a) Report, the Commission specifically stated that the fact that
SelectNet orders may have scrolled off a market maker's Nasdaq
workstation terminal screen did not excuse traders from complying with
the Firm Quote
[[Page 40755]]
Rule for those orders.\70\ Similarly, the Commission stresses that a
market maker or specialist cannot claim as a valid excuse for not
executing an ITS commitment that he did not see the commitment before
it expired (``timing out''). The Commission wishes to reiterate that
order expiration is not an exception to the Firm Quote Rule.\71\
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\70\ See Section 21(a) Report at note 134 and accompanying text.
\71\ See Exchange Act Rule 11Ac1-1.
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B. Unanimous Vote Requirement
The Commission preliminarily believes that the unanimous voting
requirement for amendments to the ITS Plan, including the admission of
new participants, is anti-competitive and impedes the ability of ITS to
adapt to market changes. As the Commission stated in a May 27, 1997
letter \72\ to the ITS Participants, the unanimous vote requirement
allows any single Participant to veto changes to the Plan that could
increase competition faced by that Participant, such as the entry of
another market into ITS or expansion of business by a particular ITS
Participant. It also allows any Participant to block modifications to
ITS designed to adapt to changed circumstances. As a result, ITS has
not been able to evolve significantly as the markets changed over the
past two decades.
---------------------------------------------------------------------------
\72\ See May 27 Letter, supra note 39.
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There are several recent instances that demonstrate the anti-
competitive impact of the unanimous vote requirement.\73\ The first
instance involved the issue of trading derivative-type securities, such
as Standard & Poor's Depository Receipts (``SPDRs''), through ITS.\74\
Initially, there was disagreement among the Participants over amending
the ITS Plan to allow eligible securities to trade in increments
smaller than \1/8\th of a dollar. this modification was necessary
before a derivative-type product such as SPDRs, which trades in
increments of \1/64\th of a dollar, could begin trading over ITS. The
Participants originally disagreed on whether to amend the Plan to
accommodate trading in smaller increments, and what, if any, the
smaller increment should be. Eventually, after much debate, the
Participants agreed to amend the Plan in two stages, to first allow
trading in smaller increments, and eventually in decimals.
Nevertheless, due to opposition by a single Participant, resolution of
this issue was delayed for several months. As a consequence, competing
markets could not trade SPDRs for an extended period of time.
---------------------------------------------------------------------------
\73\ See Minutes from the ITS Users' Committee and ITSOC
meetings held on September 18 and 19, 1997, respectively.
\74\ CHX, CSE and PCX have received Commission approval to trade
SPDRs and MidCap SPDRs, both Amex products.
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Further, as noted in the May 27, 1997 letter, the Commission
believes that the ITS provision which provides ITS Participants a
special right of review for proposed rule changes involving the
operation of the CSE's NSTS is anti-competitive because it permits
other Participants to prevent the CSE from improving its market without
prior notice to and comment from its market competitors. At the recent
ITS meeting, a single Participant was able to block action on
elimination of this provision by voting against a motion to amend the
Plan. All the other Participants voted in favor of the motion.\75\
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\75\ The single Participant subsequently changed its position to
support the Plan amendment.
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Another recent example of the significance of the unanimous vote
requirement relates to OptiMark, a Commission-approved facility of PCX.
The Commission notes that PCX and other ITS Participants have not been
able yet to unanimously agree on whether the Participants need to amend
the ITS Plan prior to the time OptiMark begins to operate, much less on
the substance of a plan amendment, despite continuous discussion of the
issue.\76\ The OptiMark experience illustrates that a unanimous vote
requirement has the potential to block changes in ITS to accommodate
innovation on the part of Participants. It also suggests the obstacles
that a new market could face in becoming a new Participant in ITS.
---------------------------------------------------------------------------
\76\ Two Participants, the NYSE and Amex, refused to participate
in a vote in December 1997, on whether an amendment to the Plan is
necessary, while the other seven Participants voted that an
amendment is not needed prior to the operation of OptiMark.
Nevertheless, on June 3, 1998, the PCX proposed to the ITSOC two
Plan amendments to link the PCX Application of the OptiMark System
to ITS. The amendments were not approved by a vote of 5-4. Although
a super-majority voting provision would not have made a difference
in the June 3 vote, the June 3 vote would never have been necessary
had a super-majority voting provision been in place for the December
vote. The Commission notes that it issued a companion release to
amend the ITS Plan to link the PCX Application of the OptiMark
System to ITS. See Securities Exchange Act Release No. 40204 (July
15, 1998).
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The above instances underscore the limiting effect of the unanimous
vote requirement. They may represent only a small portion of potential
changes to ITS hindered by the unanimous vote requirement. Most
proposals may not even get proffered by ITS Participants because of the
difficulty of overcoming the unanimous vote requirement. The potential
veto by a single Participant can slow or prevent ideas for modifying
ITS to accommodate developments in the markets from even reaching the
proposal stage, let along being adopted.
In response to the Commission May 27, 1997 letter, several of the
Participants argue that the unanimous vote requirement fosters
competition and the development of the national market system because
ITS, in conjunction with the Consolidated Quotation System, encourages
a Participant market to compete for order flow with the knowledge that
its superior-priced quotations must be honored.\77\ These Participants
further assert that ``[o]ther than providing [a] limited form of
access, the Plan has no other effect on market competition'', and that
``[t]here are no Plan provisions that allow one or more Participant
markets to veto a competitive initiative of another Participant
market.'' \78\ However, the Commission strongly believes that ITS can
affect a market's ability to compete because the unanimous vote
requirement could effectively prevent a competing market implementing
structural or operational changes from becoming an ITS Participant,
which in turn could affect that market's ability to compete for order
flow and to reach quotations in the competing ITS Participant markets.
---------------------------------------------------------------------------
\77\ See Joint Letter, supra note 55.
\78\ See id.
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Several of the Participants also believe that the unanimous vote
requirement, ``rather than being anti-competitive, * * * [constitutes
a] prudent safeguard[s] to ensure that all Participants are able to
protect the integrity of their markets and their membership status.''
\79\ In other words, a market can exercise its veto to prevent the
other ITS Participants from imposing restrictive conditions through ITS
rules, or from eroding its membership value by creating unlimited ITS
access to its market. Although the Commission recognizes these
concerns, the Commission believes that there are other means to protect
a market's interests that are less restrictive and anti-competitive.
Specifically, the Commission preliminarily believes that a two-thirds
supermajority voting requirement, with a right to appeal to the
Commission, could foster a regulatory system that will promote
innovation and competition while still permitting the Participants to
preserve the integrity of their markets and membership status.\80\
---------------------------------------------------------------------------
\79\ See id.
\80\ See May 27 Letter, supra note 39. Several commenters
support, to varying degrees, this approach. See letter from Leopold
Korins, Chairman and Chief Executive Officer, Phlx, to Jonathan G.
Katz, Secretary, SEC, dated November 12,1997 (``Phlx letter'')
(supporting a supermajority for most issues, including Plan
amendments, and a simple majority for resolution of certain
ministerial issues); letter from David Colker, Executive Vice
President and Chief Operating Officer, CSE, to Jonathan G. Katz,
Secretary, SEC, dated January 19, 1998 (``CSE Unanimous Vote
Letter'') (supporting a supermajority vote for all ITS Plan
amendments except admission of new participants under the existing
regulatory structure, for which it supports a simple majority vote);
letter from Gary K. Staggs, Vice President, Equity Floor Operations,
PCX, to Jonathan G. Katz, Secretary, Commission (``PCX Letter'')
(supporting a majority or supermajority vote for general Plan
amendments); and CHX letter, supra note 55 (supporting a
supermajority vote requirement of two-thirds of the Participants for
Plan amendments, including the admission of new Participants).
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[[Page 40756]]
Several of the Participants argue that the right to appeal to the
Commission, in the event that a Participant objects to a certain
amendment approved by a two-thirds majority, does not provide adequate
protection of their interests.\81\ The Commission believes that the
appeal right to the Commission in the Plan Rule, and the review it
undertakes in approving a Plan amendment, provides additional
protection to all Participants, in part because such review is done in
accordance with and in furtherance of the purposes of the Exchange
Act.\82\
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\81\ See id.
\82\ Paragraph (c)(2) of Rule 11Aa3-2 (the ``Plan Rule'')
provides that the Commission will approve a filing only if it finds
that a plan or amendment ``is necessary or appropriate in the public
interest, for the protection of investors and the maintenance of
fair and orderly markets, to remove impediments to, and perfect the
mechanisms of, a national market system, or otherwise in furtherance
of the purposes of the [Exchange] Act.''
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The Commission has recommended that the ITS Participants eliminate
the unanimous vote requirement but no consensus has been reached.\83\
Consequently, the Commission is proposing an amendment to eliminate the
unanimous vote requirement contained in Section 4(c) of the ITS Plan
and replace it with a supermajority/two-thirds vote requirement for
Plan amendments.\84\
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\83\See Phlx letter, supra note 80 (supporting a supermajority
for most issues, including Plan amendments, and a simple majority
for resolution of certain ministerial issues); CSE Unanimous Vote
Letter, supra note 80 (supporting a supermajority vote for all ITS
Plan amendments except admission of new participants under the
existing regulatory structure, for which its supports a simple
majority vote); PCX Letter, supra note 80 (supporting a majority or
supemajority vote for general Plan amendments); CHX Letter, supra
note 55 (supporting a supermajority vote requirement of two-thirds
of the Participants for Plan amendments, including the admission of
new participants). But see Joint Letter, supra note 55 (stating that
the unanimous vote requirement in particular is appropriate because
it fosters competition and the development of the National Market
System).
\84\ Those opposing the amendment would have the right to appeal
to the Commission.
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III. Request for Comment
The Commission solicits comment on the substance of the proposed
amendment to the ITS Plan to expand the ITS/CAES linkage as discussed
above, and also requests comment on specific questions relating to this
proposed expansion.
With regard to the substance of the trade-through rule the NASD
must implement prior to expansion of the ITS/CAES linkage, the
Commission requests comment on whether such rule should apply to all
NASD members who trade listed securities, or only those market makers
who trade listed securities. The Commission also requests comment on
the specifics of a trade-through rule and whether a trade-through rule
for the third market should be identical to the exchange trade-through
rules, or whether such rule should be similar to the trade-through rule
that already applies to ITS/CAES market makers,\85\ but expanded in
scope and application. Finally, the Commission requests comment on
what, if any, other amendments to NASD rules are necessary prior to
expanding the ITS/CAES linkage.\86\
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\85\See NASD Rule 5262.
\86\ The Commission notes that the NASD's autoquote rule would
have to be revised if the ITS/CAES linkage is expanded, as the rule
is currently inconsistent with the ITS Plan.
---------------------------------------------------------------------------
The Commission notes that under current NASD rules, participation
in CAES and the ITS/CAES linkage is limited to registered CQS market
makers. As a result, if ITS/CAES linkage were expanded to include non-
Rule 19c-3 securities, ECNs must be CQS market makers to have the
ability to access the listed markets through ITS, or else exchange
specialists will be unable to make full use of the ECN Alternative
under the Order Handling Rules. The Commission requests comment on
whether the NASD's rules need to be amended to allow ECN participation
in CAES and the ITS/CAES linkage. The Commission is interested in
commenters' views on what rule changes would be necessary to
accommodate ECN participation in CAES and ITS/CAES linkage.
The Commission is soliciting comment on whether the unanimous vote
requirement should be eliminated, and what impact such a change would
have on the operation of ITS and the respective Participant markets, if
any. The Commission also is soliciting comment on what alternative
voting scheme should be required for Plan amendments if the unanimous
vote requirement is eliminated, such as a simple majority vote or a
two-thirds vote. Should the alternative voting scheme chosen by the
Commission more directly take into account the actual number of its
participants? For example, should the Commission adopt a simple
majority or two-thirds voting scheme if the number of participants is--
as it is now--nine, but allow for automatic modification of that scheme
by the Commission if the number of participants is 7, 8, 10, or 11? In
addition, the Commission is soliciting comment on whether all
amendments to the ITS Plan should be treated equally, or whether
amendments to admit new participants (currently Section 3(c)) should be
treated differently from all other ITS Plan amendments, and, if so, why
the disparate treatment is necessary.
Some ITS Participants have expressed concerns that non-unanimous
voting threatens their sovereignty as independent markets. At the same
time, the existing ITS Plan constrains the market structure of
Participants, which limits innovation, in order to prevent unbridled
order routing to other markets through ITS. To address these concerns,
the Commission requests comment on whether other market linkages should
be developed to replace ITS. All of the Participants now operate
automated order routing systems that provide access to their markets.
As an alternative to ITS, these systems could be opened to other
markets for use on an order-by-order basis. Alternatively, ITS
Participants could provide access to other markets directly or through
one of many private vendors providing order routing services. The
Commission is requesting comment on two possible alternatives to the
existing ITS System: (1) Eliminating ITS and requiring each national
securities exchange and national securities association to provide
access to other markets through one or more private vendors for the
purpose of allowing access to better-priced quotations in their
markets; or (2) eliminating ITS and requiring each participant national
securities exchange and national securities association to provide
other markets access to its order routing systems.
Finally, the Commission requests comment on whether the changes it
has proposed to the ITS Plan should be supplemented, or wholly
replaced, by other revisions to the ITS Plan. The current provisions
can produce a restraint on competition, impediments to ITS' ability to
adapt to market changes, barriers to new Participants joining the Plan,
the encumbrances on innovation by the current Participants. The
Commission recognizes the possibility that eliminating the
[[Page 40757]]
unanimous vote requirement may not be sufficient to address the
restrictive nature of the current ITS Plan, including the difficulty
involved in the Plan, before change can occur to remove the provisions
that control the internal operation of Participant markets.
Commentators should address whether it would be productive to revise
the ITS Plan to remove or modify other provisions that unnecessarily
limit the internal operation of Participants, such as the descriptions
of specific ITS interfaces and the requirement of two-sided quotations.
Instead, the Plan could express standards or principles governing use
by Participants, such as the existing prohibition contained in Plan
Rule 8(a)(v),\87\ dealing with routing a substantial portion of order
flow to other markets through ITS. Regardless of whether commentators
believe that the current changes proposed by the Commission provide for
an adequate solution to the problems mentioned above, the Commission
requests additional comment on whether further action, including, but
not limited to, a revision of the entire ITS Plan by the Commission, is
warranted.
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\87\ Section 8(a)(v) of the ITS Plan provides that ITS is not
permitted to be used as an automated order delivery system whereby
all or a substantial portion of orders are routinely rerouted from
the market where they are received to another market for execution.
This provision further requires that each Participant take
reasonable efforts to probe its market to achieve a satisfactory
execution there before reformatting the order as an ITS commitment
to trade and rerouting it to another market.
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IV. Costs and Benefits of the Proposed Amendments and Their Effects
on Competition, Efficiency and Capital Formation
Section 23(a)(2) of the Exchange Act requires that the Commission,
when promulgating rules under the Exchange Act, to consider the
competitive effects of such rules and to not adopt any rule that would
impose a burden on competition that is not necessary or appropriate in
furthering the purpose of the Act.\88\ The Commission preliminarily has
considered the proposed amendments to the ITS Plan in light of the
standards cited in Section 23(a)(2) of the Act and believes that they
would not likely impose any significant burden on competition not
necessary or appropriate in furtherance of the Exchange Act. Indeed,
the Commission believes that the proposed amendment to expand the ITS/
CAES linkage should promote competition in non-Rule 19c-3 securities
because OTC market makers will now be able to attract orders initially
routed to exchange specialists, by disseminating a superior quote, in
all listed securities, not just Rule 19c-3 securities. Additionally,
the expansion of the ITS/CAES linkage will allow exchange specialists
to attract orders held by OTC market makers in non-Rule 19c-3
securities. The Commission also believes that eliminating the unanimous
vote requirements should promote competition by restricting the ability
of one or more Participants to block an ITS Plan amendment that would
promote competition between the markets or within one market.
---------------------------------------------------------------------------
\88\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
Commentators should consider the proposed amendment's effect on
competition, efficiency and capital formation.
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, the Commission is also requesting information regarding
the potential impact of the proposed amendment on the economy on an
annual basis. If possible, commentators should provide empirical data
to support their views.
To assist the Commission in its evaluation of the costs and
benefits that may result from the proposed amendments, commenters are
requested to provide analysis and data relating to costs and benefits
associated with the proposal herein. The Commission preliminarily
believes that the amendment to the ITS Plan proposed herein to expand
the ITS/CAES linkage to all listed securities will increase efficiency
because investors will be able to access directly the exchange and OTC
markets for all listed stocks. The Commission also notes the impact of
the proposed ITS Plan amendments on the NYSE in the proposal would
allow all ITS Participants to access the NYSE for non-Rule 19c-3
securities, and for the NYSE to access other Participant markets for
those securities. In addition, the Commission preliminarily believes
that the proposed amendments would benefit ECNs by allowing them to
fully integrate into the NMS in all listed securities, which in turn
would allow for more efficient use of the ECN Alternative mentioned in
the Order Execution Rules. The Commission also preliminarily believes
that the proposal would enhance competition between market in non-Rule
19c-3 securities and improve execution quality for non-Rule 19c-3
securities. Finally, the Commission notes that there would be
implementation costs and costs of expanding the linkage to include all
non-Rule 19c-3 securities.
In addition, the proposed amendment to eliminate the unanimous vote
requirement for ITS Plan amendments would remove a significant barrier
to imposing new and innovative modifications to ITS by preventing a
small minority of ITS Participants from thwarting innovation that could
improve market efficiency. The Commission is requesting comment on the
costs and benefits of the proposed amendments and any possible anti-
competitive impact of the proposed amendments. Specifically, the
Commission requests comments to address whether the proposed amendment
would generate the anticipated benefits or impose any costs on U.S.
investors or others.
Comments should be submitted by August 31, 1998.
V. Initial Regulatory Flexibility Analysis
This Initial Regulatory Flexibility Analysis (``IRFA'') has been
prepared in accordance with Section 3 of the Regulatory Flexibility Act
(``RFA'').\89\ It relates to proposed amendments to the ITS Plan to
expand the linkage between ITS and the NASD/CAES to all listed
securities and would eliminate the unanimous vote requirement for
amendments to the ITS Plan.
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\89\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------
A. Reasons for and Objectives of the Proposal
Although the ITS participants have addressed two of the four anti-
competitive aspects of the ITS Plan identified by the Commission, they
have been unable to take action regarding the expanded linkage and the
unanimous vote requirement. The Commission thus is proposing to amend
the ITS Plan on its own initiative.
The objective of the expanded linkage is to achieve the statutory
goals of efficient execution of securities transactions and
opportunities for best execution of customer orders for all listed
securities. The elimination of the unanimous vote requirement is
intended to improve the governance of the ITS Plan--the unanimous vote
requirement in the past has been used by the ITS participants to veto
changes to the ITS Plan that could increase intermarket competition.
B. Legal Basis
Section 11A(a)(3)(B) of the Exchange Act authorizes the Commission,
by rule or order, to authorize or require SROs to act jointly with
respect to matters as to which they share authority under the Exchange
Act in planning, developing, operating or regulating a national market
system (or a subsystem thereof) or one or more facilities thereof. It
states explicitly that the Commission not only may approve national
market system facilities in response to an application
[[Page 40758]]
by SROs, but also may require SROs to implement such facilities on
their own initiative. Rule 11Aa3-2,\90\ adopted by the Commission under
Section 11A, establishes procedures for proposing amendments to
national market system plans such as the ITS Plan. Paragraph (b)(2)
states that the Commission may propose amendments to an effective
national market system plan by publishing the text of the amendment
together with a statement of purpose of the amendments.
---------------------------------------------------------------------------
\90\ 17 CFR 240.11Aa3-2.
---------------------------------------------------------------------------
C. Small Entities Affected by the Proposed Amendments
The proposal would directly affect the nine ITS Participants, none
of which are small entities. However, specialists on the exchange
floors who trade ITS securities, broker-dealers that have access to ITS
through terminals located on exchange floors, and registered ITS/CAES
market makers who trade in ITS securities in the third market could be
indirectly affected. There would be no impact on these broker-dealers
by the proposed change in the vote requirement as it relates only to
the governance of the ITS Plan.
Paragraph (c)(1) of Rule 0-10 \91\ states that the term ``small
business'' or ``small organization,'' when referring to a broker-
dealer, means a broker or dealer that: (1) Had total capital (net worth
plus subordinated liabilities) of less than $500,000 in its prior
fiscal year audited financial statements or, if not required to file
such statements, on the last business day of the preceding fiscal year;
and (2) is not affiliated with any person (other than a natural person)
that is not a small business or small organization. The Commission
currently does not have any data on the number of small entities that
could be affected.\92\
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\91\ 17 CFR 240.0-10(c)(1).
\92\ The Commission recently adopted revised definitions of
``small entity.'' See Definitions of ``Small Business'' or ``Small
Organization'' Under the Investment Company Act of 1940, the
Investment Advisers Act of 1940, the Securities Exchange Act of
1934, and the Securities Act of 1933, Exchange Act Release No. 40122
(June 24, 1998). The revision, among other things, expanded the
affiliation standard applicable to broker-dealers, to exclude from
the definition of a small entity many introducing broker-dealers, to
exclude from the definition of a small entity many introducing
broker-dealers that clear customer transactions through large firms.
Currently, approximately 1,079 of all registered broker-dealers will
be characterized as ``small.'' See revised Rule 0-10(i). [The
Commission estimates there are 8,300 registered brokers-dealers.]
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To the extent, however, that a specialist or market maker does fall
under the definition of ``small entity,'' the effect is likely to be
indirect and positive. Under the current system, an OTC market maker
may be trading a security at a better price than an exchange specialist
(or vice versa) and the exchange specialist (or OTC market maker) is
not able to access directly the better quote for non-Rule 19c-3
securities. Expanding the ITS/CAES linkage to non-Rule 19c-3 securities
would enable the OTC market maker and the exchange specialist to access
directly those superior priced quotes through ITS, rather than
potentially executing an order at an inferior price. Finally, the
expansion of the ITS/CAES linkage to non-Rule 19c-3 securities also
would have an indirect, beneficial effect upon the ability of a broker
with ITS access on an exchange floor to achieve best execution of
customer orders.
D. Reporting, Recordkeeping, and Other Compliance Requirements
The proposals would not impose any new reporting, recordkeeping, or
other compliance requirements.
E. Duplicative, Overlapping or Conflicting Federal Rules
The Commission believes that there are no rules that duplicate,
overlap, or conflict with the proposed amendments.
F. Significant Alternatives
The RFA directs the Commission to consider significant alternatives
that would accomplish the stated objectives, while minimizing any
significant economic impact on small entities. In connection with the
proposal, the Commission considered the following alternatives: (1) The
establishment of differing compliance or reporting requirements or
timetables that take into account the resources available to small
entities; (2) the clarification, consolidation, or simplification of
compliance and reporting requirements under the Rule for small
entities; (3) the use of performance rather than design standards; and
(4) an exemption from coverage of the Rule, of any part thereof, for
small entities.
The Commission believes that none of the above alternatives is
applicable. The ITS Participants are the only parties that are subject
to the requirements of the ITS Plan. The ITS Participants are all
national SROs and, as such, are not ``small entities.'' The Commission
believes that any effect that could possibly be experienced by a
``small entity'' would be indirect and beneficial. Therefore, having
considered the foregoing alternatives in the context of the proposed
amendments, the Commission does not believe they would accomplish the
stated objectives of the proposal.
G. Solicitation of Comments
The Commission encourages the submission of comments with respect
to any aspect of this IRFA. The Commission requests comment as well as
empirical data on the impact the proposal will have on small broker-
dealers, specialists or market makers that utilize ITS. Comment is
specifically requested on whether broker-dealers that access ITS meet
the revised definition of ``small business'' and on the number of small
entities that would be affected by the proposed rules. Also, the
Commission is seeking comment on the perceived nature of the impact of
the proposed amendments on these entities. Such comments will be
considered in the preparation of the Final Regulatory Flexibility
Analysis, if the proposed rules are adopted, and will be placed in the
same public file as comments on the proposed rules themselves. Comments
should be submitted in triplicate to Jonathan G. Katz, Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549. Comments also may be submitted electronically at the
following E-mail address: rule-comments@sec.gov. All comment letters
should refer to File No. 4-208; this file number should be included on
the subject line if E-mail is used. Comment letters will be available
for public inspection and copying in the Commission's Public Reference
Room, 450 Fifth Street, N.W., Washington, D.C. 20549. Electronically
submitted comment letters also will be posted on the Commission's
Internet web site (http://www.sec.gov).
VI. Paperwork Reduction Act
The Paperwork Reduction Act does not apply because the proposed
amendments do not impose recordkeeping or information collection
requirements, or other collections of information which require
approval of the Office of Management and Budget under 44 U.S.C. 3501,
et seq.
VII. Description of Proposed Amendments to the ITS Plan
The Commission hereby proposes to amend the ITS Plan to provide for
the expansion of the ITS/CAES interface to non-Rule 19c-3 securities,
as well as for the elimination of the unanimous vote requirement for
amendments to the ITS Plan, pursuant to Rule 11Aa3-2(b)(2) and (c)(1)
and the Commission's authority under Section 11A(a)(3)(B) of the
Act.\93\ Below is the text of the
[[Page 40759]]
amended ITS Plan.\94\ Deleted text is [bracketed] and new language is
italicized.
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\93\ 5 U.S.C. 78k-1(a)(3)(B). Section 11A(a)(3)(B) authorizes
the Commission, in furtherance of its statutory directive to
facilitate the development of a national market system, by rule or
order, to authorize or require self-regulatory organizations to act
jointly with respect to matters as to which they share authority
under the Act in planning, developing, operating, or regulating a
national market system (or subsystem thereof) or one or more of the
facilities thereof.
\94\ The text reflects the latest unofficial compilation of the
ITS Plan supplied by the ITSOC, including all previously
incorporated amendments up to May 30, 1997.
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* * * * *
Section 1. Definitions.
(1)-(16) No Change.
(17) ``ITS/CAES Security (stock)'' means a security (stock) (a)
that is a System security[, (b) that is a 19c-3 security and (c)] and
(b) as to which one or more ITS/CAES Market Makers are registered as
such with the NASD for the purposes of Applications. When used with
reference to a particular ITS/CAES Market Maker, ``ITS/CAES security''
means any such security (stock) as to which the particular ITS/CAES
Market Maker is so registered.
(18)-(25) No Change.
[(26) ``19c-3'' security'' means an Eligible Security that is not a
``covered security'' as that term is defined in SEC Rule 19c-3 as in
effect on May 1, 1982.]
[(27)](26)
[(27A)](26A)
[(27B)](26B)
[(27C)](26C)
[(27D)](26D)
[(27E)](26E)
[(28)](27)
[(29)](28)
[(30)](29)
[(31)](30)
[(32)](31)
[(33)](32)
[(34)](33)
[(34A)](33A)
[(34B)](33B)
[(35)](34)
[(36)](35)
[(37)](36)
Section 2. No Change.
Section 3. No Change.
Section 4. Administration of ITS Plan.
(a)-(b) No Change.
(c) Amendments to the ITS Plan. Any proposed change in, addition
to, or deletion from the ITS Plan may be effected only by a means of a
written amendment to the ITS Plan which sets forth the change, addition
or deletion, is executed on behalf of [each Participant]two-thirds of
the Participants, and is approved by the SEC or otherwise becomes
effective pursuant to section 11A of the Act and Rule 11Aa3-2.
(d)-(f) No Change.
Section 5. The System.
(a) No Change.
(b) General Operation.
(i) No Change.
(ii) Selection of System Securities. The System is designed to
accommodate trading in any Eligible Security in the case of any ITS/
CAES Market Maker, trading in one or more ITS/CAES securities in which
he is registered as such with the NASD for the purposes of the
Applications. The particular securities that may be traded through the
System at any time (``System securities'') shall be selected by the
Operating Committee. The Operating Committee may add or delete System
securities as it deems appropriate and may delay the commencement of
trading in any Eligible Security if capacity or other operational
considerations shall require such delay. [ITS/CAES securities may be
traded by Exchange Participants and ITS/CAES Market Makers as provided
in the ITS Plan and other System securities may be traded by Exchange
Participants as provided in the ITS Plan.]
(c)-(d) No Change.
Section 6. No Change.
Section 7. No Change.
Section 8. No Change.
Section 9. No Change.
Section 10. No Change.
Section 11. No Change.
* * * * *
The proposed amendments do not address the manner which the costs
of implementing these changes would be apportioned because the
Commission believes the ITS Participants should decide this issue among
themselves.
Dated: July 24, 1998.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-20313 Filed 7-29-98; 8:45 am]
BILLING CODE 8010-01-M
