Federal Register / Vol. 65, No. 91 / Wednesday, May 10, 2000 / Notices 30175

14 15 U.S.C. 78s(b)(2).

15 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3Securities Exchange Act Release No. 42450

(February 23, 2000), 65 FR 10577 (‘‘Concept

Release’’). 4Securities Exchange Act Release No. 42723

(April 26, 2000).

interests of specialist units, who have

developed a relationship and a history

of market-making performance with a

listed company, and the interests of

listed companies in choosing the most

appropriate unit to be their specialist.

The Commission also believes that this

proposal provides the current

specialist(s) with a reasonable

opportunity to present their case to the

merged company’s new management

without, of course, any guarantee of

receiving the allocation. Accordingly,

the Commission believes that the

proposed changes would assist in

providing the opportunity for input and

choice on the part of the listing

company, and as such, are appropriate

and consistent with the Act.

H. Listed/Unlisted Company Mergers

The Exchange’s proposal under

Options 1 and 2 to preclude a company

resulting from a merger between a listed

company and an unlisted company from

excluding from consideration by the

Allocation Committee the specialist unit

that trades the listed company is

appropriate because it ensures that all

specialist units would be allowed to

compete to the allocation on an equal

basis.

I. Issuance of Tracking Stock

The Commission notes that the

Exchange is conforming its treatment of

target stocks to its treatment of spin-offs

and the listing of related companies. In

this situation, the Commission believes

that this is appropriate since target

stocks may have a similar relationship

with the parent’s specialist. If the patent

company is unsatisfied with the

specialist’s performance to date, the

Commission believes it is unnecessary

to include this unit in the pool if the

company so requests. In the same vein,

if the parent company is satisfied with

the specialist’s performance but wishes

to avail itself of the opportunity to

interview other units, the company

should have the option of including

such specialist in the interview pool

along with other specialists selected by

the Allocation Committee. Finally, it is

important to bear in mind that senior

management of the subject companies is

often the same as that of the parent (or

there is substantial overlap), and,

therefore, the choice of a specialist

would be influenced by an assessment

of the current relationship and marketmaking performance.

J. Allocation Sunset Policy

With respect to the Exchange’s threemonth allocation sunset policy, the

Commission believes that in a situation

where the selected specialist unit

merges or is involved in a combination

within the three-month period, the

proposal to permit the listing company

to choose whether to stay with the

merged specialist unit or be referred to

allocation, is appropriate. In this regard,

the Commission recognizes that the

listing company should have an ability

to reconsider its choice given the

changed circumstances.

K. Listing Company Attendees at

Specialist Interviews

Finally, with respect to the current

Policy, whereby a senior official of the

listing company of the rank of Corporate

Secretary or above must be present at

interviews with specialist units under

Option 2, the Commission believes that

the proposal to accommodate the listing

of a structured product company by

clarifying that any officer designated as

senior by the company may be allowed

to satisfy the requirement is appropriate,

as the corporate makeup of such a

company does not always exist in a

manner contemplated by the current

Policy.

In summary, the Commission believes

that the Exchange’s Policy can serve as

an effective incentive for specialist units

to maintain high levels of performance

and market quality to be considered for,

and ultimately awarded, additional

listings. This in turn may benefit the

execution of public orders and promote

competition among specialist units.

IV. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,14 that the

proposed rule change (SR–NYSE–99–

34), as amended, is approved.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.15

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 00–11609 Filed 5–9–00; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–42758; File No. SR–NYSE–

99–48]

Self-Regulatory Organizations; New

York Stock Exchange, Inc.; Order

Approving Proposed Change To

Rescind Exchange Rule 390

On December 10, 1999, the New York

Stock Exchange, Inc. (‘‘NYSE’’ or

‘‘Exchange’’) filed with the Securities

and Exchange Commission (‘‘SEC’’ or

‘‘Commission’’), pursuant to section

19(b)(1) of the Securities Exchange Act

of 1934 (‘‘Exchange Act’’) 1 and Rule

19b–4 thereunder,2 a proposed rule

change to rescind Exchange rule 390.

The proposed rule change was

published for comment in the Federal

Register on February 28, 2000.3 The

release publishing notice of the

proposed rule change also included a

Commission request for comment on

issues relating to market fragmentation.

The comment period relating to the

rescission of Exchange rule 390 expired

on March 20, 2000. The Commission

has received twelve comments letters

explicitly addressing whether Rule 390

should be rescinded. These comments

are summarized in section II below. The

comment period on issues related to

market fragmentation has been extended

for two weeks and now expires on May

12, 2000.4

Off-board trading restrictions such as

Rule 390 have long been questioned as

attempts by exchanges with dominant

market shares to prohibit competition

from other market centers. On their face,

such restrictions run contrary to the

Exchange Act’s objectives to assure fair

competition among market centers and

to eliminate unnecessary burdens on

competition. The NYSE has defended

Rule 390 on the basis that it was

intended to address market

fragmentation by promoting interaction

of investor orders without the

participation of a dealer, which also is

a principal objective of the Exchange

Act. Even granting the importance of

this objective, however, Rule 390 is

overbroad as a tool to address market

fragmentation—it applies in many

situations that do nothing to promote

investor order interaction. In the afterhours context, for example, it creates an

artificial incentive for trades to be

routed to foreign markets. Rule 390 also

effectively restricts the competitive

opportunities of electronic

communications networks (‘‘ECNs’’),

which use innovative technology to

operate agency markets that offer

investors a high degree of order

interaction. To avoid the

anticompetitive effect of the Rule, some

ECONs even have indicated that they

would accept the very substantial

regulatory responsibilities associated

with registering as a national securities

exchange, thereby foregoing the

streamlined requirements available

30176 Federal Register / Vol. 65, No. 91 / Wednesday, May 10, 2000 / Notices

5 17 CFR 240.19c–3.

6 17 CFR 240.19c–1.

7NYSE Rule 290(c)(i).

8NYSE Rule 290, Supplementary Material .10,

Interpretations of the Market Responsibility Rule.

9Concept Release, note 3 above, section IV.C.2.b.

10 George Reichhelm, General Partner, and

Andrew Schwarz, General Partner, AGS Specialist

Partners, dated March 16, 2000 (‘‘AGS Letter’’);

Deborah A. Lamb, Chair, Advocacy Committee, and

Maria J. A. Clark, Office of General Counsel,

Association for Investment Management and

Research, dated March 15, 2000 (‘‘AIMR Letter’’);

Fredric W. Rittereiser, Chairman and Chief

Executive Officer, and William W. Uchimoto,

Executive Vice President and General Counsel,

Ashton Technology Group, Inc., dated March 20,

2000 (‘‘Ashton Technology Letter’’); George W.

Mann, Jr., Senior Vice President and General

Counsel, Boston Stock Exchange, dated March 17,

2000 (‘‘BSE Letter’’); Craig S. Tyle, General Counsel,

Investment Company Institute, dated March 20,

2000 (‘‘ICI Letter’’); John Oddie, Chief Executive

Officer, Global Equities, Instinet Corporation, dated

March 20, 2000 (‘‘Instinet Letter’’); Timothy H.

Hosking, ITG, Inc., dated March 17, 2000 (‘‘ITG

Letter’’); Kenneth D. Pasternak, President and Chief

Executive Officer, and Walter F. Raquet, Executive

Vice President, Knight/Trimark Group, Inc., dated

March 21, 2000 (‘‘Knight/Trimark Letter’’); Robin

Roger, Managing Director and Counsel, Morgan

Stanley Dean Witter, dated March 27, 2000

(‘‘Morgan Stanley Letter’’); Richard G. Ketchum,

President, National Association of Securities

Dealers, Inc., dated March 31, 2000 (‘‘NASD

Letter’’); Marc E. Lackritz, President, Securities

Industry Association, dated March 21, 2000 (‘‘SIA

Letter’’); Robert C. King, Chairman, and Lee Korins,

President and Chief Executive Officer, Security

Traders Association, dated March 15, 2000 (‘‘STA

Letter’’).

In addition, the Commission has received other

letters that address fragmentation issues, but do not

address explicitly whether Rule 390 should be

rescinded. Copies of all comment letters are

available for inspection and copying in File No. SR–

NYSE–99–48 in the Commission’s Public Reference

Room, 450 Fifth Street, N.W., Washington, D.C.

Electronically-submitted comment letters are posted

on the Commission’s Internet web site (http://

www.sec.gov).

11AIMR Letter; Ashton Technology Letter; ICI

Letter; Instinet Letter; ITG Letter; Knight/Trimark

Letter; Morgan Stanley Letter; NASD Letter; SIA

Letter; STA Letter.

12 ITG Letter; Morgan Stanley Letter; SIA Letter

under Regulations ATS. Rescission of

Rule 390 will eliminate these distortions

of competition. The Commission will

address legitimate concerns about

assuring an opportunity for interaction

of investor orders in the context of its

ongoing review of fragmentation issues.

In an age when advancing technology

and expanding trading volume are

unleashing powerful forces for change

and new competitive challenges for the

U.S. securities markets, both at home

and abroad, the continued existence of

regulatory rules that attempt to prohibit

competition can no longer be justified.

Such rules typically succeed only in

distorting competition and introducing

unnecessary costs. The NYSE operates a

market of very high quality. It

recognizes that success in the future

will depend on its ability to adapt and

meet competitive challenges by

continuing to provide a market that

well-serves the interests of investors.

The NYSE’s proposed rule change to

rescind Rule 390 is approved.

I. Description of Proposed Rule Change

The proposed rule change rescinds

Rule 390, which generally prohibits

NYSE members and their affiliates from

effecting transactions in NYSE-listed

securities away from a national

securities exchange. Two Commission

rules already limit the reach of Rule

390. Exchange Act Rule 19c–3 5 limits

the application of Rule 390 to stocks

listed on the NYSE as of April 26, 1979.

Exchange Act Rule 19c–1 6 permits

NYSE members to trade as agent in the

over-the-counter market with another

person, except when the member also is

acting as agent for such other person. In

addition, Rule 390 itself contains ten

specific exceptions for unusual

situations, such as a transaction that is

part of a primary distribution by an

issuer.7 Finally, an interpretation of the

Rule permits members and their

affiliates to trade as principal or agent

on any organized foreign exchange at

any time, and to trade as principal or

agent in a foreign country’s over-thecounter market after regular trading

hours.8

The NYSE stated in its description of

the proposed rule change that the

intended purpose of Rule 390 was to

maximize the opportunity for customer

orders to interact with one another in

agency auction markets and be executed

without the participation of a dealer.

The NYSE also discussed its concerns

that broker-dealer internalization

practices and market fragmentation

would increase in the wake of Rule

390’s rescission. It asserted that

internalization—broker-dealers trading

as principal against their customer order

flow—results in the most objectionable

of all forms of market fragmentation: the

execution of captive customers’ orders

in a manner that isolates them from

meaningful interaction with other

buying and selling interest. The NYSE

asserted that such practices not only

decrease competitive interaction among

market centers, but also isolate segments

of the total public order flow and

impede competition among orders, with

no price benefit to the orders being

internalized.

To address these concerns, the NYSE

requested the Commission to adopt a

new market-wide rule prohibiting

broker-dealers from trading as principal

against their customer orders unless

they provide a price to the order that is

better than the national best bid or offer

against which the order might otherwise

be executed. The NYSE asserted that

this market-wide rule would assure that

investors receive the fairest pricing of

their internalized orders and would

eliminate broker-dealer conflicts of

interest in trading against their own

customer order flow to capture the

spread. The Commission’s Concept

Release sets forth the NYSE’s proposal

as one of the six potential options on

which comment is requested.9

II. Summary of Comments

The Commission received twelve

comment letters explicitly addressing

whether Rule 390 should be

rescinded.10 No commenter asserted

that the Rule should be retained. Nearly

all believed that the Rule imposed an

unnecessary burden on competition.

Four commenters, however, believed

that the Commission should not

approve the proposed rule change until

it also addressed fragmentation

concerns.

Many commenters supported

rescinding Rule 390 on the ground that

it is an unnecessary or inappropriate

burden on competition.11The STA

asserted that the rule is ‘‘an

anachronism that limits liquidity and

competition and thereof constrains

investors from always obtaining the best

possible price.’’ ITG stated that the rule

‘‘imposes an unnecessary barrier to

competition in listed securities between

exchanges and other markets’’ and

‘‘imposes unnecessary costs on market

participants.’’ Instinet stated that

‘‘[a]among the most significant factors

that make such [off-board trading] rules

obsolete is the development of

electronic intermarket linkages that will

ensure nationwide access to the best

bids and offers available in any

marketplace.’’ Although supporting the

rescission of the rule, AGC Specialist

Partners stated that Rule 390 was ‘‘not

intended as an anti-competitive

initiative but as a protection for the

public to ensure the proper exposure of

their orders.’’

Several of these commenters also

noted that rescission of the Rule would

enhance the opportunity for

competition between exchange markets

and alternative trading systems.12 The

SIA stated that ‘‘technological advances

and recent regulatory developments

[have] led to the development of a host

of alternative trading systems that

provide a similar capability operating

alongside the established markets in an

intensely competitive environment,’’

and that ‘‘[t]here is simply no

justification for regulations such as Rule

390 that restrict off-board trading.’’

Federal Register / Vol. 65, No. 91 / Wednesday, May 10, 2000 / Notices 30177

13AGS Letter; Ashton Technology Letter; ICI

Letter.

14AGS Letter; AIMR Letter; Ashton Technology

Letter; BSE Letter.

15 ICI Letter; Morgan Stanley Letter; STA Letter.

16Morgan Stanley also recommended that the

NYSE file an additional proposal with the

Commission to rescind Exchange Rule 393,

asserting that it no longer serves ‘‘any valid

regulatory purpose.’’ Rule 393 requires members to

obtain NYSE approval prior to participating in an

off-board secondary distribution of an NYSE-listed

security.

17 15 U.S.C. 78f.

18 In approving this proposal, the Commission

also has considered its impact on efficiency,

competition, and capital formation. 15 U.S.C. 78c(f).

19 15 U.S.C. 78k–1. 20See, e.g., Exchange Act Section 11A(c)(4), 15

U.S.C. 78k–1(c)(4) (provision added to the Exchange

Act in 1975 directing the Commission to review

exchange rules that impose off-board trading

restrictions); Securities Exchange Act Release no.

11628 (Sept. 2, 1975), 40 FR 41808 (Commission

commences proceedings under Exchange Act

Section 19(c) to determine whether to amend or

abrogate exchange rules that impose off-board

trading restrictions.

Morgan Stanley noted that ‘‘the rule still

may hinder the establishment and

development of alternative OTC trading

systems and markets in non-19c–3 listed

stocks.’’

Other commenter believed that the

Commission should take action to

address possible collateral effects that

could occur in the wake of rescinding

Rule 390.13 Ashton Technology stated

that is supported the rescission of the

rule ‘‘if conditioned upon adoption of

the NYSE Proposal as modified by an

order exposure alternative, applying

equally to upstairs market makers and

exchange specialists, and calling for a

new high powered routing mechanism

with auto-execution capabilities to

access and trade against ‘exposed’

orders.’’ The ICI supported the NYSE’s

recommendation that the Commission

adopt ‘‘a market-wide requirement that

broker-dealers not be permitted to trade

as principal with their own customer

order unless they provide for ‘price

improvement,’ i.e., a price to the order

that is better than the national bid or

offer against which the order might

otherwise be executed.’’ Nevertheless,

ICI believed that the rescission of Rule

390 should not be delayed while the

Commission considered whether to

adopt a price improvement requirement.

Other commenters did not support the

NYSE’s proposal. The Knight/Trimark

Group stated that the ‘‘NYSE’s’’

recommendation that the Commission

adopt a new rule requiring brokerdealers to improve on the NBBO if they

trade with customer orders as principal

is an attempt to replace an Exchange

rule that is explicitly anticompetitive

with a Commission rule that is

implicitly anticompetitive.’’ The NASD

criticized the NYSE proposal because it

believed the proposal would ‘‘allow

NYSE specialists to match the NBBO,

while requiring market makers to

attempt to improve [the NBBO] and also

to bear the risk of the NBBO moving

away in the interim.’’ The NASD stated

that best execution and order display

obligations could achieve the same

objectives as the NYSE’s proposal.

Other commenters believed that the

Commission should not approve the

rescission of Rule 390 until it addressed

market fragmentation issues.14 The

AIMR noted that while it tentatively

supports the rescission of the Rule, it

‘‘strongly believes that the present issue

and those surrounding market

fragmentation, which the Commission

highlighted in its official request for

public comment, are so closely related

that the Commission cannot

meaningfully consider each issue in

isolation of the others.’’ It requested that

the Commission delay its decision

regarding Rule 390 until the

Commission had reviewed all public

comments addressing possible market

fragmentation and related issues.

Finally, the BSE stated that ‘‘[a]t the

very least, perhaps the Commission

should deny the NYSE’s requests to

rescind Rule 390 until the Commission

is satisfied that is rescission will not

have a deleterious impact on the market,

or until it has decided on the solution

to any such anticipated deleterious

impact’’.

In contrast, other commenters did not

believe that the approval of Rule 390

should be delayed.15 The STA stated

that ‘‘the question of internalization of

customer orders touches upon a great

number of important, compelling and

interrelated issues regarding the roles of

the exchanges, market makers, ECNs

and investors,’’ and that it was

‘‘inappropriate to link this complex and

possibly contentious proposal with the

proposal to rescind Rule 390.’’ Morgan

Stanley also believed that the

Commission should not delay in its

approval of the proposed rule change

‘‘pending its determination of what

regulatory action should be taken to

address the fragmentation issues.’’ 16

III. Discussion

The Commission finds that the

proposed rule change is consistent with

Section 6 of the Exchange Act 17 and the

rules and regulations thereunder

applicable to a national securities

exchange.18 In particular, the

Commission finds the proposed rule

change is consistent with section

6(b)(5), which requires, among other

things, that the rules of an exchange be

designed to promote just and equitable

principles of trade, to remove

impediments to and perfect the

mechanism of a free and open market

and a national market system and, in

general, to protect investors and the

public interest, and section 6(b)(8),

which requires that the rules of an

exchange not impose any burden on

competition not necessary or

appropriate in furtherance of the

Exchange Act. The rescission of Rule

390 also is consistent with section 11A

of the Exchange Act,19 which sets forth

the findings and objectives that are to

guide the Commission in its oversight of

the national market system. Rescinding

Rule 390 will help further the national

market system objective in section

11A(a)(1)(C)(i) to assure the

economically efficient execution of

securities transactions and in section

11A(a)(1)(C)(ii) to assure fair

competition between exchange markets

and markets other than exchange

markets.

Rule 390 long has been questioned by

the Commission and others because it

directly restricts a certain type of market

center competition—competition

between exchange markets and markets

other than exchange markets.20 Given

the explicit national market system

objective to assure fair competition

among market centers, as well as the

requirement that the rules of a national

securities exchange not impose any

burden on competition not necessary or

appropriate in furtherance of the

Exchange Act, Rule 390 has been

suspect on its face.

The NYSE has defended Rule 390 on

the basis that is purpose was not to

protect the NYSE’s competitive

position, but to protect customer

interests by assuring a greater

opportunity for interaction of investors’

orders without the participation of a

dealer, This type of order interaction is

also a principal objective of the national

market system set forth in section

11A(a)(1)(C)(v) of the Exchange Act.

Over the years, the Commission has

sought to cut back on Rule 390 in ways

that would reduce its anticompetitive

nature without inappropriately reducing

the opportunity for investor orders to

interact. Exchange Act Rule 19c–1

allows NYSE members to execute trades

in markets other than exchange markets

as agents for their customers. Exchange

Act Rule 19c–3 systematically has

reduced the scope of Rule 390 over time

as more and more companies have listed

their stocks on the NYSE in the years

since 1979. Nevertheless, the Rule still

applies to securities that generate nearly

one-half of total NYSE trading volume,

30178 Federal Register / Vol. 65, No. 91 / Wednesday, May 10, 2000 / Notices

21 Jeffrey Bacidore, Katharine Ross & George

Sofianos, Quantifying Best Execution at the New

York Stock Exchange: Market Orders, NYSE

Working Paper 99–05 (December 1999) at 1 n.2 (‘‘At

the end of October 1999, 23 percent of NYSE issues

accounting for 46 percent of the volume were

subject to Rule 390.’’).

22The trades executed in foreign markets also are

not subject to NYSE surveillance or the

Commission’s regulatory oversight.

23For example, none of the various exceptions to,

and limitations on, the scope of Rule 390 would

generally allow an NYSE member to trade as

principal in a U.S. market operated by an ECN.

24See Concept Release, note 3 above, at n.26 and

accompanying text.

25Securities Exchange Act Release No. 37619A

(Sept. 6, 1996), 61 FR 48290.

26Securities Exchange Act Release No. 40760

(Dec. 8, 1998), 63 FR 70844.

27Securities Exchange Act Release No. 42536

(Mar. 16, 2000), 65 FR 15401.

28See, e.g., Hendrik Bessembinder, Trade

Execution Costs on NASDAQ and the NYSE: A

Post-Reform Comparison, 34 J. Financial &

Quantitative Analysis 387, 389 (2999) (‘‘ This study

finds that trade execution costs remain larger on

NASDAQ compared to the NYSE even after the new

SEC order-handling rules are implemented, and that

the difference in average trading costs is not

attributable to variation in observable economic

characteristics of the listed stocks.’’); Marshall E.

Blume & Michael A. Goldstein Quotes, Order Flow,

and Price Discovery, 52 J. Finance 221, 232 (1997)

(‘‘The NYSE bid price equals on average the best

bid price 97.1 percent of the time, and the NYSE

ask price equals the best ask price 96.9 percent of

the time.’’); Joel Hasbrouck, One Security, Many

Markets: Determining the Contributions to Price

Discovery, 50 J. Finance 1175, 1197 (1995) (an

analysis of ‘‘price discovery for equities traded on

the NYSE and regional exchanges revealed that

‘‘price discovery appears to be concentrated at the

NYSE: the median information share is 92.7

percent’’): Justin Schack, Cost Cotnainment,

Institutional Investor, Nov. 1999, at 43 (worldwide

survey of institutional investor trading costs found

that ‘‘[f]or the first time even NYSE-listed shares

took top honors for the cheapest cost of execution

anywhere in the world’’); compare Louis K.C. Chan

& Josef Lakonishok, Institutional Equity Trading

Costs: NYSE verus Nasdaq, 52 J. Finance 713,

(1997) (comparison of execution costs for

institutional investors on Nasdaq and NYSE found

that ‘‘costs are lower on Nasdaq for trades in

comparatively smaller firms, while costs for trading

larger stocks are lower on NYSE’’).

29Some ECNs offer an opportunity for large

trading interest to interact by including a reserve

including many of the most active NYSE

issues.21

The Commission believes that

whatever beneficial effect Rule 390 may

have in enhancing the interaction of

investor orders can no longer justify

anticompetitive nature. To the extent

the Rule promotes the interaction of

investors’ orders, it does so in an

undesirable way—by attempting a direct

restriction on competition. Such

attempts can never be wholly successful

and typically succeed primarily in

distorting, rather than eliminating,

competition and introducing

unnecessary costs. An egregious effect

of Rule 390 is the artificial incentive it

provides for NYSE members to route

orders to foreign OTC markets for

execution after regular trading hours.

Such distortions can no longer be

justified in an increasingly competitive

international environment.22

In addition, Rule 390 is much too

broad even when considered solely as a

tool to address market fragmentation

and to promote the interaction of

investor orders. As noted by several

commenters, the Rule effectively

restricts NYSE members from

participating in markets operated by

ECNs or ATSs.23 These market centers

offer their customers, among other

things, agency limit order books that

provide a high degree of investor order

interaction. Using advanced technology

for communicating and organizing

information, ECNs can offer a number of

advantages to investors, including low

costs, fast display of limit orders, and

fast executions against displayed trading

interest.

These ECN limit order markets also

can benefit the national market system

as a whole by enhancing the process of

public price discovery. Displayed limit

orders are perhaps the most significant

source of price competition in the

securities markets. Limit order markets

also allow for both investor and brokerdealer participation, but minimize

principal-agent conflicts by adopting

trading rules that establish a level

playing field for the trading interest of

both investors and broker-dealers—

principally through price/time priority

rules. Whatever limit order is first in

line at the best price, whether submitted

by investor or broker-dealer, such limit

order has the right to trade first at that

price. Price competition in invigorated

and spreads are narrowed because those

who improve the best bid or offer

through limit orders know that they will

be the first to trade. The price/time

priority rules of limit order markets also

can enhance depth and liquidity by

providing an incentive for trading

interest to stack up at prices that are at

or around the best bid and offer.

Because the second, third, and fourth

orders in line at a price will be the

second, third, and fourth to trade at that

price (and so on), there is a strong

incentive to submit limit orders even at

prices that match or are outside the best

bid or offer. The deeper a market, the

less vulnerable it will be to excessive

short-term price swings.24

In recent years, the Commission has

taken a number of steps that have paved

the way for ECNs to compete with

established market centers and be

integrated into the national market

system. In 1996, the Commission

adopted the Order Handling Rules,25

which required, among other things, the

inclusion in the consolidated national

best bid and offer (‘‘NBBO’’) of limit

order prices and sizes that improved the

market for a security (by either

improving the price of the NBBO or

adding significant depth to the NBBO).

These rules applied to both customer

limit orders handled by specialists and

market makers, as well as the limit

orders of specialists and market makers

themselves if they were displayed in an

ECN. In 1998, the Commission adopted

Regulation ATS,26 which provides a

streamlined regulatory regime for

trading systems (including ECNs) that

choose to be regulated as ATSs. In

addition, ATSs with significant trading

volume are required to display publicly

their ‘‘top-of-book’’ trading interest in

the consolidated national quote stream,

even if such interest is not associated

with a specialist or market maker. Most

recently, the Commission approved a

proposed rule change by the NASD that

would enable ECNs to participate in the

Intermarket Trading System that links

market centers trading listed

securities.27 With the rescission of Rule

390, yet another regulatory barrier to

competition will be eliminated.

The Commission emphasizes strongly,

however, that its desire to clear away

regulatory barriers to competition from

ECNs in the listed market should not be

interpreted as an indication of whether

the ECNs will or should attract a

significant amount of listed market

share. That will be determined by

competition. Similarly, the

Commission’s criticism of Rule 390

should not be interpreted as a criticism

of the quality of the NYSE’s market. To

the contrary, studies repeatedly have

demonstrated the merits of the NYSE’s

market, both in terms of its execution

quality and its public price discovery

function.28

The NYSE offers a multi-facted

trading mechanism that can

accommodate a wide variety of

participants and trading strategies. Like

the ECNs, it offers a limit order book

with price/time priority among orders

on the book. In addition, the NYSE,

through its floor, offers a mechanism for

investors with large trading interest to

be represented in the market. Such

investors typically will not display their

full interest in a limit order because it

likely would move the market against

them, thereby increasing their

transaction costs or even precluding any

execution at all. The NYSE floor allows

the large trading interest to interact with

trading interest of all sizes on the other

side of the market.29 This enhanced

Federal Register / Vol. 65, No. 91 / Wednesday, May 10, 2000 / Notices 30179

size feature in their limit order book. See Concept

Release, note 3 above, at text accompanying n.27. 30See Quantifying Best Execution, note 21 above,

at Table 10 & Table 14. A market’s price

improvement rate is affected by the quality of the

publicly displayed quotations that are ‘‘priceimproved.’’ The quality of the NYSE’s public

quotations is one of the issues addressed in the

studies cited in note 28 above. 31See Kenneth A. Kavajecz, A Specialist’s Quoted

Depth and the Limit Order Book, 54 J. Finance 747,

753 (1999) (comparison of spreads on NYSE limit

order book with specialist’s quoted spreads

‘‘suggests that the specialist plays an important role

in narrowing the spread the market participants

face when demanding liquidity, especially for

smaller (less frequently traded) stocks.’’).

32 In February 2000, the agency markets operated

by ECNs executed approximately 19% of the share

volume in Nasdaq securities, a drop of 3% from

September 1999. See NASD Economic Research

Dept., <http://www.marketdata.nasdaq.com>

(visited April 10, 2000) (In February 2000, ECNs

that are ATSs collectively accounted for 19.2% of

Nasdaq share volume, 25.1% of Nasdaq dollar

volume, and 24.6% of Nasdaq trades.); NASD

Economic Research Dept., <http://

www.marketdata.nasdaq.com> (visited Dec. 11,

1999) (In September 1999, ECNs that are ATSs

collectively accounted for 22.2% of Nasdaq share

volume, 29.2% of Nasdaq dollar volume, and 28.0%

of Nasdaq trades.). In calculating the market share

of ATSs, the NASD adds orders executed internally

on an ATS and the orders routed to an ATS for

execution. Orders routed out to another market

participant are not included.

33See, e.g., Lawrence Harris, Consolidation,

Fragmentation, Segmentation, and Regulation, in

Modernizing U.S. Securities Regulation: Economic

and Legal Perspectives 269, 286 (Kenneth Lehn &

Robert W. Kamphius, Jr., eds., 1992) (‘‘[F]ew

brokerage clients—and probably no small clients—

can observe, monitor, and measure their brokers’

efforts at low cost. Given the high volatility of

securities prices, the general lack of real-time

market information available to most brokerage

clients, and the high cost of processing that

information even when it is readily available, most

clients cannot accurately determine whether their

orders are well executed or not. Moreover, even if

they could measure their broker’s performance,

fairly evaluating that information is still more

difficult. A fair evaluation would require that the

clients compare the quality of service offered by at

least a few different brokers’’) (footnotes omitted).

Retail investors have greater access to real-time

market information today than in 1992. The order

barriers to monitoring execution quality continue to

exist.

opportunity for interaction can benefit

both large and small investors. Indeed,

the NYSE’s very substantial price

improvement rate for smaller orders is

attributable to such interaction—more

than 50% of market orders of less than

500 shares routed to the NYSE floor in

stocks with a quoted spread of greater

than 1⁄16th are executed at a price better

than the NBBO.30

Finally, the NYSE has adopted a

comprehensive set of trading rules that

address the potential principal-agent

conflicts that can arise when both

broker-dealers and their customers trade

in the same market center. These rules

are intended to prevent NYSE members

and professionals from obtaining unfair

advantages in trading. In addition, the

NYSE incorporates one market maker—

the specialist—into its trading

mechanism. Specialist trading is limited

to help assure that it supplements, but

does not supplant, public trading

interest and thereby contributes to a fair

and orderly market.31 The NYSE also

monitors the actual performance of its

specialists to assure that they comply

with their affirmative and negative

market-making responsibilities. The outcome of the competition

between the NYSE and other market

centers will depend on which market

centers are most able to serve investor

interests by providing the highest

quality trading services at the lowest

possible costs. The Commission’s

regulatory task is removing unwarranted

regulatory barriers to competition

between the NYSE and other market

centers. Its approval of the rescission of

Rule 390 is intended solely to free the

forces of competition and allow investor

interests to control the success or failure

of individual market centers.

Freeing of forces of competition to

serve investor interests underlies the

Commission’s comprehensive review of

issues related to market fragmentation.

As discussed in the Concept Release,

the Commission is concerned about

certain broker-dealer practices that may

substantially reduce the opportunity for

investor orders to interact. Reduced

order interaction may hamper price

competition, interfere with the process

of public price discovery, and detract

from the depth and stability of the

markets.

Currently, brokers that handle

customer orders have a strong financial

incentive either to internalize their

orders by trading against them as

principal or to route their orders to

dealers that will trade against them as

principal and share a portion of the

profits with the broker. Internalization

and payment for order flow

arrangements provide dealers with a

guaranteed source of order flow,

eliminating the need to compete

aggressively for orders on the basis of

their displayed quotation. Instead, the

dealers can merely match the prices that

are publicly displayed by other market

centers. These prices in many cases will

represent limit orders that are displayed

by agency market centers (such as the

NYSE or an ECN). The limit orders may

be denied an opportunity for an

execution if dealers choose not be route

orders to the market center displaying

the limit orders and instead match the

limit order prices.32

Price-matching dealers thereby take

advantage of the public price discovery

provided by other market centers

(which must make their best prices

publicly available pursuant to Exchange

Act price transparency requirements),

but do not themselves necessarily

contribute to the process of public price

discovery. Moreover, if a substantial

portion of the total order flow in a

security is subject to dealer pricematching arrangements, it reduces the

ability of other dealers to compete

successfully for order flow on the basis

of their displayed quotations. In both

cases (unfilled limit orders and

disregarded dealer quotations), those

market participants who are willing to

participate in public price discovery by

displaying firm trading interest at the

best prices are not rewarded for their

efforts. This creates disincentives for

vigorous price competition, which, in

turn, could lead to wider bid-asked

spreads, less depth, and higher

transaction costs. These adverse effects

would harm all orders, not just the ones

that are subject to internalization and

payment for order flow arrangements.

Consequently, a loss of execution

quality and market efficiency may not

be detectable simply by comparing the

execution prices of orders that are

subject to such arrangements with those

that are not.

Moreover, an agent-principal

monitoring problem may tend to

perpetuate rather than alleviate the

isolation of investor orders that are

subject to internalization and payment

for order flow arrangements. It can be

very difficult for retail customers to

monitor the quality of execution

provided by their brokers, particularly

in fast-moving markets.33 Given the

difficulty of monitoring execution

quality, the most rational strategy for

any individual customer may be simply

to opt for the lowest commission

possible (which may be low in part

because the broker is receiving payment

for order flow, part of which is passed

on the customer). If many individual

customers adopt this strategy, it could

blunt the forces that otherwise would

reward market centers that offer high

quality executions.

Finally, the fragmentation concerns

raised in the Concept Release are not

limited to assuring that investors receive

at least the best displayed prices,

whatever they happen to be. Assuring

that investors receive the best prices

displayed anywhere in the national

market system is crucial, but is not

sufficient to assure that the best prices

displayed in the system are the most

efficient prices reasonably possible. For

example, the spread between the best

displayed bid and the best displayed

offer may be wider than it otherwise

would be if a

30180 Federal Register / Vol. 65, No. 91 / Wednesday, May 10, 2000 / Notices

34The spread between the best bid and offer is

an indication of the premium that must be paid by

investors seeking liquidity and therefore of the

efficiency of the market. See Concept Release, note

3 above, at n.20 and accompanying text.

35See Concept Release, note 3 above, section

IV.C.2.b.

36After the end of the comment period, the

Commission intends to review expeditiously the

comments submitted in response to the Concept

Release and determine what, if any, further action

is necessary. 37 15 U.S.C. 78s(b)(2).

market structure fails to promote

vigorous price competition.34 Similarly,

the depth of trading interest at the best

displayed prices may be very thin, so

that prices will be more volatile than

they otherwise would be if a market

structure does not reward traders for

displaying multiple orders (and thereby

adding depth) at the best prices. In

addition, some market centers offer

investors an opportunity for price

improvement—an execution at a price

better than the best displayed prices. To

meet their best execution

responsibilities, brokers must take these

price improvement opportunities into

consideration in deciding where to

route customers orders.

Several commenters believed that the

Commission should not approve the

rescission of Rule 390 until it had

addressed market fragmentation

concerns. The Commission does not

believe, however, that the potential

fragmentation of the listed market due

to an increase in internalization and

payment for order flow arrangement

warrants a delay in approving the

proposed rule change. First, the

Commission already has commenced its

review of market fragmentation issues,

and the comment period for the Concept

Release ends on May 12, 2000. Several

of the six potential options to address

fragmentation set forth in the Concept

Release would address internalization

and payment for order flow

arrangements.35 The Concept Release

also requests comment on any

additional options, or modifications of

any of the six options, that commenters

believe would be useful in addressing

fragmentation.36 Second, the

Commission intends to monitor any

significant changes in the order-routing

practices of NYSE members resulting

from the rescission of Rule 390,

particularly decisions to internalize

their customer order flow. To comply

with the duty of best execution owed

their customers, brokers would need to

assure that such changes further their

customers’ interests and not merely

their own.

IV. Conclusion

It is Therefore Ordered, pursuant to

Section 19(b)(2) of the Act,37 that the

proposed rule change (SR–NYSE–99–

48) is approved.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 00–11682 Filed 5–9–00; 8:45 am]

BILLING CODE 8010–01–M

SMALL BUSINESS ADMINISTRATION

[Declaration of Disaster #3241]

State of Ohio; Amendment #1

In accordance with information

received from the Federal Emergency

Management Agency, the abovenumbered Declaration is hereby

amended to extend the deadline for

filing applications for physical damage

as a result of this disaster from May 6,

2000 to May 8, 2000.

All other information remains the

same, i.e., the deadline for filing

applications for economic injury is

December 7, 2000.

(Catalog of Federal Domestic Assistance

Program Nos. 59002 and 59008)

Dated: April 28, 2000.

Bernard Kulik,

Associate Administrator for Disaster

Assistance.

[FR Doc. 00–11644 Filed 5–9–00; 8:45 am]

BILLING CODE 8025–01–P

DEPARTMENT OF STATE

[Public Notice 3307]

Culturally Significant Objects Imported

for Exhibition Determinations:

‘‘Painting on Light: Drawings and

Stained Glass in the Age of Durer and

Holbein’’

DEPARTMENT: United States Department

of State.

ACTION: Notice.

SUMMARY: Notice is hereby given of the

following determinations: Pursuant to

the authority vested in me by the Act of

October 19, 1965 (79 Stat. 985, 22 U.S.C.

2459), the Foreign Affairs Reform and

Restructuring Act of 1998 (112 Stat.

2681, et seq.), Delegation of Authority

No. 234 of October 1, 1999, and

Delegation of Authority No. 236 of

October 19, 1999, as amended, I hereby

determine that the objects to be

included in the exhibition ‘‘Painting on

Light: Drawings and Stained Glass in

the Age of Durer and Holbein,’’

imported from abroad for the temporary

exhibition without profit within the

United States, are of cultural

significance. These objects are imported

pursuant to loan agreements with

foreign lenders. I also determine that the

exhibition or display of the exhibit

objects at the J. Paul Getty Museum in

Los Angeles, CA, from July 11, 2000

through September 24, 2000, and at the

St. Louis Museum of Art in St. Louis,

MO from November 4, 2000 through

January 7, 2001 is in the national

interest. Public Notice of these

Determinations is ordered to be

published in the Federal Register.

FOR FURTHER INFORMATION CONTACT: For

further information, including a list of

exhibit objects, contact Jacqueline

Caldwell, Attorney-Adviser, Office of

the Legal Adviser, U.S. Department of

State (telephone: 202/619–6982). The

address is U.S. Department of State, SA–

44, 301 4th Street, SW., Room 700,

Washington, DC 20547–0001.

Dated: May 4, 2000.

William B. Bader,

Assistant Secretary for Educational and

Cultural Affairs, United States Department

of State.

[FR Doc. 00–11701 Filed 5–9–00; 8:45 am]

BILLING CODE 4710–08–P

DEPARTMENT OF TRANSPORTATION

Office of the Secretary

Aviation Proceedings, Agreements

Filed During the Week Ending April 7,

2000

The following Agreements were filed

with the Department of Transportation

under the provisions of 49 U.S.C.

Sections 412 and 414. Answers may be

filed within 21 days after the filing of

the application.

Docket Number: OST–2000–7203.

Date Filed: April 5, 2000.

Parties: Members of the International

Air Transport Association.

Subject:

PTC COMP 0609 dated 31 March 2000

Mail Vote 074—Resolution 024j

Special Construction Rules

(Amending)

Intended effective date: 15 April 2000

Andrea M. Jenkins,

Federal Register Liaison.

[FR Doc. 00–11687 Filed 5–9–00; 8:45 am]

BILLING CODE 4910–62–P