[Federal Register Volume 65, Number 28 (Thursday, February 10, 2000)]
[Notices]
[Pages 6664-6665]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-3036]


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SECURITIES AND EXCHANGE COMMISSION

(Release No. 34-42383; File No. SR-Amex-99-35)


Self-Regulatory Organizations; American Stock Exchange LLC; Order 
Approving Proposed Rule Change To Rescind Exchange Rule 106, 
``Substitute Principals''

February 3, 2000.

I. Introduction

    On September 1, 1999, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or `Commission'') pursuant to Section

[[Page 6665]]

19(b)(1) of the Securities Exchange Act of 1934 (`Act''),\1\ and Rule 
19b-4 thereunder,\2\ a proposed rule change to rescind Exchange Rule 
106. The proposed rule change was published for comment in the Federal 
Register on October 22, 1999.\3\ The Commission did not receive any 
comment letters with respect to the proposal. This order approves the 
Exchange's proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 42010 (Oct. 14, 1999), 
64 FR 57167.
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II. Description of the Proposal

    The Amex proposes to delete Exchange Rule 106, ``Substitute 
Principals.'' Exchange rule 106 currently provides that: ``No party to 
a contract shall be compelled to accept a substitute principal unless 
the name proposed to be substituted was declared in, and as part of, 
the bid or offer giving rise to the contract.'' Rule 106 dates back to 
the 1921 Constitution of the New York Curb market,\4\ a predecessor of 
the Exchange. The Rule's original purpose appears to be related to the 
clearance and settlement of trades, specifically, the terms of 
contracts and the creditworthiness of counterparties. The proposed rule 
change was filed in response to a recent dispute where an Exchange 
member invoked Rule 106 in an attempt to renege on a contract. 
Apparently, the Exchange member's counterparty provided an incorrect 
give-up at the time of the trade, and later sought to correct the error 
by substituting the correct clearing member.
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    \4\ Section 7 of the Article XXIV of the 1921 Constitution of 
the New York Curb Market stated: ``No party to a contract shall be 
compelled to accept a substitute principal, unless the name proposed 
to be substituted shall be declared in marking the offer and as a 
party thereof.''
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III. Discussion

    For the reasons discussed below, the Commission finds that the 
proposed rule change is consistent with the Act and the rules and 
regulations under the Act applicable to national securities exchange. 
In particular, the Commission believes the proposed rule change is 
consistent with the Section 6(b)(5) \5\ requirements that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, prevent fraudulent and manipulative acts and practices, and 
protect investors and the public interest.\6\ The Commission also finds 
that the proposal may serve to remove impediments to and perfect the 
mechanism of a free and open market by rescinding Rule 106, which 
provides a potential basis for parties to Exchange contracts to break 
trades without appropriate justification.
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    \5\ 15 U.S.C. 78f(b)(5).
    \6\ In approving this proposed rule change, the Commission has 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
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    Since Exchange Rule 106 was adopted in 1921 the process of 
clearance and settlement has evolved. Broker-dealers no longer compare 
individual trades as was the case at the time of the inception of 
Exchange Rule 106. Today, trades executed on the Amex are required to 
be cleared and settled through a registered clearing agency.\7\ 
Typically, clearing agencies guarantee the completion of a transaction 
by becoming the counterparty to each side of the transaction. This has 
substantially reduced the risk of trade default and made concerns about 
counterparty identity largely irrelevant.
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    \7\ See American Stock Exchange Constitution, Article X, Section 
2.
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    Clearing agencies perform comparison, clearance, and settlement of 
trades. Clearance activities confirm the identity and quantity of the 
security being bought or sold, the transaction price and date, and the 
identity of the buyer and the seller, Settlement is the fulfillment, by 
the parties to the transaction, of the obligations of the trade.
    The largest clearing agency is the National Securities Clearing 
Corporation (``NSCC''), which acts as the contraside to every trade it 
processes. The NSCC guarantees the trades of its member participants 
and incurs the risk of default from the time of the guarantee until the 
settlement of obligations and payments. Thus, it is the NSCC and not 
the Exchange member--as was the case in 1921--who assumes counterparty 
risk. When the NSCC guarantees a trade, it becomes the buyer to every 
seller and the seller to every buyer. As a result, the clearing 
corporation incurs the risk that a counterparty to a transaction might 
default on its obligations.
    Rule 106 was adopted in another era, prior to the utilization of 
modern clearing practices. The total assumption of default risk by 
clearing agencies has obviated the need for Exchange members to 
maintain strict control over the identify of trading counterparties. 
Because clearing corporations like NSCC eliminate the risk of trade 
default, trades are guaranteed irrespective of the identity of a 
counterparty. Thus, in light of clearance corporations and modern 
clearance and settlement practices, Rule 106 no longer serves the 
purpose of protecting a counterparty from the default risks associated 
with a trade.
    Furthermore, Rule 106 may have the disruptive effect of permitting 
parties to Exchange contracts to break trades without appropriate 
justification. This kind of action is contrary to the goals of 
preserving the public's interest and protecting investors. The 
Commission therefore believes it is appropriate for the Exchange to 
rescind Rule 106.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\8\ that the proposed rule change (SR-Amex-99-35) is approved.
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    \8\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-3036 Filed 2-9-00; 8:45 am]
BILLING CODE 8010-01-M