40748 Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices

5UtiliCorp expects to acquire the Australian

Companies in the near term using bank borrowings

at a subsidiary level, which may require a guarantee

by UtiliCorp or from its existing earnings and/or

debt facilities at the UtiliCorp level. UtiliCorp states

that its obligations are subject to multiple state

approvals.

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’’).

2Rule 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

metropolitan area of Melbourne, with

fixed assets valued at approximately

N.Z. $650.5 million; (5) Energy 21

(‘‘Energy 21’’), a gas retail company,

serving eastern Melbourne, the

Morningstar Peninsula and northern

and western Victoria; (6) Stratus

(‘‘Stratus’’), a gas distribution company,

with fixed assets valued at

approximately N.Z. $650.5 million,

serving the northern and southeastern

suburbs of Melbourne and the

Morningstar Peninsula; and (7) Gas

Transmission Corporation (‘‘GTC’’), a

gas transmission and supply company

(Kinetick, Westar, Ikon, Multinet,

Energy 21, Stratus and GTC collectively,

‘‘Australian Companies’’).

The bidding process for the

Australian Companies will be

conducted by the Victorian government

in two phases, commencing in June

1998 and ending in November 1998. For

purposes of the bidding process, the

paired companies of Kinetik and

Westar, Ikon and Multinet, and Energy

21 and Stratus, are regarded as

‘‘stapled’’ businesses. UtiliCorp expects

to submit bids for the Australian

Companies through one or more

subsidiaries, which may invest as a

member of a group on consortium. For

Australian tax considerations, UtiliCorp

explains that it may structure the

proposed acquisitions as a series of asset

and stock acquisitions.

UtiliCorp proposes to acquire an

equity ownership interest of up to, but

not more than, 50% in one or more of

the three stapled businesses. With

respect to GTC, UtiliCorp proposes to

acquire a less than twenty percent

interest. UtiliCorp plans to invest no

more than $500 million in any

combination of permissible acquisitions

under the bidding rules established by

the Victorian government.5

Neither UtiliCorp nor any corporation

owned or controlled by UtiliCorp is a

holding company subject to regulation

under the Act or a subsidiary company

of a holding company subject to

regulation under the Act. None of the

Australian Companies is a public utility

company operating in the United States.

None of the Australian Companies

presently serves, and following the

proposed acquisitions by UtiliCorp none

will serve, customers in the United

States. None of the Companies is

qualified to do business in any state of

the United States; each operates

exclusively within Australia.

UtiliCorp requests an order under

section 3(b) of the Act exempting each

of the Australian Companies from all

provisions of the Act. UtiliCorp states

that none of the Australian Companies

will derive any material part of its

income, directly or indirectly, from

sources within the United States.

Further, none of the Australian

Companies will be, or have any

subsidiary company which is, a public

utility company operating in the United

States. UtiliCorp asserts that rule

10(a)(1) will provide an exemption for

UtiliCorp and any subsidiary of

UtiliCorp insofar as they are holding

companies of the Australian Companies.

Further, UtiliCorp asserts that rule

11(b)(1), together with rule 10(a)(1), will

provide an exemption from the approval

requirements of sections 9(a)(2) and 10

to which UtiliCorp would otherwise be

subject.

For the Commission, by the Division of

Investment Management, under delegated

authority.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–20314 Filed 7–29–98; 8:45 am]

BILLING CODE 8010–01–M

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.

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
Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices 40749

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.

3Pub. L. 94–29 (June 4, 1975).

4Section 11A(a)(1)(D) of the Act, 15 U.S.C. 78k–

1(a)(1)(D).

5Securities 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.

8The 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).

11Securities 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.

12Securities 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.

13The 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.

15The 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.

18Securities 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’’).

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.

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

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

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

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

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-thecounter 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

On June 11, 1980, the Commission

adopted Rule 19c–3 under the Act,

which eliminated off-board trading

restrictions with respect to most newlylisted 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
40750 Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices

19The term ‘‘internalization’’ refers to ‘‘the

withholding of retail orders from other market

centers for the purpose of executing them ‘‘inhouse,’’ 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.

20The 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.

21 Id. at 15–16, 45 FR 41127.

22These 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.

23See 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.

24See 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.

25See 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.

26With 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.

27Fragmentation 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).

29Securities Exchange Act Release No. 17744

(April 21, 1981), 46 FR 23856 (April 28, 1981).

30Securities 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.

31A majority of the amendments were noncontroversial 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 tradethrough 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’ tradethrough 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

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

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

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

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
Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices 40751

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.

32See 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.’’).

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’’).

35Specifically, 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.

37See Securities Exchange Act Release No. 36310

(September 29, 1995), 60 FR 52792 (October 10,

1995).

38See Order Execution Rules, supra note 36.

39Preliminarily, 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.

40See 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’’).

41Section 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 selfregulatory 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

Continued

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

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 nonRule 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

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

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 anticompetitive 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 anticompetitive 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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Release No. 16410 (December 7, 1979), at 13–14, 44

FR 72607, 72608–09.

42See Securities Exchange Act Release No. 19456

(January 27, 1983), 48 FR 4938 (February 3, 1983).

43More 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.

44The 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’’).

45See Securities Exchange Act Release No. 34280

(June 29, 1994), 59 FR 34880 (July 7, 1994).

46See 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.

47See NYSE 1996 Fact Book at 26 and 14.

48The 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.

49The 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.

50Non-exchange member OTC market makers

presently are able to access exchange floors only

through correspondent relationships with member

firms.

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.

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.

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 exchangelisted 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 nonRule 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.

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
Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices 40753

51See Section 11A(a)(1)(C)(ii) of the Act, 15

U.S.C. 78k–1(a)(1)(C)(ii).

52Currently, third market makers can trade nonRule 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.

53See Market 2000 Study, supra, note 34.

54See 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.

55See 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’’).

56See NYSE Letter, supra note 55.

57See Joint Letter, supra note 55.

58See CSE Letter, supra note 55.

59See Amex Letter, supra note 55.

60See 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.

61Prior to 1980, third market principal

transactions were reported to the consolidated

system at a ‘‘net’’ price which included the markup 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

Continued

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.

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.

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

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

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 tradethrough rule, if the linkage were

expanded. One Participant believes that

the NASD must implement a tradethrough 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 tradethrough 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

The Participants also expressed

concerns regarding adequate tradereporting 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
40754 Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices

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.

62See 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 nonRule 19c–3 securities, has indicated that it intends

to modify its last trade reporting rules for exchangelisted securities in order to address concerns

relating to the ITS/CAES linkage expansion. See

NASD Petition, supra note 36.

64The 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.

66The 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.

67See 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.

69The Firm Quote Rule by its terms applies to ITS

commitments.

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

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

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

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

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
Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices 40755

70See Section 21(a) Report at note 134 and

accompanying text.

71See Exchange Act Rule 11Ac1–1.

72See May 27 Letter, supra note 39.

73See Minutes from the ITS Users’ Committee

and ITSOC meetings held on September 18 and 19,

1997, respectively.

74CHX, CSE and PCX have received Commission

approval to trade SPDRs and MidCap SPDRs, both

Amex products.

75The single Participant subsequently changed its

position to support the Plan amendment.

76Two 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).

77See Joint Letter, supra note 55.

78See id.

79See id.

80See 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

Continued

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

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.

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 1⁄8th of a

dollar. this modification was necessary

before a derivative-type product such as

SPDRs, which trades in increments of

1⁄64th 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.

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 anticompetitive 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

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.

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.

Several of the Participants also

believe that the unanimous vote

requirement, ‘‘rather than being anticompetitive, * * * [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
40756 Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices

(‘‘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).

81See id.

82Paragraph (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.’’

83See 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).

84Those opposing the amendment would have

the right to appeal to the Commission.

85See NASD Rule 5262.

86The 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.

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

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/twothirds vote requirement for Plan

amendments.84

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 tradethrough rule for the third market should

be identical to the exchange tradethrough 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

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 betterpriced 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
Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices 40757

87Section 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.

88See 15 U.S.C. 78w(a)(2). 89 5 U.S.C. 603(a).

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 twosided 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.

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.

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 anticompetitive 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.

A. Reasons for and Objectives of the

Proposal

Although the ITS participants have

addressed two of the four anticompetitive 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
40758 Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices

90 17 CFR 240.11Aa3–2.

91 17 CFR 240.0–10(c)(1).

92The 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.]

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

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.

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

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 brokerdealers, 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
Federal Register / Vol. 63, No. 146 /Thursday, July 30, 1998 / Notices 40759

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.

94The text reflects the latest unofficial

compilation of the ITS Plan supplied by the ITSOC,

including all previously incorporated amendments

up to May 30, 1997.

1 17 CFR 200.30–3(a)(12).

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

2 17 CFR 240.19b–4.

amended ITS Plan.94 Deleted text is

[bracketed] and new language is

italicized.

* * * * *

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

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–40197A; File No. SR–

MSRB–98–04]

Self-Regulatory Organizations;

Municipal Securities Rulemaking

Board; Order Granting Approval of

Proposed Rule Change Relating to

Rule G–32, on Disclosures in

Connection With New Issues

July 23, 1998.

Correction

In FR Document No. 98–19445,

beginning on page 39322 for

Wednesday, July 22, 1998, the first full

paragraph of the page is revised to read:

The amendment provides an alternate

method of compliance with Rule G–32

in the case of Exempt VRDOs where the

final official statement is either

unavailable or incomplete. The

amendment is intended to provide relief

to dealers in the event they do not

receive the final official statement from

the issuer with enough time to deliver

the document to their customers by

settlement. Therefore, in those limited

circumstances where dealers may in fact

receive the official statement in final

form in sufficient time to deliver it to

customers by settlement (e.g., if an

issuer approves completion of the

official statement in final form prior to

execution of the purchase contract),

dealers would have the option of

complying with the existing provision

of the rule by delivering the official

statement in final form to the customer

by settlement.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.1

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–20366 Filed 7–29–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–40252; File No. SR–NASD–

98–46]

Self-Regulatory Organizations; Notice

of Filing and Immediate Effectiveness

of Proposed Rule Change by the

National Association of Securities

Dealers, Inc. Relating to Technical

Corrections to Delegation Plan and IM–

1000–4

July 23, 1998.

On July 9, 1998, the National

Association of Securities Dealers, Inc.

(‘‘NASD’’) through its regulatory

subsidiary NASD Regulation, Inc.

(‘‘NASD Regulation’’) filed with the

Securities and Exchange Commission

(‘‘Commission’’) a proposed rule change

pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 and Rule 19b–4 thereunder.2

The proposed rule change is described

in Items I, II, and III below, which Items

have been prepared by NASD

Regulations. NASD Regulation has

designated this proposal as one

constituting a stated policy, practice, or

interpretation with respect to the

meaning of an existing rule under

Section 19(b)(3)(A)(i) of the Act, which