Self-Regulatory Organizations; American Stock Exchange, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 to Proposed Rule Change Relating to Priority of Agency Orders to Cross Blocks of 25,000 Shares or More Under Rule 126(g), Commentary .01 and .02.

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34089; File No. SR-Amex-92-41]

Self-Regulatory Organizations; American Stock Exchange, Inc.;

Order Approving Proposed Rule Change and Amendment No. 1 to Proposed

Rule Change Relating to Priority of Agency Orders to Cross Blocks of

25,000 Shares or More Under Rule 126(g), Commentary .01 and .02.

May 19, 1994.

I. Introduction

On November 23, 1992, the American Stock Exchange, Inc. (``Amex''

or ``Exchange'') submitted to the Securities and Exchange Commission

(``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4

thereunder,\2\ a proposed rule change to amend Amex Rule 126(g)

relating to the priority and precedence of bids and offers. The

proposed rule specifies that agency block cross transactions,\3\ where

both buy and sell orders are for accounts other than that of a member

or member organization, can be effected without interference at the

proposed cross price. The proposal, however, would allow the cross to

be broken up at a price that is better than the proposed cross price

for one side or the other. The proposed rule change is known as the

``clean cross'' proposal. On March 30, 1994, the Exchange submitted to

the Commission Amendment No. 1 to the proposed rule change in order to

increase the minimum size of agency crosses that would be entitled to

priority under the proposal from 10,000 to 25,000 shares.\4\

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\1\15 U.S.C. 78s(b)(1) (1988).

\2\17 CFR 240.19b-4 (1991).

\3\In a cross transaction, a member who has an order to buy and

an order to sell an equivalent amount of the same stock wishes to

execute the orders against each other. Because the member already

has both sides of the trade, the member does not wish to interact

with other market interest. The member, however, must comply with

the provisions of Amex Rule 151 and make a public bid and offer on

behalf of both sides of the cross before effecting the transaction.

The offer must be made at a price which is higher than the bid by

the minimum fractional change permitted in the security. See Amex

Rule 127.

\4\See letter from Geraldine M. Brindisi, Corporate Secretary,

Amex, to Diana Luka-Hopson, Branch Chief, Division of Market

Regulation, SEC, dated March 28, 1994.

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The proposed rule change was published for comment in Securities

Exchange Act Release No. 33835 (March 30, 1994), 59 FR 16247 (April 6,

1994). The Commission received no comment letters. This order approves

the proposed rule change, including Amendment No. 1.

II. Background

The Exchange's auction market procedures are codified in Amex Rule

126, which provides for the manner in which bids and offers at the same

price will be sequenced for execution. A member who makes the first bid

or offer at a particular price has ``priority'' at that price, which

means that the member is the first one in the market entitled to

receive an execution at that price.\5\ If no member can claim priority,

all members who are bidding or offering at a particular price are

deemed to be on ``parity'' with each other, or equivalent in status.\6\

When members are on parity, a member with orders to cross blocks of

25,000 shares or more may claim ``precedence based on size'' and

thereby be entitled to the next execution at that price.\7\

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\5\See Amex Rule 126(e)(1).

\6\See Amex Rule 126(e)(2)-(4). Members are on parity with each

other when two or more bids or offers are announced simultaneously,

or after a trade takes place leaving several bids or offers unfilled

at the same price as the executed trade.

\7\See Amex Rule 126(g), Commentary .01.

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Currently, members attempting to effect a ``cross'' transaction may

be required to yield either some or all of one side of their cross in

accordance with these rules. More specifically, a cross transaction may

be ``broken up'' (i.e., participated in by another member) if that

other member trades with either the bid or the offer side of the

transaction. The Amex states that the proposed amendments to Rule 126

would facilitate the ability of members to execute certain types of

cross transactions on the Exchange at the cross price, while still

providing the opportunity in the auction market for another member to

offer price improvement to the buyer or seller, as the case may be.

III. Description of the Proposal

The Amex proposes to amend its priority rules to allow a member who

has an order to buy and an order to sell 25,000 shares or more of the

same security,\8\ where neither order is for the account of a member or

a member organization, to cross those orders at a price that is at or

within the prevailing quotation without being broken up at the cross

price, irrespective of pre-existing bids and offers at that price.\9\

The proposal will allow another member to trade with either the bid or

offer side of the cross transaction to provide a price that is better

than the proposed cross price, but the other member could not trade

with the cross bid or offer at a price which is the same as the cross

price. Moreover, the proposal will require that the member who is

providing a better price to one side of the cross transaction must

trade with all other market interest having priority at that price

before trading with any part of the cross transaction.\10\

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\8\Amendment No. 1, supra note 4, increased the minimum size of

a ``clean cross'' to 25,000 shares.

\9\The Amex will continue to require that the member follow the

crossing procedures of Amex Rule 151 and make a public bid and offer

on behalf of both sides of the cross. See supra, note 3. Unlike

existing block cross procedures under Rule 126(g), Commentary .01,

See infra note 11, orders to be crossed under proposed Rule 126(g),

Commentary .02 will not be required to be on parity with other

orders on the floor; that is it will not be required that the

priority of earlier bids and offers first be removed, by means of a

sale, before effecting the cross.

\10\The proposal also will require that transactions effected at

the cross price in reliance on Commentary .02 be printed as

``stopped stock.''

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To avoid conflict with the Amex's proposed clean cross rule, as

discussed above, Commentary .01 to Rule 126(g) will be amended so as to

afford size precedence to orders to cross 25,000 shares or more only

when members or member organizations are involved as principal on one

or both sides of the cross. In addition, the amendments to Commentary

.01 will clarify that such orders to cross are entitled to precedence

only when they are on parity with other orders on the Floor (i.e., both

sides of the cross must be represented at the specialist's post when a

sale clearing the floor takes place).\11\

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\11\In this respect, size precedence differs from priority. See

supra note 9.

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The Amex states that the proposal is intended to facilitate the

execution of agency cross transactions on the Exchange. According to

the Amex, confining the proposed size priority threshold to block size

orders of 25,000 shares or more will limit the effects of the rule

primarily to actively traded, liquid securities. In addition, the

Exchange states that the proposal furthers the important auction market

principle of price improvement by allowing another member to trade with

either the bid or offer side of the cross to provide a price that is

better than the proposed cross price. The Amex also suggests that the

proposal preserves the auction market principle of priority by

requiring that a member who wants to break up a cross by providing a

better price must first satisfy all other market interest having

priority at that better price before trading with any part of the cross

transaction.

The Exchange believes that the proposed rule change is consistent

with Section 6(b) of the Act in general and furthers the objective(s)

of Section 6(b)(5) in particular in that it is designed to prevent

fraudulent and manipulative acts and practices, to promote just and

equitable principles of trade, to foster cooperation and coordination

with persons engaged in regulating, clearing, settling, processing

information with respect to, and facilitating transactions in

securities, and, in general, to protect investors and the public

interest.

IV. Discussion

The Amex clean cross proposal is designed to facilitate the

execution of cross transactions on the Exchange. As discussed below,

due to the Amex's current priority rules, some Amex members have

developed the practice of transporting cross trades to the regional

exchanges for execution, avoiding exposure to the Amex's active trading

crowd and to limit orders on the Amex's specialists' books. The clean

cross proposal, in contrast, should encourage Amex members to execute

their cross transactions on the Amex because the proposal will allow a

member who has a customer order to buy and a customer order to sell

25,000 shares or more of the same security to cross those orders at a

price that is at or within the prevailing quotation, irrespective of

pre-existing bids or offers at that price. The proposal will allow

another member to trade with either the bid or offer side of the cross

to provide a price that is better than the proposed cross price, but

the other member could not trade with the cross bid or offer at a price

which is the same as the cross price. Moreover, the proposal will

uphold traditional auction market principles of priority and price

improvement because it will require that the member who is providing a

better price to one side of the cross must trade with all other market

interest having priority at that price before trading with any part of

the cross.

The Commission recognizes that the Amex's clean cross proposal was

prompted by the competition that exists between the Amex and the

regional exchanges for order flow and, in particular, for block

business. The Commission also recognizes that the Amex's current

priority rules may restrict the ability of Amex members to execute

agency block cross transactions on the Exchange. Under the current

rules, a member who tries to execute a block-sized agency cross on the

Amex faces the possibility that another member will break up the cross

at the cross price. As a result, the member may take block-sized orders

in Amex-listed securities to a regional stock exchange for execution.

The relatively smaller number of limit orders on the books of the

regional stock exchange specialists and the virtual absence of a

trading crowd at the regional exchanges helps to ensure that member

firms will be able to execute their cross transactions on the regional

exchanges with little or no interference. Indeed, the regional

exchanges compete aggressively with the Amex for block

transactions.\12\ In addition, blocks go to the regional exchanges

because of the low probability that a block will be broken up on the

regional exchange.

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\12\See infra, note 15.

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The clean cross proposal should facilitate the ability of Amex

members to execute block agency cross transactions on the Amex by

giving such orders priority over orders at or within the prevailing

quotation. At the same time, the proposal preserves the auction market

principle of price improvement by permitting the cross transaction to

be broken up at a better price. The proposal also preserves the

principle of priority by requiring that a member who breaks up a cross

by providing a better price must first satisfy all existing market

interest having priority at that better price before trading with any

part of the cross.

The Commission recognizes that approval of the clean cross proposal

could disadvantage orders on the book, or in the trading crowd, at the

same price as the cross transaction. This is the only aspect of the

proposal that really represents a departure from existing auction

market principles. Thus, under the proposal, a clean cross could be

executed while a public investor's limit order on the book remains

unexecuted. For example, if a public customer left a limit order on the

specialist's book at 10 a.m., bidding for 500 shares of XYZ at 40, a

so-called clean cross could be executed at 10:10 at a price of 40

without satisfying the public customer order.

The Commission recognizes that the Amex proposal may not be the

ideal means to address the current situation, in which a block

transaction can be effected on one of the regional stock exchanges or

in the third market and completely avoid the Amex's limit order book. A

preferable approach would be to establish a means of intermarket price

protection for all limit orders in all market centers.\13\ However,

with no means of intermarket price protection for public limit order,

and given Commission approval of the NYSE's identical clean cross

proposal,\14\ as well as certain regional exchange proposals designed

to minimize interference with cross transactions,\15\ it could be

unfair to preclude the Amex from adapting to the present competitive

environment by facilitating the execution of agency block cross

transactions on the Exchange. Thus, the Commission believes that it is

not unreasonable or inconsistent with the Act for the Amex to react to

competitive pressures for block business by permitting large agency

crosses to occur at or within the bid or offer price. The proposed rule

change should further competition among exchanges and other competing

market centers and increase opportunities for the more efficient

execution of block-sized agency cross transactions.

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\13\The Commission originally attempted to address the

underlying issues of limit order protection and competition among

the exchanges through an integrated national market system rule.

Specifically, the Commission proposed Rule 11Ac1-3 under the Act in

1979 to require that all limit orders that are collected in a

particular market center receive intermarket price protection

against executions at inferior prices. See Securities Exchange Act

Release No. 15770 (April 26, 1979), 44 FR 26692 (addressing the

practice of transporting block orders from one market to another to

avoid limit orders in the former market). Due to the lack of

interest from the relevant markets and potential difficulties in

implementing a system for intermarket price protection, the

Commission withdrew proposed Rule 11Ac1-3. See Securities Exchange

Act Release No. 31344 (October 21, 1992), 57 FR 48581 (October 27,

1992).

\14\See Securities Exchange Act Release No. 31343 (October 21,

1992), 57 FR 48645 (October 27, 1992) (File No. SR-NYSE-90-39)

(``NYSE Clean Cross Order'').

\15\See Securities Exchange Act Release Nos. 33708 (March 3,

1994), 59 FR 11339 (March 10, 1994) (File No. SR-MSE-93-05); 33391

(December 28, 1993), 59 FR 336 (January 4, 1994) (File No. SR-PSE-

91-11); and 27205 (August 31, 1989), 54 FR 37180 (September 7, 1989)

(File No. SR-Phlx-89-17).

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As described above, members who do not believe that they can

execute their block-sized agency orders on the Amex currently take

their orders to the regional stock exchanges, completely avoiding

exposure to limit orders on the Amex specialist's book. The Commission

believes that approval of the proposal will not result in incremental

harm to public customers. Assume, for example, that the market in XYZ

is quoted 20\1/4\ bid, 20\3/8\ offer, 100,000 shares by 100,000 shares.

Investor A has a limit buy order on the book at 20\1/4\ for 1,000

shares of XYZ. In today's environment, a member intending to effect a

100,000 share agency cross transaction at a price of 20\1/4\ could go

to another market to execute the cross, thereby avoiding exposure to

Investor A's limit buy order of 20\1/4\. As a result of the proposed

rule change, the member would, to comply with Rule 151, bid 20\1/4\ for

100,000 shares and offer 100,000 shares at 20\3/8\ on the Amex floor.

The member's 100,000 share clean cross of 20\1/4\ would have priority,

and the cross could not be broken up at that price. Although Investor

A's limit buy order would not be executed, this is the same result as

if the block was done on another market under the Amex's current rules.

The commission also believes that the proposal restricts

sufficiently the circumstances in which members may execute clean cross

transactions on the Exchange. In particular, the Commission believes

that the share size threshold of 25,000 shares or more should help to

ensure that the clean cross proposal will apply primarily to larger

block-sized orders where the depth of the prevailing bid or offer may

be less likely to satisfy either side of the clean cross. In addition,

because the proposal is limited to non-member orders only, the proposal

should assist public customers in effecting cross transactions on the

Amex and should not give any special advantage to members and member

organizations in their proprietary trading.

Finally, the Commission finds that the proposed amendments to

Commentary .01 will eliminate potential confusion by specifying that

the Amex's existing size precedence rule does not apply to those agency

crosses of 25,000 shares which can be executed pursuant to Commentary

.02. The Commission also has concluded that the Amex proposal will

clarify the procedures for claiming precedence based on size, and

should help to ensure that bids or offers with priority are not

disadvantaged.

V. Conclusion

For the above reasons, the Commission believes that the proposed

rule change, as amended, is not inconsistent with Sections 6(b)(5),

6(b)(8) and 11A(a)(1)(C)(ii) of the Act.\16\

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\16\15 U.S.C. 78f and 78k-1 (1988).

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It therefore is ordered, Pursuant to Section 19(b)(2) of the

Act\17\ that the proposed rule change (SR-Amex-92-41), including

Amendment No. 1, is approved.

\17\15 U.S.C. 78s(b)(2) (1988).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-12823 Filed 5-25-94; 8:45 am]

BILLING CODE 8010-01-M