Order Execution Obligations

SUMMARY: The Securities and Exchange Commission (``Commission'') today

is proposing two rules and amendments to a rule to improve the handling

and execution of customer orders. In light of the availability of

improvements in order handling technology and the proliferation of

ancillary order handling arrangements, including payment for order

flow, directed order handling and internalization, the Commission is

proposing rules that are intended to improve the opportunity of

investors to obtain the best execution possible for their orders. At

the same time, the proposals are designed to preserve the benefits of a

competitive market structure that has greatly enhanced market

liquidity, transparency and efficiency.

DATES: Comments should be submitted on or before January 16, 1996.

ADDRESSES: Interested persons should submit three copies of their

written data, views and opinions to Jonathan G. Katz, Secretary,

Securities and Exchange Commission, 450 Fifth Street NW., Washington,

DC 20549, and should refer to File No. S7-30-95. All submissions will

be made available for public inspection and copying at the Commission's

Public Reference Room, Room 1024, 450 Fifth Street NW., Washington, DC

20549.

FOR FURTHER INFORMATION CONTACT: David Oestreicher regarding Rules

11Ac1-4 and 11Ac1-5, Ethan Corey regarding best execution obligations,

and Gautam S. Gujral, Elizabeth Prout Lefler or Gail A. Marshall

regarding amendments to Rule 11Ac1-1 at (202) 942-0158, Division of

Market Regulation, Securities and Exchange Commission, 450 Fifth Street

NW., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission proposes to amend Rule 11Ac1-

1 (``Quote Rule'') \1\ under the Securities Exchange Act of 1934

(``Exchange Act'') \2\ to require exchanges and over-the-counter

(``OTC'') market makers in listed securities to publish quotations for

listed securities where the exchange or OTC market maker trades more

than 1% of the aggregate trading volume for that security. The

Commission also proposes to amend the Quote Rule to require exchange

specialists and OTC market makers to quote to the public any better

prices that they privately quote through certain electronic

communications networks. Further, the Commission proposes to require

specialists and OTC market makers to display customer limit orders

priced better than the specialist's or OTC market maker's quote.

Finally, the Commission proposes to require that specialists and OTC

market makers provide customer market orders some opportunity for price

improvement before executing the order. The rule provides for order

exposure procedures that, if followed, would be deemed to satisfy the

requirement that a specialist or OTC market maker provide an

opportunity for price improvement. These procedures are not, however,

intended to be the only method by which OTC market makers and

specialists may offer the opportunity for price improvement.

\1\ 17 CFR 240.11Ac1-1.

\2\ 15 U.S.C. 78a to 78ll (1988).

---------------------------------------------------------------------------

I. Introduction

A. Background

The vision of a ``national market system'' (``NMS''), which

Congress adopted in the Securities Acts Amendments of 1975 (``1975

Amendments''),\3\ has served our markets well, fostering a market

system that by any measure is the fairest and most efficient in the

world. The idea of an integrated system in which competition among

linked markets would make the best prices universally available,

transparent disclosure of quotes and trades would promote best

execution, and broker-dealers would place the interests of customers

first, represented a significant step forward for our markets. The

costs and dislocations associated with implementing the systems

required were substantial and concerns that liquidity would be impaired

were pervasive. The undertaking primarily was placed on the shoulders

of the securities industry: the Commission took seriously the

Congressional mandate that it ``facilitate'' these goals while allowing

maximum flexibility in the design.

\3\ Pub. L. No. 94-29, 89 Stat. 97 (1975).

---------------------------------------------------------------------------

The last 20 years have seen continued progress toward an NMS. Major

infrastructure developments such as the Consolidated Quotation System

(``CQS''), the consolidated transaction tape, last-sale reporting for

OTC securities, and the Intermarket Trading System (``ITS'') have made

information about trading interest, volume, and prices widely available

to market participants. The technological innovations of the last two

decades have made it possible to display, route, and execute orders in

volumes unheard of even a few years ago. Communication among markets

and market participants, once slow and costly, is now instantaneous and

economical. Now more than ever, investors can expect that their orders

will be executed at the best prices available across a spectrum of

markets. In a very real sense, investors have benefited directly from

the NMS initiatives, as increased transparency has contributed to

greater liquidity and better enabled investors to monitor the quality

of their executions, and technology has allowed better, quicker, and

cheaper access to the markets.

Notwithstanding these positive developments, improved technology

also has made possible market practices and structures that raise the

issue of whether customers are consistently afforded the enhanced

opportunities for better prices made possible by innovations in price

dissemination and order handling. Questions have been raised about

whether increasingly commonplace practices such as the routing of

customer order flow to market makers and specialists in return for

payment and the internalization of customer orders by integrated firms

may reduce competition based on published quotes. In addition,

customers' limit orders are not always displayed in all markets. At a

minimum, those customers whose orders are not displayed lose the

opportunity to have their orders interact with the market.

There are also concerns about whether quotations fully convey the

quality of information intended by the 1975 Amendments. The development

of electronic trading systems that allow market makers to display

different prices to different customers has created the potential for

two-tiered markets in which market makers quote one price to public

investors while quoting better prices in private systems. As a result,

investors without access to these ``hidden'' quotes may not obtain the

benefit of the best available prices. Similarly, investors may not

receive the best available prices when other customers' limit orders

are not represented in the quotes. When specialists and OTC market

makers fail to display limit orders that improve the inside quotes, the

quotes do not convey the real quotation spread and may

[[Page 52793]]

present an inaccurate picture of trading interest.

In many respects, these structures and practices have neither kept

pace with investors' needs nor advanced Congress' mandate for an NMS.

Some investors have sufficient market power, sophistication and access

to information and markets necessary to ensure best execution of their

orders. Retail customers, however, typically depend on their brokers

for information and access to the market. Regardless of whether the

execution occurs in an exchange market or OTC, investors expect prompt

executions at the best prices reasonably obtainable. Investors should

be able to rely on published quotations for an accurate picture of the

market. Investors should receive fair treatment for their orders and

should not have to compete with their own brokers for quality

executions.

Ultimately, if market structures and practices work to their

disadvantage, investors will lose confidence in the fairness of the

market. The tremendous success of our markets over the last 20 years

has been due in large part to investor confidence in their fairness,

integrity, and efficiency. To the extent that practices and structures

such as hidden limit orders, payment for order flow, internalization,

and two-tiered markets may not satisfy investor needs and diminish

transparency, these practices threaten to undermine investor confidence

and market efficiency.

Congress saw competition as the primary source of change and

innovation in achieving an NMS and directed the Commission to use its

rulemaking authority to remove impediments to competition and

facilitate the development of an NMS. To the extent that order flow

increasingly is routed on a basis other than quote competition, the

transparency and competitiveness of our markets may suffer. Similarly,

the continued fragmentation of quotations erodes the value of the

quote. Accordingly, the Commission believes that it is time to propose

action to ensure the future confidence of investors and the

competitiveness of American markets.

The Commission today is proposing a series of initiatives that

would enhance transparency in our markets and improve the handling and

interaction of customer orders. The proposed rules stress that markets

and dealers should disclose as much information about supply and demand

as is practicable. Transparency of customer orders ensures that prices

fully reflect overall supply and demand and prevents market

fragmentation. The proposed rules assure the continued availability of

quality information with respect to quotations. In addition, the

proposed rules seek to improve opportunities in auction and dealer

markets for market orders to interact directly with other market orders

and public limit orders, consistent with the goals of a national market

system.

The proposed rules reinforce the importance of fair competition

among markets and market participants. The Commission believes that the

introduction of new technologies during the past 20 years has been

largely a product of competition in our markets. In recognition of the

importance of fostering continued innovation through competitive market

forces, as well as Congress's mandate to facilitate-but-not-design, the

proposals do not require any particular system or market structure.

Rather, they attempt to achieve their intended effect by establishing

minimum standards for the handling of customer orders. The intent is to

further the goals of an NMS while preserving an atmosphere in which

innovation is welcome and rewarded.

B. The Duty To Seek Best Execution of Customer Orders

Even absent the rule proposals being issued for comment today, the

duty of best execution requires a broker-dealer to seek the most

favorable terms reasonably available under the circumstances for a

customer's transaction.4 Although the duty of best execution is

longstanding, the specific obligations of broker-dealers in fulfilling

that duty have evolved over time. As developments in market structure

and technology create new opportunities to achieve better execution of

customer orders, it is incumbent on the Commission and the markets to

take full advantage of those developments.

\4\ See Securities Exchange Act Release No. 30920 (July 14,

1992), 57 FR 32587 (July 22, 1992); Division of Market Regulation,

Market 2000: An Examination of Current Equity Market Developments

(Jan. 1994) (``Market 2000''), Study V.

---------------------------------------------------------------------------

Historically, with the development of sophisticated price

dissemination and order routing systems, broker-dealers gained better,

more economical means to determine the best price for a security

trading in multiple markets. For example, before the advent of the

Nasdaq automated quotation system, broker-dealers manually routed their

customer orders to OTC market makers, and were viewed as having made

reasonable efforts if they contacted three market makers to find the

best available price. The development of Nasdaq enabled broker-dealers

to check the quotations of all Nasdaq market makers at once, thus

expanding the range of OTC quotes to be taken into account in seeking

best execution.5 In the listed markets, the CQS provided broker-

dealers for the first time with the currently reported bids, offers,

and quotation sizes of brokers and dealers trading listed securities

both on exchanges and in the OTC market.6 In approving the CQS,

the Commission stressed that it would expect broker-dealers to take

into account the pricing information made available through the system

in fulfilling their best execution obligations.7

\5\ Market 2000, supra note 4, at II-11.

\6\ Securities Exchange Act Release No. 15009 (July 28, 1978),

43 FR 34851 (Aug. 7, 1978)(first declaring temporarily effective CQS

Plan); Securities Exchange Act Release No. 16518 (Jan. 22, 1980), 45

FR 6521 (June 28, 1980) (permanently approving CQS Plan).

\7\ Id.

---------------------------------------------------------------------------

Over time, exchanges and broker-dealers also have developed

automated order routing systems to process small trades. The Commission

concluded in response that an automated order routing environment was

not necessarily inconsistent with the achievement of best

execution.8 Indeed, the Commission recognized that it could be

impractical, both in terms of time and expense, for a broker that

handled a large volume of orders to determine individually where to

route each order it received. The Commission therefore stated that

broker-dealers routing orders for automated execution could satisfy

their best execution obligations by assessing periodically the quality

of competing markets to assure that aggregated order flow was directed

to markets providing the most advantageous terms for their customers'

orders.9

\8\ Securities Exchange Act Release No. 15671 (Mar. 22, 1979),

44 FR 20360 (Apr. 4, 1979); Securities Exchange Act Release No.

15926 (June 15, 1979), 44 FR 36912, 36923 n. 118 (June 22, 1979);

Securities Exchange Act Release No. 17583 (Feb. 27, 1981), 46 FR

15713, 15715 n. 16 (Mar. 9, 1981); Securities Exchange Act Release

No. 26870 (May 26, 1989), 54 FR 23963, 23973 n. 127 (June 5, 1989);

Market 2000, supra note 4, Study V at V-1 n. 8; Securities Exchange

Act Release No. 34902 (Oct. 27, 1994), 59 FR 55006, 55009 n. 30

(Nov. 2, 1994) (``Payment for Order Flow Release'').

\9\ See sources cited supra note 8.

---------------------------------------------------------------------------

In this regard, the Commission recently cited a staff position

warning broker-dealers against presuming that routing order flow to a

market providing quote-based executions always would satisfy the duty

of best execution for small orders in listed securities; at the same

time, the Commission noted the role of price improvement as a factor in

best execution, speaking in the context of aggregate order routing

decisions for

[[Page 52794]]

listed and OTC stocks.10 For example, trades in listed securities

that are routed to an exchange typically are exposed to other public

orders or interest in the trading crowd that exists on the trading

floor.11 Such order exposure brings with it the possibility for

price improvement, i.e., an execution at a price that is better than

the existing quotes. In addition, with the development of sophisticated

order handling systems, some OTC market makers are now providing an

opportunity for price improvement for their customer orders.

\10\ See Payment for Order Flow Release, supra note 8, at text

accompanying nn. 31-33.

\11\ See Payment for Order Flow Release, supra note 8. In

addition, most regional exchanges have incorporated order exposure

features into their small order routing and execution systems so

that price improvement may be offered. Most regional exchanges

program their automated execution systems to ensure that customer

orders receive a price at the national best bid or best offer

(``NBBO'') or better, and the specialist is provided an opportunity

to improve the price. Payment for Order Flow Release, supra note 8,

at n. 32 and sources cited therein. This feature by itself, however,

rarely provides an execution between the spread.

---------------------------------------------------------------------------

As technology has advanced, certain order handling routines that

may not have been economical or even possible several years ago have

become available. Using internal automated systems, some broker-dealers

now are able to route orders automatically to the dealer market or

automated system offering the best price, or alternatively, match the

best price themselves and execute the order as principal. It now is

possible for some broker-dealers to seek better prices for their

customers' orders not only on the CQS and Nasdaq, but also on other

market systems, such as SelectNet. More importantly, the availability

of sophisticated order handling systems has made it possible for some

broker-dealers and market centers to provide an opportunity for price

improvement for their customer orders. The use of these efficient

routing and execution facilities by firms and exchanges suggests that

price improvement procedures and other best execution safeguards in an

automated environment are increasingly practicable and are setting new

standards for the industry.

In the past, quote based executions in OTC securities were

generally recognized as satisfying best execution obligations.12

The development of efficient new facilities, however, alters what

broker-dealers must consider in seeking best execution of customer

orders. In determining the parameters of what is reasonable in

particular circumstances, the Commission believes that in light of

recent developments broker-dealers must now consider not only their

customers' expectations, but also ways of obtaining improved executions

for customers using the range of available new technologies as they

evolve. While not all markets and trading systems are equally

accessible to large and small broker-dealers, and not all order

handling technologies are equally affordable to all broker-dealers,

when efficient and cost effective systems are readily accessible,

broker-dealers must evaluate carefully whether they can be used in

fulfilling their duty of best execution.

\12\ Market 2000, supra note 4, Study V at V-4.

---------------------------------------------------------------------------

C. Overview of the Proposed Rules

The rules proposed today will increase the opportunities for

investors to receive best execution for their orders and promote market

efficiency. Moreover, by stressing the importance of transparency and

price improvement, the proposed rules should reinforce competition

among markets and market participants. The rules proposed today,

however, are not intended to alter or displace the well-established

duty under the antifraud principles for market participants to provide

customers with best execution. Broker-dealers remain obligated to seek

the most favorable terms possible under the circumstances for their

customers.

The first of these rule proposals involves amendments to the Quote

Rule that would improve information about the significant market makers

in a security and the prices they are quoting. The proposals would

require exchanges and OTC market makers that account for more than 1%

of the volume in a listed security to publish their quotations for that

security. In addition, the amendments would require exchange

specialists and OTC market makers who submit priced orders to certain

electronic communications networks to include those orders in their

published quotes.

Second, the Commission is proposing a minimum standard for all

markets that would require the display of customer limit orders under

certain circumstances. The proposed rule would promote best execution

of customer limit orders, and would increase market transparency and

efficiency by ensuring that prices fully reflect overall supply and

demand.

Finally, the Commission has previously stated in other contexts

that broker-dealers have a duty to consider opportunities for price

improvement when deciding where to route customer orders for

execution.13 In support of this duty, the rules would require OTC

market makers and specialists to provide their customer orders with an

opportunity for price improvement. Recognizing that OTC market makers

and specialists currently employ a variety of systems and procedures to

provide price improvement opportunities, the proposed rule does not

impose any one formula or mechanism for achieving price improvement.

Nonetheless, to provide guidance to dealers as to one set of conditions

under which they would satisfy their obligation under the rule, the

Commission is proposing a non-exclusive safe harbor. The safe harbor

sets out a procedure that would satisfy the price improvement

obligation while allowing for the duty to be satisfied by alternative

means. The Commission also seeks comment on alternative safe harbors.

\13\ See Payment for Order Flow Release, supra note 8.

---------------------------------------------------------------------------

While the legislative history of the 1975 Amendments recognized

that order exposure and interaction may not be appropriate for some

securities, Congress intended that for as many securities as feasible,

the NMS should ensure that public investors receive the benefits and

protections associated with transparency and order interaction.

Accordingly, the rules proposed today are designed to comport with the

principle that a broker-dealer will seek the same quality of execution

regardless of whether the broker-dealer is acting as principal or

agent, and regardless of whether the transaction is effected in an

exchange or OTC market.

II. Proposals

A. Amendments to the Quote Rule

1. Background

The proposed amendments to the Quote Rule are designed to: (1)

expand the coverage of existing broker-dealer quotation requirements to

include substantial market makers in non-Rule 19c-3 securities,14

and (2) ensure that OTC market makers and exchange specialists reflect

in their public quotes the best prices they have published in certain

electronic communications networks.

\14\ See 17 CFR 240.19c-3. Exchange Act Rule 19c-3 prohibits the

application of off-board trading restrictions to securities that:

(1) were not traded on an exchange before April 26, 1979; or (2)

were traded on an exchange on April 26, 1979, but ceased to be

traded on an exchange for any period of time thereafter.

Accordingly, exchange-traded securities not subject to off-board

trading restrictions are referred to as Rule 19c-3 securities, and

exchange-traded securities subject to off-board trading restrictions

are referred to as non-Rule 19c-3 securities.

---------------------------------------------------------------------------

The Commission believes these amendments are important to enhance

competition in publicly disseminated

[[Page 52795]]

quotes. Furthermore, these amendments are intended to improve published

quotation information by ensuring that OTC market makers and exchanges

publicly disseminate quotations in the exchange-listed securities they

actively trade, and by ensuring that the best bid and offer prices are

made available to public investors.

The legislative history of the 1975 Amendments makes it clear that

a prompt, accurate and reliable composite quotation reporting system is

an essential element of the NMS.15 Congress believed it essential

that the composite quotation reporting system include quotations from

all market centers.16 Those Amendments also granted the Commission

``pervasive rulemaking power to regulate securities communications

systems.'' 17

\15\ S. Rep. No. 75, 94th Cong., 1st Sess. 9-10 (1975) (``Senate

Report''). Cf. H.R. Rep. No. 229, 94th Cong. 1st Sess. 29 (1975)

(``House Report) (noting that conference committee adopted the

Senate's provisions on the NMS with minor revisions).

\16\ Senate Report, supra note 15 at 101.

\17\ Id. at 93.

---------------------------------------------------------------------------

a. Dissemination of Quotes Under the Rule

Public quote reporting for equity securities is governed by Section

11A of the Exchange Act,18 the Quote Rule 19 and Rule 11Aa3-2

(the ``Plan Rule''),20 as well as exchange and NASD rules. These

rules require registered exchanges and securities associations 21

to file quotation reporting plans with the Commission that provide for

the collection and transmission of quotation information on a real-time

basis.22 Specialists and OTC market makers communicate their

quotes to the exchange and to the NASD pursuant to these plans and the

SROs in turn make this information available to vendors for

dissemination to the public.23 The Quote Rule requires public

dissemination of the best bid, best offer, and size for each market

trading the security as well as the consolidated best bid and

offer.24 Quotations provided to vendors must be firm, and a

specialist or OTC market maker generally is obligated to execute any

order at a price at least as good as its published bid or offer.25

Brokers and dealers covered by the Rule, including dealers trading

listed securities in the OTC market (i.e., third market makers), must

supply quotations to their exchange or association for dissemination to

quotation vendors.

\18\ 15 U.S.C. 78k-1.

\19\ 17 CFR 240.11Ac1-1 (1993). See Securities Exchange Act

Release No. 14415 (Jan. 26, 1978), 43 FR 4342 (Feb. 1, 1978).

\20\ 17 CFR 240.11Aa3-2 (1993).

\21\ The NASD is the only registered national securities

association.

\22\ See Rule 11Ac1-1(b)(1), 17 CFR 240.11Ac1-1(b)(1)

(dissemination requirements for exchanges and associations).

\23\ Rule 11Ac1-2, 17 CFR 240.11Ac1-2 (``Vendor Display Rule'')

requires vendors of market information to display quotation

information in a non-discriminatory manner.

\24\ See Rule 11Ac1-1(b)(1), 17 CFR 240.11Ac1-1(b)(1).

\25\ See Rule 11Ac1-1(c)(1), 17 CFR 240.11Ac1-1(c)(1).

---------------------------------------------------------------------------

b. Mandatory and Voluntary Quotes Under the Rule

When the Commission first proposed the Quote Rule, it noted that a

lack of reliable quotation information from the various markets was

hampering private and self-regulatory efforts to establish a viable

composite quotation system which consequently was impeding the

development of an NMS.26 Accordingly, the Quote Rule, as

originally adopted, mandated that specialists and OTC market makers

subject to the Rule's provisions communicate their quotations promptly

to their relevant exchange or association and that such quotations be

``firm.''

\26\ See Securities Exchange Act Release No. 12670 (July 29,

1976), 41 FR 32856 (Aug. 5, 1976) (``Quote Rule Proposing

Release'').

---------------------------------------------------------------------------

Shortly after the rule was adopted, the Commission granted

exemptive relief to exchanges and OTC market makers 27 responsible

for less than 1% of the aggregate trading volume in a reported

security, primarily because the costs of compliance with the mandatory

Quote Rule for such exchanges and OTC market makers with de minimis

market share were substantially disproportionate to any reasonably

anticipated competitive benefits.28

\27\ See e.g. Securities Exchange Act Release No. 15747 (Apr.

19, 1979), 17 S.E.C. Doc. 304, granting Amswiss International

Corporation exemptive relief from paragraph (c)(1) of the Quote

Rule, pursuant to paragraph (d) of the rule, (``Amswiss

exemption''). The Commission also granted exemptive relief to

certain exchanges which accounted for a de minimis share of the

consolidated volume in any reported security. See Securities

Exchange Act Release No. 15012 (July 28, 1978), 43 FR 33978 (Aug. 2,

1978) (Intermountain Stock Exchange); Securities Exchange Act

Release No. 15011 (July 28, 1978), 43 FR 33983 (Aug. 2, 1978)

(Spokane Stock Exchange); Securities Exchange Act Release No. 15010

(July 28, 1978), 43 FR 33976 (Aug. 2, 1978) (Cincinnati Stock

Exchange); Securities Exchange Act Release No. 15013 (July 28,

1978), 43 FR 33981 (Aug. 2, 1978) (Philadelphia Stock Exchange).

\28\ See Securities Exchange Act Release No. 15771 (Apr. 26,

1979), 44 FR 26067 (May 4, 1979). See also Securities Exchange Act

Release No. 18482 (Feb. 11, 1982), 47 FR 7399, 7405 ( Feb. 19, 1982)

(stating that the Commission has followed an established policy of

granting exemptive relief to OTC market makers with a de minimis

share of the order flow in a particular security).

---------------------------------------------------------------------------

In 1982, the Commission amended the rule to make quote

dissemination voluntary rather than mandatory for those OTC market

makers and exchanges with less than 1% of the volume in Rule 19c-3

securities. For non-Rule 19c-3 securities, the amendment required OTC

market makers and exchanges to communicate quotes only when they

qualified as the principal market for the security. Market makers could

voluntarily quote if they elected to do so in accordance with the Rule.

Thus, under the Quote Rule presently, unless an OTC market maker or

exchange is responsible for such a significant share of the trading

volume that it can be considered the principal market for an exchange-

traded security, its decision to register to communicate its quotes in

non-Rule 19c-3 securities is purely voluntary.29

\29\ An OTC market maker in reported securities may effectively

elect to disseminate quotations under proposed paragraph

(a)(25)(ii)(B) by registering as a NASD market maker and

``communicating'' its best bids and offers to the association by

entering two-sided quotations in the Nasdaq System. See NASD By-

Laws, Schedule D, Part V, Sec. 1 (CCH) para. 1816D.

Similarly, an exchange that is not the principal market for a

reported security may voluntarily elect to disseminate quotes for

the security pursuant to proposed paragraph (a)(25)(i)(B).

---------------------------------------------------------------------------

The Commission noted that many of the quotations provided by

dealers to comply with the mandatory rule had been inaccurate and stale

or produced by systems designed to track the primary market

automatically.30 Processing and dissemination of the resulting

quotation information, some of which was deemed unreliable, had been a

strain on vendor systems. The Commission also believed that the

operation of the ITS,31 through which third market makers who

disseminate quotes may effect transactions with other markets in Rule

19c-3 securities, would create an economic incentive to quote

competitively in the affected securities in the absence of a mandate.

\30\ See Securities Exchange Act Release No. 17583 (Feb. 27,

1981), 46 FR 15713 (Mar. 9, 1981).

\31\ The ITS commenced operation on a pilot basis on April 17,

1978. The ITS is an intermarket order routing facility which permits

orders for the purchase and sale of multiply-traded securities to be

sent directly from one market center to another. OTC market makers

do not have access to ITS for non-Rule 19c-3 securities.

---------------------------------------------------------------------------

However, after the adoption of the voluntary quote rule, regional

exchanges continued to quote the securities they traded using automated

quotation devices that tracked the national best bid and offer.32

Today, although many

[[Page 52796]]

third market makers quote competitively, some do so selectively,

choosing not to display quotes for securities that are subject only to

voluntary quote provisions. In fact, several active third market makers

maintain continuous, two-sided quotations but do not disseminate them

to the investing public because they are not obligated to do so. This

has left a significant gap in the quotation information which is

available to all investors, contrary to an essential goal of the NMS.

\32\ In this regard, the ITS Plan provides:

each Participant that furnishes to other Participants bid-asked

quotations that are generated by an automated quotation tracking

system (such as the Autoquote or the Centramart system currently

employed by certain Participants) agrees that no such quotation

shall be for more than 100 shares.

ITS Plan, 8(d)(ii). Thus, it is not unusual for exchanges to

disseminate quotations, presumably generated by computers, that are

bid at \1/8\ below the best national bid and offered at \1/8\ above

the best national offer, for 100 shares on each side.

---------------------------------------------------------------------------

While the Commission believes that the 1% threshold for mandatory

quotes continues to be appropriate, the Commission believes the

disparate treatment of Rule 19c-3 and non-Rule 19c-3 securities now

should be revisited.33 Since the Quote Rule initially was

promulgated, and thereafter amended, trading under the regulatory

scheme has evolved and market participants and the Commission have

gained substantial experience under Rule 19c-3 and the Quote Rule. For

example, as more securities have become subject to Rule 19c-3, trading

volume in the third market has grown.34 Thus, off-board trading in

Rule 19c-3 securities now accounts for a greater number of stocks and a

more substantial percentage of U.S. trading volume than it did when the

Commission initially established the disparate treatment for quotations

in Rule 19c-3 and non-Rule 19c-3 securities under the Quote Rule.

\33\ Firms that trade non-Rule 19c-3 securities off an exchange

are not subject to the same requirements as third market makers that

meet the 1% threshold for Rule 19c-3 securities. For example, a

third market maker required to quote in a Rule 19c-3 security must

register as a CQS market maker with the NASD. NASD Manual, Schedule

D to the By-Laws, Part VI, Sec. 1, (CCH) para. 1828. CQS market

makers are subject to the NASD's CQS market maker rules, which

include firm and continuous two-sided quote obligations and

mandatory participation in Nasdaq's Computer Assisted Execution

System (``CAES''), and in the ITS. NASD Manual, Schedule D to the

By-Laws, Part IV, Sec. 1, 2, (CCH) para. 1828, 9.

\34\ See Fragmentation vs. Consolidation of Securities Trading:

Evidence from the Operation of Rule 19c-3, Office of Economic

Analysis, SEC, pp. 4-5 (Mar. 29, 1995).

---------------------------------------------------------------------------

In view of the growth of third market trading volume, much of which

is executed by automated systems at prices derived from the principal

markets, the Commission questions whether this trading should continue

to be conducted on the basis of voluntary quotations, or whether it

should be subject to standards similar to those for trading Rule 19c-3

securities. Under the Quote Rule presently, executing market makers are

subject to disparate quotation requirements for non-Rule 19c-3 and Rule

19c-3 securities. The Commission questions whether there are sufficient

distinctions between trading in Rule 19c-3 securities and other listed

securities to justify different quotation standards. Requiring OTC

market makers and exchanges that account for more than 1% of the volume

in a listed security to disseminate quotations for that security would

provide greater information about significant market makers in the

security, and the prices at which they are willing to trade.

The proposed uniform application of the Quote Rule to all exchange-

listed securities, if adopted, raises the issue of the disparate

treatment of Rule 19c-3 and non-Rule 19c-3 securities under the ITS

Plan. Currently, the ITS Plan provides access to any participant in any

Rule 19c-3 security in which the participant disseminates continuous

two-sided quotations, but excludes OTC market makers from ITS access

for non-Rule 19c-3 securities. The proposed amendments to the Quote

Rule would subject OTC market makers and exchanges to the same

quotation requirements for all exchange-listed securities. Accordingly,

the Commission believes it is appropriate to reconsider the issue of

ITS access by third market makers. The Commission requests comment on

whether the amendments should be accompanied by an expansion of the

linkage between ITS and the NASD's CAES to provide ITS access to and

from any market maker for any exchange-listed security in which that

market maker disseminates continuous two-sided quotations.

Requiring active third market makers to quote also raises the issue

of whether revisions to a current NASD rule that restricts certain

computer generated quotations are necessary.35 Regional exchange

specialists currently may use automated mechanisms to track the NBBO in

a security if they maintain a quotation size of no more than 100

shares. OTC market makers, however, are prohibited, by NASD

requirements, from using similar automated quotation tracking systems.

The NASD requirements are designed to prevent the multiplication of

non-competitive quotes, with their attendant burden on system capacity.

In the absence of an amendment to the NASD rule, market makers in

effect often would be required to maintain firm, continuous two-sided

markets without using computers to generate those quotes. The

Commission requests comment on whether computer generated quotations

should be permitted if active third market makers are required to quote

in non-Rule 19c-3 securities, and if so, under what conditions.

\35\ NASD Manual, Schedules to the By-Laws, Schedule D, Part IV,

Sec. 2, (CCH) para. 1829. The NASD, however, provides an automated

quotation update capability (auto-refresh) which market makers may

elect to use. Specifically, the quote of a market maker using auto-

refresh will be automatically updated when the market maker exhausts

its exposure limit in the NASD's Small Order Execution System.

---------------------------------------------------------------------------

The Commission also notes that the proposed amendments to the Quote

Rule would extend the coverage of the rule to all Nasdaq securities

(including SmallCap securities) where previously the rule applied only

to Nasdaq/National Market securities. The Commission preliminarily

believes that this element of the proposal should not impose new costs

on market participants because the NASD rules concerning quotations

already treat Nasdaq/National Market and SmallCap securities similarly.

The Commission believes that this aspect of the proposed Quote Rule

amendment, therefore, simply extends Exchange Act rule coverage to the

same range of securities as existing NASD rules.

c. Dissemination of Quotes Through Electronic Communications Networks

Since the Quote Rule's adoption in 1978, electronic communications

networks have been developed that allow participants to enter priced

orders which are widely disseminated to third parties and which permit

such orders to be executed in whole or in part. Participants may

include investors (retail and institutional), broker-dealers, and

market makers. The sponsors of these systems may be regulated as

broker-dealers even though the manner of operation of the systems may

differ from the activities of traditional broker-dealers.36

\36\ See Market 2000, supra note 4, at III-12. See also 17 CFR

240.17a-23 regarding regulation of Broker Dealer Trading Systems.

---------------------------------------------------------------------------

The Commission traditionally has been concerned with the creation

of so-called ``hidden markets'' whereby an OTC market maker or

specialist publishes quotations in some market centers at prices

superior to the quotation information disseminated broadly by such OTC

market maker or specialist.37 Due to an increasing number of

electronic communications networks being developed by market

participants and market centers, quotation information is becoming

splintered, with OTC market makers and specialists publishing different

[[Page 52797]]

proposed trading prices in different quotation systems, some with

limited access. As a result, smaller retail customers do not always

obtain the benefit of the best available price.

\37\ See Securities Exchange Act Release No. 17583, supra note

30.

---------------------------------------------------------------------------

While these systems may have increased intermarket competition, the

Commission believes that consolidated quotations and their

dissemination to the public continue to be important elements of the

NMS. Moreover, while competition is an important goal of the NMS,

competition based on fragmented quotations may reduce efficient pricing

of publicly disseminated bids and offers, thereby impeding the NMS goal

of consolidated quotations. More importantly, the availability of

accurate quotation information enables investors to police the efforts

of their brokerage firms to obtain the best price possible for their

orders.

Over 20 years ago, the Commission noted that an essential purpose

for the establishment of an NMS ``is to make information on prices,

volume, and quotes for securities in all markets available to all

investors, so that buyers and sellers of securities, wherever located,

can make informed investment decisions and not pay more than the lowest

price at which someone is willing to sell, or not sell for less than

the highest price a buyer is prepared to offer.'' 38 In adopting

the 1975 Amendments, Congress embraced the Commission's position by

specifying in Section 11A(a)(1)(C)(iii) of the Exchange Act that it is

in the public interest and appropriate for the protection of investors

and the maintenance of fair and orderly markets to assure ``the

availability to brokers, dealers and investors, of information with

respect to quotations for and transactions in securities.'' 39

\38\ Securities and Exchange Commission, Statement of the

Securities and Exchange Commission on the Future Structure of the

Securities Markets (Feb. 2, 1972) (``Future Structure Statement'')

at 9-10, 37 FR 5286, 5287 (Feb. 4, 1972) (emphasis added). See also

SEC, Policy Statement of the Securities and Exchange Commission on

the Structure of a Central Market System (1973) at 25-28.

\39\ 15 U.S.C. Sec. 78k-1(a)(i)(c)(iii).

---------------------------------------------------------------------------

The proposed amendments to the Quote Rule are intended to improve

the quality and expand the scope of published quotation information

from OTC market makers and specialists by requiring them to reflect in

their public quotes the bid and offer prices (e.g., priced orders) they

disseminate through electronic communications networks that provide the

ability to execute against these priced orders. The amendments are

designed specifically to address what the Commission believes to be the

potential for market makers to quote one price to public investors but

to publish firm quotes in private systems at better prices.

2. Proposed Amendments

a. Definition of Subject Security

Coverage of the Quote Rule would be expanded pursuant to proposed

subparagraph (a)(6), which defines a ``covered security.'' As proposed,

a covered security would mean any reported security and any other

security for which a transaction report, last sale data or quotation

information is disseminated through an automated quotation system as

described in Section 3(a)(51)(A)(ii) of the Exchange Act.40 This

expansion of coverage would bring Nasdaq SmallCap securities within the

scope of the Quote Rule.41 Thus, market makers in those securities

would be obligated under the Rule, as well as NASD rules, to provide

quotes and to honor those quotes in trading with the public.42

\40\ 15 U.S.C. Sec. 78c(a)(51)(A)(ii).

\41\ Section 11A(c)(1) grants the Commission the authority to

prescribe, among other matters, rules and regulations to assure

accurate and reliable quotations ``with respect to any security

other than an exempted security.'' The Commission believes that

extending the requirements of the Quote Rule to Nasdaq SmallCap

securities will further these interests.

\42\ In addition to the changes discussed in greater detail

herein, the Commission is proposing to make technical, non-

substantive changes to the Quote Rule. The terms ``association,''

``revised bid or offer,'' and ``revised quotation size'' will be

separately defined in the rule. The definition of ``exchange-traded

security'' has been revised to exclude OTC securities traded on an

exchange pursuant to unlisted trading privileges. The definition of

``plan processor'' has been amended to reflect the appropriate

cross-reference. The definition of ``principal market'' has been

removed from the Quote Rule because it is no longer applicable. In

addition, the definitions have been rearranged in alphabetical

order.

Paragraph (b)(1)(i) of the rule has been reorganized to

separately set forth the exclusions in subparagraphs (A) and (B).

Paragraph (b)(1)(iii) has been eliminated and the substance of the

provision has been incorporated into paragraphs (b)(1)(i) and

(b)(1)(ii).

The Commission is also proposing to amend the definition of the

term ``reported security'' as it appears in Rule 11Aa3-1(a)(4). The

amendment alters the form but not the meaning of the term or its

application. The amendment will make the term consistent with the

definition of ``reported security'' in the Quote Rule.

---------------------------------------------------------------------------

b. Market Makers That Trade More Than 1% of a Security in a Quarter

The proposed amendments to the Quote Rule would expand the

definition of a subject security to include non-Rule 19c-3 securities

as well as Rule 19c-3 securities. As a result, firms that hold

themselves out as willing to buy and sell non-Rule 19c-3 securities on

a regular or continuous basis, even if they have not elected to

register as market makers with the NASD, would be subject to the rule,

contingent upon meeting the 1% threshold. Exchanges that trade more

than 1% of either a Rule 19c-3 or a non-Rule 19c-3 security would also

be required to make continuous two-sided quotes available to the

public.

The practical implication of this amendment is that the most active

market makers in non-Rule 19c-3 securities, who currently have no

obligations to report quotations, would be required to register as CQS

market makers and disseminate continuous two-sided quotations publicly.

The Commission also is proposing an amendment to the definition of

``OTC market maker'' to include a market maker that holds itself out as

willing to buy from and sell to its customers, if it does so on a

regular or continuous basis. This would apply even if the market maker

does not hold itself out as willing to buy and sell to the market in

general. Dealers that internalize customer order flow in particular

stocks, and dealers that hold themselves out to particular firms as

willing to execute their customer order flow, and who execute these

orders on a regular or continuous basis, would be considered market

makers under the proposed amendment. As in the past, broker-dealers

would not be considered to be holding themselves out as regularly or

continuously willing to buy or sell a security if they occasionally

execute a trade as principal to accommodate a customer's request.

Moreover, the proposed definition does not encompass block positioning.

c. Use of Electronic Communications Networks

The Commission is proposing to include prospectively within the

definition of ``bid'' or ``offer'' under the Quote Rule priced orders

that market makers enter into widely disseminated electronic

communications networks, thereby requiring market makers to include

such orders in the bids and offers they communicate to their exchange

or association for reflection in their published quotations.43 New

paragraph (c)(5)(i)(A) would deem, prospectively, dissemination of a

priced order by an exchange market maker, defined to include

specialists, and an

[[Page 52798]]

OTC market maker in an electronic communications network to be a

publication of a bid or offer.44 The rule would not require the

OTC market maker or specialist to publish in its publicly disseminated

quote the full size of the priced order included in the electronic

communications network. Rather, the OTC market maker or specialist

would be required to disseminate publicly the price of the order and

the minimum size set by the exchange or association.

\43\ Paragraph (a)(3) of the amended Quote Rule defines the

terms ``best bid'' and ``best offer'' to mean the highest priced bid

and lowest priced offer.

Conforming amendments to the definition of ``bid'' and ``offer''

and paragraph (c)(1) are proposed to, in effect, require brokers and

dealers to report their ``best bids'' and ``best offers'' rather

than their ``most recently'' communicated bids and offers. This

represents a change from the existing rule's reliance on a temporal

standard to a price standard.

\44\ Pursuant to proposed subparagraph (c)(4)(i), no exchange or

OTC market maker would be able to make available, disseminate or

otherwise communicate to any quotation vendor, directly or

indirectly, for display on a terminal or other display device any

bid, offer, quotation size, or aggregate quotation size for any

covered security which is not a subject security with respect to

such exchange or OTC market maker.

---------------------------------------------------------------------------

The term ``electronic communications network'' would include

continuous auction systems, but is not intended to include crossing

systems or broker-dealer internal order routing systems. The term

``priced order'' within the rule refers to orders at a specified price,

not indications of interest. Thus, the Commission intends the scope of

this proposal to include disseminated commitments to buy or sell a

security at a particular price for a particular number of shares (which

may be effected in whole or in part). The Commission does not intend

the scope of the amendments to include disseminated interest to buy or

sell a security where price or the number of shares is not included as

part of the dissemination. Furthermore, the rule does not apply to odd-

lot orders. Unlike the other proposals, these proposed amendments do

not include exceptions for block orders or orders for which an OTC

market maker's or specialist's customer has expressly requested that

the order not be displayed. However, the Commission requests comment on

whether the rule should exclude orders where an OTC market maker or

specialist is acting as agent if its customer requests that the order

not be displayed.

The Commission recognizes that the exchanges and the NASD impose

minimum price variations for securities traded or quoted by their

members. For example, currently most exchange-listed securities are

quoted and traded with a minimum price variation of \1/8\ point or, in

some instances, \1/16\ point. Nasdaq securities may be traded and

reported in variations as low as \1/256\, and may be quoted in minimum

variations of \1/16\. Some existing electronic communications networks

allow for trading variations as low as \1/256\, and some systems also

provide for decimal variations as low as a penny. The fact that systems

allow for different minimum variations in the quote may cause conflicts

for OTC market makers and specialists attempting to comply with the

proposed amendments to the Quote Rule. For example, a market maker may

submit an order in an electronic communications network at a price of

20\5/16\, but only have the facility to post a quote in the primary

market in minimum variations of \1/8\. The Commission does not intend

to create incentives for OTC market makers or specialists to increase

the size of the fractions they would quote in electronic communications

networks or in any other market. As such, the proposed amendment to the

quote rule, if adopted, may necessitate simultaneous changes to the

minimum price variations across markets.

The proposed amendments would ensure that OTC market makers and

specialists in a stock reflect in their quotes superior priced

quotation information including buy and sell orders in that stock that

they have entered into electronic communications networks, as

described. As a result, an OTC market maker or specialist that was

making a continuous market in a stock, but was not previously

publishing quotes in that stock, would obligate itself by making quotes

available to electronic communications networks to publish two-sided

quotes in that stock. While this obligation to publish quotations

resulting from entry of a priced order in an electronic communications

network would end once the order is removed from the network, as a

practical matter, immediate withdrawal of public quotations could

result in the OTC market maker or specialist being unable to re-enter

quotations for that security for a subsequent period.

3. Request for Comments

The Commission requests comment on issues raised by the proposed

amendments to the Quote Rule. Concerning the proposed addition of

quotations in non-Rule 19c-3 securities in the existing mandatory and

voluntary Quote Rule requirements, commenters are encouraged

specifically to address the following questions:

(1) The primary effect of this amendment is that the most active

market makers in non-Rule 19c-3 securities (generally, those trading

more that 1% of the consolidated volume in the securities), who

currently are not required to disseminate quotes in the securities,

would be required to register as ``CQS market makers,'' pursuant to

NASD rules. The Quote Rule and NASD rules currently require CQS market

makers, among other matters, to maintain firm, continuous two-sided

markets in the securities they trade. The Commission seeks comment on

whether the proposed amendment would result in more accurate and useful

quotations. The Commission also seeks comment on whether market makers

required to register as CQS market makers, and thereby maintain two-

sided quotes, should be granted greater ITS access.

(2) In view of the various ITS and NASD restrictions on computer

generated quotations, the Commission seeks comment on the costs and

benefits to market participants and the markets in general that would

be associated with the proposed amendments. The Commission also invites

comment on whether amendments to SRO rules are necessary to achieve the

Commission's objectives.

Concerning the proposed amendment for inclusion of best bids and

offers that are disseminated through electronic communications

networks, the Commission specifically seeks comment on the following

issues:

(1) The proposed amendments are designed to deter fragmented

markets and to promote improved quotations. The Commission seeks

comment on whether the proposed amendments achieve this goal, and

invites suggestions for alternatives to the rule that would better

achieve this goal. The Commission also requests comment generally as to

whether there are business justifications or economic rationale for

permitting market makers to publish bid and offer prices for execution

in electronic communications networks which differ from their

quotations in public markets. The Commission requests comment on

whether market participants utilize electronic communications networks

to quote in finer increments because such finer increments are not

possible on an exchange or Nasdaq.

(2) The Commission notes that the proposed rule will have the

effect of prohibiting market makers that do not currently publish

quotes in a covered security from placing an order, bid or offer into

an electronic communications network, unless they elect to publish

quotations for such orders in that security. The Commission seeks

comment on whether this result is appropriate.

(3) The Commission seeks comment on the types of electronic

communications networks that would be subject to the rule. The

Commission solicits comment on whether the definition of the term

``electronic

[[Page 52799]]

communications network'' unintentionally captures crossing systems or

broker-dealer internal order routing systems or any other systems

inconsistent with the Commission's objectives. The Commission also

seeks comment on whether the proposal should apply to crossing systems

or broker-dealer internal systems in some manner. Finally, the

Commission seeks comment on the competitive effects of the proposal on

existing electronic communications networks, their subscribers and

users, and whether there are alternatives to the proposal that would

minimize any negative competitive effects while achieving the

Commission's goals. For example, should the Commission require these

systems to furnish these prices to the applicable exchange or

association for further dissemination, and provide some access, such as

a linkage, to the prices in their electronic network?

(4) As indicated in the discussion, differences in the minimum

trading variation across markets and electronic communication networks

raise concerns about how the proposed amendment to the Quote Rule would

apply across all systems. The Commission seeks comment on the steps

necessary to ensure that differential minimum variation requirements do

not frustrate the purposes of the rule. What modifications to SRO

member firm facilities are required?

Would an acceptable alternative be to require an OTC market maker

or specialist that enters a priced order at a smaller price variation

than is used by the exchange or association's quotation system, to

display a quotation at a price that is rounded to the next quotation

increment used in that market? While this approach would not provide

full public disclosure of the better price available in the electronic

communications network, it also would not require changes to existing

quotation systems.

(5) As discussed above, the proposed amendments would not apply to

any firm that occasionally executes customer orders as principal, but

does not generally hold itself out as willing to buy and sell the

security. The Commission seeks comment on whether the proposed

amendments should be modified to include these firms in the definition

of OTC market maker. In addition, the Commission requests suggestions

for alternative language to achieve the Commission's stated goals.

(6) The Commission requests comments on whether there should be

exceptions under the rule, and if so, under what circumstances.

Specifically, the Commission seeks views on whether the rule should

exclude orders where a market maker is acting as agent if its customer

expressly requests that the order not be displayed. In particular,

should an exception be provided for customer limit orders entered into

an electronic communications network if the customer has requested,

pursuant to the exception from the limit order display rule, that its

limit order not be displayed?

(7) The proposed rule would only require OTC market makers and

specialists to display the minimum quotation size established by an

exchange or association for an order displayed in an electronic

communications network. Should the OTC market maker or specialist be

required to display publicly the full size of the order? Alternatively,

should the rule require the public display of the full size unless the

customer requests otherwise?

4. Consideration of the Proposed Rule's Costs and Benefits

The proposed amendments would require some market participants to

modify their current quotation dissemination systems. Although the

Commission believes that these amendments would not impose significant

implementation costs, it seeks comment on the order of magnitude of the

costs. The Commission believes that the proposed amendments would

provide several benefits to the markets and to investors in those

markets, including improved price discovery, liquidity and competition

between market makers. In addition, the proposed amendments would

improve execution prices of customer market orders that are priced off

the consolidated best bids and offers. These benefits are distributed

across a wide constituency, so the Commission seeks guidance on how

best to evaluate the benefits associated with the proposed amendments.

The Commission seeks detailed comment on the following specific

questions regarding the costs and benefits of amendments to the Quote

Rule:

(1) What system changes and costs under the proposed amendments to

the Quote Rule would be necessary?

(2) If the amendments were adopted, what would be the likely impact

on OTC market makers, specialists, and electronic communications

networks?

(3) Currently, some market makers receive the benefits associated

with OTC market maker or specialist designation (e.g., favorable margin

treatment, short-sale trading exemptions, and enhanced market access)

without being required to disseminate continuous two-sided quotes. How

should the Commission quantify the benefits derived from OTC market

maker or specialist status? How should the Commission quantify the

costs associated with disseminating continuous two-sided quotes? In

particular, how should the Commission quantify the costs associated

with disseminating such quotes manually, rather than through computer

generated mechanisms?

(4) How should the Commission assess the potential benefits

associated with public access to the best prices in the market and how

should those benefits be quantified?

(5) How would the proposed amendments contribute to transparency in

the market and how should the improvements in transparency be

quantified?

(6) To the extent that OTC market makers and specialists maintain

superior bids (offers) in electronic communications networks, those

bids (offers) would be reflected in the consolidated quotes that are

available to the public. How should the Commission quantify the savings

to customers associated with the concomitant narrowing of publicly

disseminated spreads?

B. Display of Customer Limit Orders

1. Background

The failure to display limit orders that are priced better than

current quotes raises at least three regulatory concerns. First, the

failure to display limit orders can produce an artificial widening of

spreads, raising the concern that investors may not have access to

optimum prices. Second, there are concerns about fair competition. If

the quotes from a market or market maker do not fully represent the

buying and selling interest in a given security, quote competition is

less keen, and the price discovery process may be impaired. Third,

because many markets and market makers offer automatic executions of

small orders at the best displayed quotes, a failure to display limit

orders that improve the best displayed quotes can result in inferior

executions for these orders.

In connection with Market 2000,45 the Commission received

comments

[[Page 52800]]

concerning whether the optimal degree of pre-trade disclosure of limit

orders was being achieved within a given market. Some commentators

alleged that specialists and third market dealers sometimes fail to

display limit orders priced better than the displayed quotation.46

Questions were also raised about the lack of limit order exposure on

Nasdaq. Although the OTC market recently has made improvements in the

manner in which customer limit orders are handled, there is no

requirement that limit orders be displayed.47

\45\ Market 2000 recommended that the securities exchanges

consider whether to encourage the display of all limit orders (i.e.,

orders to buy or sell at a specified price) in listed stocks priced

better than the best intermarket quotes, unless the ultimate

customer requests that the order not be displayed. Market 2000 also

recommended that the NASD consider whether to encourage the display

of limit orders in Nasdaq stocks when the orders are at prices

better than the best Nasdaq quotes, unless the customer requests

that the order not be displayed. See Market 2000, supra note 4 at

IV-6.

\46\ See Thomas H. McInish & Robert A. Wood, ``Hidden Limit

Orders on the NYSE'', 21 J. Portfolio Mgmt 19 (No. 3, Spring 1995).

The authors assert that New York Stock Exchange (``NYSE'')

specialists only display about 50% of limit orders that better

existing quotes. In their opinion, this practice represents a

serious policy issue because it places both public investors and

regional exchanges at a disadvantage. They assert that hiding limit

orders impedes strategic decisions on order placement; results in

publicly submitted market orders receiving inferior prices; hampers

the monitoring of order executions; reduces the probability of a

limit order being executed; results in a delay in reporting limit

order executions; interferes with the ability of the regional

exchanges to execute public orders; and artificially improves NYSE

performance relative to the regional exchanges using a common

benchmark. The authors also claim that NYSE Rule 60 is ambiguous in

that the specialists may have some leeway in choosing what to

disclose in their quotes. The NYSE, in Information Memo 93-12, infra

note 51-52 and accompanying text, reminded members of the duty to

represent limit orders at their limit prices when requested to do

so. Some traders, however, have continued to accuse NYSE specialists

of hiding limit orders. See Traders Accuse Specialists of Holding

Back Limit Orders, Investment Dealers' Digest, 8, (Feb. 14, 1994).

In its comment letter to Market 2000, however, the NYSE asserted

that its publicly disseminated best bid or offer includes all firm

trading interest announced on the floor as required by the

exchange's rules. See Letter from William H. Donaldson, Chairman and

Chief Executive Officer, NYSE, to Jonathan G. Katz, Secretary, SEC

at 25-26 (Nov. 24, 1992) (``NYSE Letter''). In addition, as

discussed later, a recently issued NYSE policy statement indicates

that specialists have an obligation to reflect in their quotes

certain limit orders received manually or via the Designated Order

Turnaround System (``SuperDot''). See infra note 54-55 and

accompanying text.

\47\ See infra note 56-60 and accompanying text.

---------------------------------------------------------------------------

Section 11A(a)(1)(C)(v) of the Exchange Act expresses Congress'

goal that, consistent with the other objectives of the NMS, investor

orders, including limit orders, should be permitted to interact without

the participation of a dealer.48 Congress envisioned that the NMS

would make all specialists and market makers aware of public customer

limit orders held anywhere in the system, and provide enhanced

protection and priority for those orders.49

\48\ 15 U.S.C. Sec. 78k-1(a)(1)(C)(v) (1988).

\49\ Senate Report, supra note 15 at 18 (``The Committee is

satisfied that [the legislation] grants the Commission complete and

effective authority to implement a system for the satisfaction of

public limit orders.'').

---------------------------------------------------------------------------

The Commission does not believe that the differences between dealer

and auction markets compel different results in the degree of investor

protection afforded in competing markets. Accordingly, the Commission

believes it is appropriate at this time, and consistent with investor

expectations, to propose the uniform disclosure of customer limit

orders across all markets. The increased transparency of customer limit

orders in all markets could produce, among other benefits, spreads that

more fully represent buying and selling interest in the market and

enhance an investor's ability to monitor execution quality. This, in

turn, should increase competition among dealers based on their

respective quotations.

The Commission also believes that the proposed rule will benefit

orders routed to automated execution systems. Execution on these

systems is often tied to the best displayed quotation for a particular

security. The display requirement should result in executions at prices

that more accurately reflect buying and selling interest in the market,

thus resulting in better executions for orders priced through automated

execution systems.

2. Discussion

Limit orders currently are handled differently in the various

auction and dealer markets. Generally, exchange rules require that a

limit order be displayed in the quotation for a security when it

improves the best bid or offer. NYSE specialists, for example, must

reflect a customer limit order in their quotations at the limit price

when requested to do so.50 In addition, the NYSE's order handling

procedures assume that all limit orders routed to a specialist through

SuperDot implicitly contain a display request.51 Therefore, except

in the unusual and infrequent circumstance where a specialist believes

market conditions suggest the likelihood of imminent price improvement,

a limit order received by a specialist through SuperDot should be

reflected in the specialist's quote as soon as practicable following

receipt of the order.52 According to the NYSE, 93% of all limit

orders that improve the best bid or offer displayed are reflected in

the specialist's quote within two minutes of receipt, while 98% of such

limit orders are reflected within five minutes of receipt.53

\50\ See NYSE Rule 79A.10 (when a limit order is presented to

the specialist by a floor broker, the floor broker must

affirmatively request that the specialist display the limit order;

failure to so request leaves the decision whether to display the

limit order to the discretion of the specialist); see also NYSE Rule

60 (requiring specialists to promptly report, inter alia, the best

bid and offer in the trading crowd in each reported security in

which the specialist is registered).

Of course, adoption of the Commission's proposal would supersede

any exchange or association rule regarding the display of customer

limit orders to the extent such exchange or association rule is

inconsistent with the Commission's proposal.

\51\ NYSE Information Memo 93-12 (Mar. 30, 1993).

\52\ Id.

\53\ Telephone Conference between Edward A. Kwalwasser,

Executive Vice President, NYSE, and Holly Smith, Associate Director,

Division of Market Regulation, SEC, January 9, 1995.

Other exchanges also have rules regarding dissemination of bids

and offers. Generally, these rules either cite, in whole or in part,

language from the Quote Rule, or are drafted in such a manner as to

allow for broad interpretation with respect to the display of limit

orders. See, e.g., Boston Stock Exchange Guide, Rules of the Board

of Governors, Chapter II, Sec. 7, (CCH) para. 2020; Pacific Stock

Exchange Guide, Rules of the Board of Governors, Rule 5.6(f), (CCH)

para. 3979; American Stock Exchange Guide, General and Floor Rules,

Rule 115, (CCH) para. 9265; Chicago Stock Exchange Guide, Article

XX, Rule 7, (CCH) para. 1688; Philadelphia Stock Exchange Guide,

Rules 105 and 229 (CCH) para. 2105 and 2229.

---------------------------------------------------------------------------

The Commission recently approved a proposed rule change by the NYSE

that clarifies the exchange's policy with respect to the display of

limit orders received by a specialist.54 This policy requires

specialists to display the full size of all orders received through

SuperDot as well as orders received by specialists manually which are

subsequently entered into the electronic book. This requirement

includes increasing the size of a quotation for orders at the same

price as the current bid or offer; when a member requests that less

than the full size of the order be shown, the specialist is obligated

to show the size requested. Specialists must display as soon as

practicable any order which, in relation to current market conditions

in a particular security, represents a material change in the supply or

demand for that security. If the quotation already reflects significant

supply or demand, and the specialist receives an order that is de

minimis in relation to such supply or demand, the specialist may take a

reasonable time (generally not more than two minutes) before updating

the size of the quotation.55

\54\ See Securities Exchange Act Release No. 35687 (May 8,

1995), 60 FR 25751 (May 12, 1995) (notice of the proposal), and

Securities Exchange Act Release No. 36231 (Sept. 14, 1995), 60 FR

48736 (Sept. 20, 1995) (approval order).

\55\ The NYSE provides the following example of when a

specialist may take a reasonable time to update the size of the

quotation: If the market in XYZ security is 20 (5000)-20\1/4\

(50,000), and the specialist receives an order to sell 200 shares at

20\1/4\, such order would be considered de minimis and the

specialist would be permitted to wait a reasonable period of time

(but not more than two minutes) before changing the size of the

offer to 50,200. The Commission requests comment on whether, in the

context of its rule proposal, a discretionary de minimis threshold

is appropriate; whether an alternative standard (e. g., 5% of the

outstanding size) is appropriate; or whether there should be no

exception for de minimis size orders. See Part 4, Request for

Comments (No. 3).

[[Page 52801]]

---------------------------------------------------------------------------

The OTC market operates as a dealer market, in which the quote for

any security represents a dealer's own bid and offer. The rules of the

NASD currently do not require market makers to display customer limit

orders that better the best bid or offer for the security.56

Generally, customer limit orders in OTC securities either will be

routed to a broker-dealer's market making desk or to a non-affiliated

market maker for execution if the firm does not make a market in the

security.57 In the past, market makers typically did not execute

limit orders until the best bid or offer displayed on Nasdaq equaled

the limit price. This practice has changed, however, over the course of

the past year. In June 1994, the Commission approved a proposed rule

change filed by the NASD that prohibits broker-dealers from trading

ahead of their customers' limit orders.58 The Commission further

expanded this prohibition in May 1995, when it approved another NASD

proposed rule change that prohibits broker-dealers from trading ahead

of customer limit orders they accept from other brokers.59 The

Commission also has published for comment a proposed rule change filed

by the NASD that would require, in certain circumstances, the display

of customer limit orders for exchange-listed securities traded

OTC.60

\56\ See NASD Manual, Schedule D to the By-Laws, Part V, Section

2 (CCH) para. 1819.

\57\ Market 2000, supra note 4 at V-5.

\58\ See Securities Exchange Act Release No. 34279 (June 29,

1994), 59 FR 34883 (July 7, 1994).

\59\ See Securities Exchange Act Release No. 35751 (May 22,

1995), 60 FR 27997 (May 26, 1995).

\60\ See Securities Exchange Act Release No. 35471 (Mar. 10,

1995), 60 FR 14310 (Mar. 16, 1995). The proposed rule, applicable to

exchange listed securities traded OTC, generally would require a

market maker either to execute immediately a limit order of 500

shares or less priced better than the market maker's quotation, or

display the order in its quotation with a minimum quotation size of

500 shares. Limit orders greater than 500 shares would be required

to be displayed in the market maker's quotation but the quotation

size need not equal the size of the limit order. Any portion of the

order not displayed, however, would have to be executed at a price

at least as favorable as the displayed price.

---------------------------------------------------------------------------

The exchanges and the NASD use automated trading systems to route

and, in some instances, execute orders of predetermined size. Some of

these systems accept limit orders. Each system, however, may differ in

its handling of limit orders that are not executed immediately upon

receipt. For example, the NYSE's SuperDot system routes limit orders to

the specialists' posts where they are handled in accordance with NYSE

rules governing specialist representation of such orders. The American

Stock Exchange's (``Amex'') PER system routes limit orders in the same

manner as SuperDot and the orders are handled in accordance with Amex

rules. The NASD's Small Order Execution System (``SOES'') treats limit

orders priced at the current inside market as market orders that are

immediately executed.61 All other limit orders reside in a limit

order file that can be reviewed by market makers.62 The NASD has

filed for Commission approval a proposed system, ``NAqcess,'' that

would replace SOES and include a limit order file designed to improve

the handling of customer limit orders.63

\61\ Preferenced orders (i.e., orders routed to a specific

market maker pursuant to a pre-existing agreement) are executed

immediately at the inside quote. Unpreferenced orders are executed

against market makers in a security in rotation. SOES, however, does

not execute an unpreferenced order against a single market maker

more than once every 15 seconds.

\62\ The current SOES rules have been extended, with certain

changes that do not affect the handling of limit orders, through

October 2, 1995. See Securities Exchange Act Release No. 35535 (Mar.

27, 1995), 60 FR 16690 (Mar. 31, 1995). The NASD has requested that

the Commission grant a further extension through January 31, 1996.

Securities Exchange Act Release No. 36154 (Aug. 25, 1995), 60 FR

45502 (Aug. 31, 1995).

\63\ See File No. SR-NASD-95-42, submitted on September 22,

1995.

---------------------------------------------------------------------------

The Commission is proposing new Rule 11Ac1-4 to require the uniform

display of customer limit orders that improve a specialist's or OTC

market maker's best bid or offer for a particular security as well as

the size of such orders. In addition, the rule would require the

display of the size of certain limit orders priced at the NBBO. The

Commission has considered and is building upon the special role played

by market makers and specialists in discovering prices and providing

liquidity to the securities markets. While the proposed rule generally

mandates display of limit orders, market makers and specialists still

would retain some flexibility in handling limit orders accepted for

execution.

Specifically, the rule would allow an OTC market maker or

specialist, immediately upon receipt of the limit order, to: (1) Change

its quote and the size associated with its quote to reflect the limit

order; (2) execute the limit order; (3) place the limit order in a

limit order book in its own market or another market that complies with

the requirements of the rule; or (4) send the limit order to another

market maker or specialist who complies with the requirements of the

rule. The proposed rule prescribes the duty of a specialist or OTC

market maker to display a customer limit order when the order is

``held'' by the specialist or OTC market maker. If the specialist or

OTC market maker immediately sends the order to a limit order book or

another specialist or OTC market maker that would display the order in

compliance with the rule, the specialist or OTC market maker that

routes the order would have no duty to display. The Commission believes

that these alternatives will provide all market makers, specialists,

and market centers an opportunity to continue to provide their valuable

services while offering customers the best available execution

opportunities.

3. Proposed Rule

Proposed Rule 11Ac1-4 applies to ``customer limit orders'' in

``covered securities.'' A covered security is defined as any reported

security and any other security for which a transaction report, last

sale data or quotation information is disseminated through an automated

quotation system that is sponsored by a registered securities

association. This definition is designed to encompass all exchange-

listed securities, Nasdaq National Market securities and Nasdaq

SmallCap securities.64

\64\ Regionally listed securities that do not substantially meet

NYSE or Amex original listing criteria do not satisfy the definition

of ``covered security.'' Such securities are not ``reported

securities'' as that term is defined, nor do they meet the other

elements of the definition of covered security. OTC Bulletin Board

(``OTCBB'') securities also do not satisfy the definition of covered

security. The Commission has determined not to extend the display

requirement to such securities at the present time. The Commission

requests comment, however, on the appropriate scope of the rule. See

Part 4, Request for Comments (No.5).

---------------------------------------------------------------------------

A customer limit order includes any order to buy or sell a covered

security at a specified price not for the account of a broker or

dealer. Limit orders transmitted for execution by a broker or dealer on

behalf of a customer are included in the definition.65 The size of

any limit order that improves the NBBO would be displayed in full. The

size of a limit order priced at the NBBO would be displayed when it

represents more than a de minimis change in relation to the size

displayed by the specialist or OTC market maker.

\65\ SRO rules typically provide some time and price priority

for orders submitted by non-broker-dealer customers, in recognition

of the time and price advantages associated with professional

orders. But see Securities Exchange Act Release No. 35751, supra

note 59, in which the Commission discussed the appropriateness of

excluding options market makers from the customer class protected by

the NASD prohibition against ``trading ahead.''

[[Page 52802]]

---------------------------------------------------------------------------

The proposed rule would apply to: (i) Every member of an exchange

that is registered by that exchange as a specialist or has been

authorized by an exchange to perform functions substantially similar to

that of a specialist (collectively ``specialist''); 66 (ii) third

market makers; 67 (iii) members of an association that are OTC

market makers; 68 and (iv) exchange members that trade an OTC

security pursuant to UTP.69 These persons would be required to

reflect immediately in their bid or offer the price and size of each

customer limit order they hold at a price that would improve their bid

or offer in the security.70 For example, in the case where a

person covered by the rule is quoting 10-10\1/2\ when it receives a

customer limit order in a covered security to buy at 10\1/4\, it must

change its bid to 10\1/4\ immediately to reflect the limit order. The

size of the order also must be included in the quote. Where the order

betters the NBBO, the person would be required to change the price and

size of its quote regardless of the size of the limit order, except in

the case of an odd-lot or block size order. Nasdaq market makers,

however, are subject to minimum quotation size requirements which

depend on the characteristics of the security. The proposed rule would

require that the size of the customer limit order be displayed. The

Commission recognizes, therefore, that the NASD may need to amend its

quote size rules to allow display of small customer limit

orders.71

\66\ Proposed Sec. 240.11Ac1-4(b)(1)(i).

\67\ Proposed Sec. 240.11Ac1-4(b)(1)(ii).

\68\ Proposed Sec. 240.11Ac1-4(b)(2)(i). If an OTC market maker

is not quoting publicly, it still must publish a quotation that

identifies the limit order, or avail itself of one of the

exceptions.

\69\ Proposed Sec. 240.11Ac1-4(b)(2)(ii).

\70\ See Proposed Sec. 240.11Ac1-4(b)(1)(i)(A), (b)(1)(ii)(A),

(b)(2)(i)(A) and (b)(2)(ii)(A). The Commission notes that the rule

does not provide for any discretion in the timing of the display of

the limit order.

\71\ See also Section II.C.2. (regarding proposed price

improvement rule).

---------------------------------------------------------------------------

All persons covered by the rule also would be obligated to reflect

in their quotes the size of a customer limit order that: (1) Is priced

equal to their bid or offer; (2) is priced equal to the national best

bid or offer for the security; and (3) represents more than a de

minimis change in relation to the size associated with their bid or

offer.72 For example, assume a regional specialist's quote is 10

(1000)-10\1/2\ (1000), when the specialist receives a customer limit

order to buy 2000 shares at 10. Assume further that the NBBO is 10-

10\1/4\. Under the rule, the specialist would be obligated to change

immediately its bid to 10 (3000).

\72\ See Proposed Sec. 240.11Ac1-4(b)(1)(i)(B), (b)(1)(ii)(B),

(b)(2)(i)(B) and (b)(2)(ii)(B).

---------------------------------------------------------------------------

As noted above, the rule would require the ``immediate'' display of

certain customer limit orders. To satisfy this requirement, a

specialist or OTC market maker must display the limit order immediately

upon receipt unless there exists an applicable exception to the display

requirement.

There are six exceptions to the general requirements of the

proposed rule. The first exception applies to any customer limit order

that is executed upon receipt of the order.73 If the order is

executed upon receipt, then no duty arises under the proposed rule.

\73\ Proposed Sec. 240.11Ac1-4(c)(1).

---------------------------------------------------------------------------

The second exception applies to any limit order that is placed by a

customer who expressly requests that the order not be displayed.74

This exception is included because there may be instances where a

customer may prefer to exclude its order from public display. This

exception will permit customers to negotiate individually execution

parameters for the handling of their orders with their broker-dealers

either on an order-by-order basis or prospectively. Standardized

disclaimers or contractual language by a firm would not be deemed to be

a request by a customer that its order not be displayed. For example, a

customer with a large limit order may wish to let its broker work the

order rather than display the entire order. This exception gives the

customer the right to decide if the order should be displayed in total,

in part, or not at all. The rule would require a customer to expressly

request that an order not be displayed. A customer request that an

order be placed in a particular non-public trading system would not, by

itself, be deemed to come within the exception. The Commission expects

that most retail customers will want their limit orders displayed

pursuant to the rule. Thus, the Commission has crafted the rule to

require specialists and OTC market makers to assume that retail

customers wish to have their orders displayed.

\74\ Proposed Sec. 240.11Ac1-4(c)(2).

---------------------------------------------------------------------------

The third exception applies to odd-lot orders.75 The rule does

not require the display of an order for less than a unit of trading

pursuant to the rules of the exchange or association. In the event that

a round-lot limit order represented in the quote is partially filled

and, as a result, would then be deemed an odd-lot order, the exchange

or association may treat the remainder of the order as an odd-lot for

purposes of this rule.

\75\ Proposed Sec. 240.11Ac1-4(c)(3).

---------------------------------------------------------------------------

The fourth exception applies to block size orders.76 Orders of

at least 10,000 shares or for a quantity of stock having a market value

of at least $200,000 need not be displayed in accordance with the

rule.77 Customers placing block orders, however, may request that

the order be displayed in accordance with the requirements of the rule.

The specialist or OTC market maker would be obligated to honor such a

request.

\76\ Proposed Sec. 240.11Ac1-4(c)(4).

\77\ This block definition is consistent with the current

definition used in NYSE Rule 127.10.

---------------------------------------------------------------------------

The fifth exception applies to a limit order that is delivered

immediately to an exchange or association sponsored system that

displays limit orders and complies with the requirements of the rule

with respect to that order.78 This exception, however, does not

relieve a specialist or OTC market maker from its display obligation

for orders it receives through exchange or association facilities,

unless the system itself displays the order.

\78\ Proposed Sec. 240.11Ac1-4(c)(5).

---------------------------------------------------------------------------

The sixth exception applies to a limit order that is delivered to

another exchange member or OTC market maker that complies with the

display requirements of the rule with respect to that order.79 For

example, a market maker that receives a limit order subject to the

display requirement under the rule may immediately send the order to

another market maker in the security if it reasonably believes that the

other market maker will display the order in accordance with this rule.

\79\ Proposed Sec. 240.11Ac1-4(c)(6).

---------------------------------------------------------------------------

4. Request for Comments

The Commission requests comment on issues raised by this proposal,

including the following matters:

(1) The proposed rule is designed to increase transparency of

customer limit orders. The Commission seeks comment on whether the rule

promotes transparency consistent with customers' agency expectations.

(2) As discussed earlier, some commenters believe that specialists

sometimes fail to display limit orders entered at prices better than

the displayed quotation. The present rule proposal is designed, in

part, to address this concern. Accordingly, the Commission seeks

comment on the extent to which specialists currently fail to reflect

immediately in their quotes limit orders that improve the best bid or

offer; whether the rule addresses legitimate concerns that limit orders

are not presently displayed in a consistent manner in all auction

markets; and whether there may be situations where,

[[Page 52803]]

in the interest of best execution, a specialist should have the

discretion not to announce some or all of a customer's order on the

floor.80

\80\ See NYSE Letter, supra note 46 at 26 (specialist allowed to

use professional judgment as an agent on how best to serve the

customer). But see NYSE Information Memo 93-12, supra note 51

(except in unusual and infrequent circumstances, a limit order

received through SuperDot will be reflected in the specialist's

quote).

---------------------------------------------------------------------------

(3) In certain circumstances, the rule would require that the size

of a customer limit order be reflected where the limit order is priced

equal to the NBBO and represents more than a de minimis change in

relation to the size displayed by the specialist or OTC market maker.

The Commission seeks comment on whether it is appropriate to base the

display requirement on a de minimis threshold; whether this threshold

should be quantified (e.g., 5% of current quote size); or whether the

size of all orders priced equal to the NBBO should be displayed.

(4) The Commission seeks comment on whether the scope of the

definition of ``block size'' is appropriate, particularly whether the

definition should be changed to apply to orders of greater size or

market value (e.g., 25,000 shares as in NYSE Rule 72(b)).

Alternatively, the Commission requests comment on whether orders of

block size should be subject to the display requirement.

(5) The proposed rule would apply to exchange listed securities,

Nasdaq National Market securities and Nasdaq SmallCap securities. The

Commission seeks comment on the scope of the rule.

(6) The Commission seeks comment on the rule's interaction with

other initiatives, such as the NASD's proposal to create a new small

order execution system; 81 the NASD's proposal to impose display

requirements on market makers holding limit orders for exchange-listed

securities traded over-the-counter; 82 and the NASD's trading

ahead prohibitions.83

\81\ See File No. SR-NASD-95-42, supra note 63.

\82\ See Securities Exchange Act Release No. 35471, supra note

60.

\83\ See, supra note 58-59.

---------------------------------------------------------------------------

(7) The Commission requests comment on whether the exception to the

display requirement for limit orders delivered immediately upon receipt

to an exchange- or association-sponsored system that displays those

limit orders in accordance with the rule should be extended to

electronic communications networks or other proprietary trading

systems. If so, the Commission seeks comment on whether the extension

of such exception should be predicated on the level of accessibility

and transparency afforded by these systems.

(8) The Commission seeks comment on whether it would be appropriate

to include within the definition of limit orders those orders, however

defined by a particular exchange or association, as to which a

specialist, market maker or system sponsor has some discretion over the

price at which the order is executed. For example, the Commission is

interested in the potential costs and benefits of including CAP orders

within the scope of the rule.84

\84\ Such orders are percentage orders entered with a ``convert

and participate'' instruction, and are executed based on the

execution of other orders. For a discussion of percentage orders,

see NYSE Rule 123A.

---------------------------------------------------------------------------

(9) The Commission seeks comment on the effect of the rule on

passive market making activities pursuant to Rule 10b-6A of the

Exchange Act (17 CFR 240.10b-6A).

(10) The Commission seeks comment on whether a market maker should

be required to obtain some form of assurance that a customer limit

order it sends to another market maker will be displayed in accordance

with this rule, before the market maker would be allowed to send the

limit order pursuant to paragraph (c)(6) of the rule.

5. Consideration of the Proposed Rule's Costs and Benefits

To evaluate fully the impact of the proposed rule, the Commission

requests commenters to provide their views on the costs and benefits

associated with the proposed rule, and any data that may support those

views.

The proposed limit order display rule would require market makers

and specialists to display customer limit orders that either narrow

their own spread or increase the size associated with the NBBO. This

rule is intended to encourage quote competition between markets and

market participants; to enhance customer-to-customer interaction

without the intervention of a specialist or OTC market maker; to

increase opportunities for the execution of limit orders; and to

improve transparency in all markets.

The Commission acknowledges that the display obligations would

require some market participants to modify their current order handling

and display practices. The Commission notes that market makers may

continue to receive or demand compensation for executing customer limit

orders, such as by charging a commission for handling the order. The

Commission believes that the implementation cost of the proposed rule

is minor, but seeks comment on the order of magnitude of such costs.

The Commission envisions that this rule would have significant

benefits for the financial markets and investors in those markets.

Investors are expected to benefit from enhanced transparency, improved

price competition and the interaction of customer orders without the

intervention of a market maker or specialist, all of which should lower

the cost for investors to trade in the market. The financial markets as

a whole should benefit from the proposed rule because the price

discovery process will be enhanced, market transparency will be

improved and price competition will be promoted. By their very nature,

these benefits are broad-based and pervasive. Because incremental

amounts on a trade-by-trade basis produce significant cumulative

amounts for the market as a whole, the Commission seeks guidance on how

to represent accurately the savings associated with the implementation

of this rule.

The Commission seeks further comment on the following specific

questions:

(1) What would be the necessary system changes and costs associated

with implementation of the limit order display rule?

(2) If the rule were adopted, what would be the likely impact on

OTC market makers and specialists? Would these effects on the

commitment of capital be influenced by the trading characteristics of

particular securities, e.g., high volume vs. limited volume?

(3) The Commission recognizes that subsequent to adoption of the

rule, market makers may need to charge commissions for the handling and

display of public limit orders. What would be the anticipated level of

commissions for a limit order and what would be the overall cost to the

customer?

(4) How should the Commission assess the potential benefits

associated with the narrowing of spreads?

(5) What would be the likely impact of the proposed rule on the

depth of the market and how should that impact be quantified?

(6) What would be the likely impact of the rule on the liquidity of

the market and how should that impact be quantified?

(7) How would the proposed rule contribute to transparency in the

market and how should the improvements in transparency be quantified?

(8) What degree of customer-to-customer interaction could be

expected if the rule is adopted and what are the savings to those

customers?

[[Page 52804]]

C. Price Improvement for Customer Market Orders

1. Background

The Commission today seeks comment on a market-wide price

improvement rule for customer market orders. The rule would apply

across exchange and OTC markets to promote best execution for all

securities covered by the rule. The Commission also is proposing a non-

exclusive safe harbor as one means by which a specialist or OTC market

maker can be assured that an order has received a sufficient

opportunity for price improvement for purposes of the rule.

The Commission believes this rule will encourage market

participants to take advantage of current technologies and provide

customer market orders with improved access to price improvement

opportunities, regardless of where such orders are routed for

execution. Although the proposed rule speaks to OTC market makers and

specialists, if adopted it would have clear implications for the best

execution obligations of broker-dealers generally. The Commission does

not intend for the proposed rule to displace the existing best

execution obligation; 85 rather, the Commission believes that the

rule would complement the long-standing duties of broker-dealers to

seek to obtain best execution of their customer orders. Moreover, the

rule is intended to foster competition among markets and market makers

on the basis of price improvement opportunities.

\85\ See Payment for Order Flow Release, supra note 8.

---------------------------------------------------------------------------

Although the rule proposed today would require OTC market makers

and specialists to provide price improvement opportunities for customer

orders, the Commission is not prescribing any particular method of

achieving price improvement in recognition of the fact that competition

can produce innovative price improvement mechanisms. However, to

provide certainty regarding one alternative by which a specialist or

OTC market maker will be deemed to have provided price improvement

opportunities to customer market orders, the Commission is proposing a

non-exclusive safe harbor. A specialist or OTC market maker that

executes a customer market order in accordance with the conditions of

the safe harbor would be deemed to have satisfied its price improvement

obligation.

The Commission wishes to stress, however, that the order exposure

procedures set out in the proposed safe harbor are not mandatory, nor

are they the exclusive means by which to satisfy the obligation to

provide an opportunity for price improvement. The Commission believes

that methods other than the exposure of customer orders can satisfy the

obligation. The Commission is interested in receiving comment regarding

alternative methods by which price improvement opportunities may be

provided. For example, some specialists and OTC market makers utilize

systems based on algorithms that automatically provide an opportunity

for price improvement. Orders that are processed manually also can be

provided enhanced opportunities to achieve better executions. The

Commission requests comment on an alternative safe harbor procedure,

described infra.86

\86\ See Part 3, Request for Comments (No. 15).

---------------------------------------------------------------------------

Under the safe harbor proposed today, a specialist or market maker

would expose in its quote a customer order at an improved price and

provide the customer with a guaranteed execution at the ``stop'' price.

This procedure is designed to promote the interaction of exposed orders

at prices better than the displayed NBBO with orders or trading

interest in other markets. The safe harbor also could lead to increased

competition by encouraging OTC market makers and specialists to compete

more actively for order flow on the basis of their published

quotations.

The 1975 Amendments were designed to facilitate the creation of a

``market characterized by economically efficient executions, fair

competition, broad dissemination of basic market information and the

maximum interplay of auction market principles.'' 87 One of the

``paramount objectives'' Congress established for the NMS was ``the

centralization of all buying and selling interest so that each investor

will have the opportunity for the best possible execution of his

order.'' 88 Congress made it clear that the Commission has broad

discretion how best to facilitate the development of an NMS.89

\87\ Senate Report, supra note 15 at 101.

\88\ Id. at 100.

\89\ Id. at 18, 19; accord H.R. Rep. No. 229, 94th Cong., 1st

Sess. 29 (1975).

---------------------------------------------------------------------------

The proposed safe harbor is based, in part, on the order exposure

proposals considered by the Commission in 1982.90 In August 1983,

the Commission postponed further action on these initiatives, due, in

part, to then existing market structure and practices.91 The

largest market maker trading Rule 19c-3 securities had ceased

operations earlier that year and the Commission believed that, due to

the low level of OTC trading in Rule 19c-3 securities and certain

technological impediments, the costs associated with the rule would

outweigh the benefits that could be achieved at that time.

\90\ See Securities Exchange Act Release No. 18738 (May 13,

1982), 47 FR 22376 (May 24, 1982); Securities Exchange Act Release

No. 19372 (Dec. 23, 1982), 47 FR 58287 (Dec. 30, 1982).

\91\ See Securities Exchange Act Release No. 20074 (Aug. 12,

1983), 48 FR 38250 (Aug. 23, 1983).

---------------------------------------------------------------------------

The utility of an order exposure requirement was debated again in

response to Market 2000,92 with comment divided on the need for

such a rule.93 The NYSE suggested that the Commission reconsider

an order exposure rule to provide for greater interaction and enhance

best execution of customer orders. The regional exchanges believed that

an order exposure rule could restore the incentive of market makers and

exchanges to compete on the basis of their displayed quotations.94

The U.S. General Accounting Office suggested that order exposure rules

be considered in connection with any new proposals to further repeal

off-board trading restrictions.95 Other commenters to Market 2000

were ambivalent; for example, the Securities Industry Association noted

that ``currently there is no compromise or consensus between those who

would advocate a uniform public order exposure rule for listed

securities and those who believe transparency requirements should be

determined by customer demand and not mandated.'' 96 The National

Specialists Association, commenting on prior Commission NMS

initiatives, stated that the Association was ``aware of nothing that

should persuade the Commission to revisit any of these proposals,

except, perhaps, the order exposure rule.'' 97 The NASD stated

that a new order exposure rule was unnecessary, but that if one were to

be

[[Page 52805]]

developed it should apply to all markets equally.98

\92\ See Market 2000, supra note 4 at IV-10. Because some SROs

supported an order exposure rule, Market 2000 suggested that all

interested SROs coordinate the development of an order exposure rule

for Commission consideration. See, e.g., NYSE Letter, supra note 46;

Letter from William G. Morton, Jr., Boston Stock Exchange, John L.

Fletcher, Midwest Stock Exchange, Leopold Korins, Pacific Stock

Exchange, and Nicholas A. Giordano, Philadelphia Stock Exchange, to

Jonathan G. Katz, Secretary, SEC (Dec. 11, 1992) (``Regional

Letter''). Since the publication of Market 2000, however, no efforts

have been initiated toward this end.

\93\ See NYSE Letter, supra note 46.

\94\ See Regional Letter, supra note 92.

\95\ See GAO, Securities Markets: SEC Actions Needed to Address

Market Fragmentation Issues (June 1993).

\96\ See Letter from Thomas M. O'Donnell, Chairman, and Marc E.

Lackritz, President, Securities Industry Association, to Jonathan G.

Katz, Secretary, SEC (July 1, 1993).

\97\ See Letter from David Humphreville, National Specialists

Association, to Jonathan Katz, Secretary, SEC (Dec. 11, 1992).

\98\ See Letter from Joseph R. Hardiman, President, NASD, to

Jonathan G. Katz, Secretary, SEC (Nov. 20, 1992).

---------------------------------------------------------------------------

2. Proposed Rule

Proposed Rule 11Ac1-5 would require each specialist or OTC market

maker 99 in a covered security that accepts a customer market

order to provide that order with an opportunity for price

improvement.100 The term ``price improvement'' is defined as the

execution of an order at a price that is better than the existing

NBBO.101 A covered security is defined as any reported security

and any other security for which a transaction report, last sale data,

or quotation information is disseminated through an automated quotation

system that is sponsored by a registered securities association.

Therefore, the definition of covered security includes exchange-listed

securities, and those Nasdaq securities that satisfy a threshold

requirement based on average daily volume.102 The threshold for

inclusion of Nasdaq securities has been proposed to include the 250

Nasdaq stocks with the highest average daily trading volume over the

previous quarter. The Commission preliminarily believes that customer

market orders for certain Nasdaq securities are not presently received

with sufficient regularity to provide a substantial likelihood of price

improvement. Therefore, at the present time, the Commission questions

whether the potential costs associated with providing the opportunity

for price improvement are justified for these securities. Accordingly,

the Commission has set a threshold in an attempt to identify the

securities for which price improvement opportunities are appropriate.

The Commission would consider, at a later date, whether to extend the

rule with respect to Nasdaq securities falling below the threshold.

\99\ See Proposed Sec. 240.11Ac1-5(a)(9). The term OTC market

maker has the same meaning provided in Sec. 240.11Ac1-1. This

definition is not coextensive with the definition found at 15 U.S.C.

78c(a)(38). See supra section II.A.2.b. regarding the amendments to

the Quote Rule.

\100\ Proposed Sec. 240.11Ac1-5(b).

\101\ Proposed Sec. 240.11Ac1-5(a)(10).

\102\ Proposed Sec. 11Ac1-5(a)(3). In addition, regionally

listed securities that do not substantially meet NYSE or Amex

original listing criteria do not satisfy the definition of ``covered

security.'' Such securities are not ``reported securities'' as that

term is defined in the proposed rule, nor do they meet the other

elements of the definition of covered security. OTC Bulletin Board

securities also do not satisfy the definition. The Commission has

determined not to extend the requirements of the rule to such

securities at the present time. The Commission has, however,

requested comment on the appropriate scope of the rule. See Part 3,

Request for Comments (Nos. 11 and 17).

---------------------------------------------------------------------------

The proposed rule applies to all customer market orders, defined to

include any order to buy or sell a covered security at the best

available price that is not for the account of either a broker or a

dealer. Further, the proposed rule applies in those instances where the

spread between the NBBO is greater than the minimum variation. The

``minimum variation'' is defined as the minimum increment by which a

covered security may be quoted on the primary market for the

security.103

\103\ Proposed Sec. 240.11Ac1-5(a)(6).

---------------------------------------------------------------------------

The proposed rule does not specify the extent to which an

opportunity for price improvement must be provided, or what method must

be used to provide this opportunity. To clarify one acceptable means of

satisfying the rule's requirement, however, the rule includes a safe

harbor that describes order exposure procedures that would be deemed to

provide sufficient price improvement opportunities under the

rule.104 Under these procedures, prior to executing a customer

market order in a covered security, the specialist or market maker

would be required to stop the customer order at the NBBO,105 and

publish, and maintain for 30 seconds, a bid or offer on behalf of the

customer. The specialist or market maker's quote must be for at least

the size of the customer order, at a price one minimum variation away

from the stop price on the opposite side of the market.106 If the

exposed order is not executed at the new quote, the specialist or

market maker would fill the customer order at the stop price for the

lesser of: (1) the full number of shares of the order; or (2) the size

associated with the NBBO at the time the order was stopped. The

exposure procedures would not apply in circumstances where the order is

for a security with a spread between the NBBO greater than four times

the minimum variation to avoid excessive quotation volatility resulting

from the exposure requirement in markets with a wide spread.107

\104\ Proposed Sec. 240.11Ac1-5(c).

\105\ Proposed Sec. 240.11Ac1-5(d)(1)(i).

\106\ Proposed Sec. 11Ac1-5(d)(1)(ii). When a specialist or

market maker ``stops'' an order, such specialist or market maker

guarantees the execution or partial execution of the order at a

specified price. Proposed Sec. 240.11Ac1-5(a)(12). The specified

price is defined as the ``stop price.'' Proposed Sec. 240.11Ac1-

5(a)(13).

\107\ Proposed Sec. 240.11Ac1-5(d)(5)(i). For example, a

customer market order for an NYSE listed security with a current bid

of 20 and an offer of 20\3/4\ would not be subject to the exposure

requirements of the safe harbor.

---------------------------------------------------------------------------

The following example illustrates the operation of the safe harbor.

Assume that an exchange specialist is quoting 20 (500)--20\3/8\

(1,000), the NBBO for XYZ security. Assume further that a customer

market order to sell 1000 shares of XYZ security is received by that

exchange specialist. Pursuant to the safe harbor, the exchange

specialist would stop the order at 20 for 500 shares, and expose the

entire 1,000 share order on the offer at an increment \1/8\ higher than

the stop price for 30 seconds. The new inside quote, therefore, would

be 20 (500)--20\1/8\ (1000) for 30 seconds. The size associated with

the exposed order may be reduced to the extent of any partial execution

during the exposure period.108

\108\ Proposed Sec. 240.11Ac1-5(d)(4).

---------------------------------------------------------------------------

Although the exposure procedures require a market maker or

specialist to expose a customer market order at a price that is one

minimum variation better than the stop price, the Commission considered

alternative approaches. For example, the Commission considered whether

to require exposure of the order at one minimum variation better than

the bid (for a buy order) or the offer (for a sell order). To

illustrate, assume that the NBBO is 20--20\3/8\, and a customer market

order to sell is received. The proposed exposure procedures would

require that the order be stopped at 20 (up to the size associated with

the NBBO) and exposed as an offer at 20\1/8\. The Commission considered

whether the exposure procedures should, instead, require the specialist

to stop the order at 20 and expose it as an offer at 20\1/4\ (\1/8\

better than the best offer). Although the alternative potentially would

result in a better execution price for an exposed order where the

spread between the NBBO was greater than \1/4\, it appears that there

would be less likelihood that the order would receive price improvement

because it would be displayed at a price less likely to draw contra-

side orders.109 Nevertheless, the Commission seeks comment on

whether this alternative would be preferable.

\109\ For example, if the NBBO is 20--20\3/8\ when a customer

sell order is received, the new NBBO under the proposal would be

20--20\1/8\ and 20 --20\1/4\ under the alternative. If a buy market

order was received, the current proposal could result in execution

at 20\1/8\ and the alternative could result in an execution at 20\1/

4\. However, the buy market order would be more likely to be

executed on the offer of 20\1/8\ because it is more advantageous for

buy orders and so would be more likely to be executed at the

exposure price.

---------------------------------------------------------------------------

It should be noted that because exposure of orders under the

proposed safe harbor would result in the dissemination of a new NBBO

during the exposure period, the price improvement opportunity for other

customer market orders received during

[[Page 52806]]

the exposure period will be determined on the basis of the new NBBO.

For example, if the NBBO is 20--20\1/2\ and thereafter is reduced to

20--20\1/8\ because of the exposure of a customer sell order, customer

market orders sent to other markets during the exposure period would

not be entitled to price improvement under the rule because the new

NBBO (during the exposure period) has been narrowed to the minimum

variation, although the Commission is seeking comment on whether the

safe harbor should be extended to minimum increment markets. But, under

best execution principles, other customer orders presumably would be

required to be executed at prices at least as favorable as the new NBBO

during the period it existed.

The order exposure procedures contain provisions designed to

facilitate efficient order execution during periods in which orders are

received in rapid succession. For example, the order exposure

procedures provide that if the specialist or market maker receives a

subsequent customer market order on the same side of the market during

the exposure period, the specialist or market maker may immediately

execute the exposed order at the stop price and must stop and expose

the subsequent customer market order.110 This means that in the

example stated above, the specialist could execute immediately the

exposed order at the stop price of 20 (up to the amount of the order

that has been stopped), stop the subsequent sell-side customer market

order at 20, and expose the subsequent order at 20\1/8\ for 30 seconds

(assuming the NBBO remains the same).

\110\ Proposed Sec. 240.11Ac1-5(d)(2).

---------------------------------------------------------------------------

The order exposure procedures also provide an exception for order

execution where another specialist or market maker executes a

transaction at a price equal or inferior to the stop price on the same

side of the market.111 In the example given above, if the XYZ

specialist in another market executes an order at 20, the specialist

who currently is exposing an order at 20\1/8\ could immediately execute

the exposed order at 20 rather than continue to expose the order for

the full 30 seconds.

\111\ Proposed Sec. 240.11Ac1-5(b)(3)(i).

---------------------------------------------------------------------------

In addition, the order exposure procedures provide for the

execution of an exposed order prior to the expiration of the exposure

period where the market for a particular security moves away from the

stop price.112 This exception is meant to reduce the risk

associated with stopping an order during a substantial market move. If

another specialist or market maker changes its bid (in the case of a

stopped buy order) or offer (in the case of a stopped sell order) to

the stop price, then the specialist or market maker exposing the order

may execute that exposed order at the stop price prior to the

expiration of the exposure period. For example, if a specialist on

another exchange changes its offer to the stop price in response to

market conditions, the specialist that has been exposing the customer

market order at 20\1/8\ also may change its offer and immediately

execute the customer order at the stop price of 20 rather than expose

the order for the full 30 second period at 20\1/8\.

\112\ Proposed Sec. 240.11Ac1-5(b)(3)(ii).

---------------------------------------------------------------------------

The order exposure procedures would not apply in certain

circumstances. The procedures contain an exception for any order of

block size.113 The safe harbor also contains an exception for

orders of non-block size that are effected in conjunction with a block

trade effected outside of the NBBO.114 For example, if a customer

order to sell is stopped at 20 and exposed on the offer at 20\1/8\, and

a block transaction is effected at 20\1/4\, the exposed order may be

executed in accordance with exchange practices.

\113\ Proposed Sec. 240.11Ac1-5(d)(5)(ii).

\114\ Proposed Sec. 240.11Ac1-5(d)(5)(v).

---------------------------------------------------------------------------

The final two exceptions to the safe harbor apply to odd-lot orders

and orders received within 5 minutes of the opening and closing of the

trading day. The latter exception is intended to allow for the

efficient opening and closing of all markets.

The rule, as a whole, contains an exception for ``fast market''

conditions.115 Specifically, the requirement to provide an

opportunity for price improvement would not apply to transactions where

firm quotations on an exchange or by the association are not required

based on unusual market conditions. In addition, the proposed rule

contains an exception that permits a specialist or market maker to send

a customer market order to another market or market maker if those

markets or market makers are in compliance with the rule.116

\115\ Proposed Sec. 11Ac1-5(e) (1), (2) and (3).

\116\ Proposed Sec. 11Ac1-5(e)(4).

---------------------------------------------------------------------------

3. Request for Comments

The Commission requests comment on issues raised by this proposal,

including the following matters:

(1) The proposed rule would require that market makers or

specialists provide an opportunity for price improvement before

executing customer orders, and sets forth non-exclusive procedures that

would satisfy that requirement. The Commission requests comment on

whether the rule should set forth the specific degree or manner by

which the price improvement opportunity must be provided.

(2) The Commission recognizes that some automated execution systems

operated by markets do not currently provide an opportunity for price

improvement for market orders, but include the possibility of

interaction with limit orders entered into the system. The Commission

seeks comment on whether these systems should be adapted to allow

market makers to provide opportunities for price improvement, or

whether they should be deemed to satisfy the rule's requirement as

currently operated.

(3) The payment for order flow rules require broker-dealers that

receive payment for order flow in a security to disclose their order

routing practices to their customers, including the availability of

price improvement opportunities. The Commission seeks comment on

whether an extension of these disclosure rules to all covered

securities, irrespective of whether payment for order flow is received,

would provide sufficient additional incentive for market makers and

specialists to provide price improvement opportunities, without the

adoption of a specific price improvement rule.

(4) Under the order exposure procedures, the quote exposing the

order would become the NBBO for the length of time that the order is

exposed (e.g., up to 30 seconds). After execution of the order or

expiration of the exposure period, the spread for the NBBO would widen.

The Commission seeks comment on what effect, if any, rapid quote

changes may have on system capacity, autoquote systems, automated

execution systems that execute customer orders at the NBBO, and the

expectations of investors with respect to the execution prices of

market orders.

(5) Under the safe harbor, the Commission has proposed an exposure

period of 30 seconds. The Commission seeks comment on the effect of a

30-second exposure period on the functions of specialists or market

makers, and whether a longer (e.g., 45 or 60 seconds) or shorter (e.g.,

15 seconds) period is appropriate.

(6) As noted above, the proposed rule is designed to ensure that

price improvement opportunities will be more widely available for

customer orders. Such a rule should promote the interaction of exposed

orders with orders or trading interest in other markets. The Commission

seeks comment on whether exposure of orders

[[Page 52807]]

in non-Rule 19c-3 listed securities would be fully effective without

extension of the ITS interface, which links Nasdaq with the registered

securities exchanges for trading in Rule 19c-3 securities, to all

listed securities.117

\117\ See supra section II.A.1.b. regarding the amendments to

the Quote Rule.

---------------------------------------------------------------------------

(7) The Commission has proposed several exceptions to the order

exposure procedures for situations where a specialist or market maker

receives orders in rapid succession. While alleviating the problems

associated with queuing, the exceptions may affect the overall utility

of the rule. The Commission seeks comment on alternative methods for

addressing potential order queues and rapidly moving markets.

(8) As proposed, the requirement to provide an opportunity for

price improvement would apply to situations where the spread between

the NBBO is greater than the minimum variation. The Commission seeks

comment on whether application of the rule should be extended to

situations where the spread between the NBBO is equal to the minimum

variation. If extended, under the exposure procedures a specialist or

market maker would be required to stop a customer buy order at the

national best offer and expose it at the national best bid; a sell

order would be stopped at the national best bid and exposed at the

national best offer.

(9) If the exposure procedures were extended to minimum variation

markets, the Commission seeks comment on whether the rule should

contain an exception to the exposure procedures in situations where a

specialist or market maker receives an order that would be executed

against a limit order represented in the quote. The effect of the

exception is illustrated in the following example: assume that the NBBO

is 20-20\1/8\ and that the offer price represents a customer limit

order. If a market order to buy is received, the exception would allow

the trade to be executed immediately at 20\1/8\. Alternatively, if

there were no exception for agency orders represented in the quote, the

market order would be stopped at 20\1/8\ and exposed at 20 for 30

seconds. Comment is requested on both approaches. Further, the

Commission seeks comment on whether the rule should contain an

exception to the exposure procedures in situations where a specialist

or market maker receives an order that would be executed against a

limit order represented in the quote, where the spread between the NBBO

is greater than the minimum variation.

(10) The Commission seeks comment on whether the order exposure

procedures should apply to agency cross transactions, e.g., the

execution of a buy and sell order for the same security by an entity

acting as agent for both orders.

(11) The proposed rule would apply to exchange listed securities,

and those OTC securities that satisfy the threshold requirement. The

Commission seeks comment on whether the scope of the rule is

appropriate.

(12) The Commission seeks comment on how the rule would interact

with other initiatives, such as the Commission's proposed amendments to

the Quote Rule and the Commission's proposed Limit Order Display Rule.

(13) In light of the activity that takes place at the beginning and

the end of the trading day, the proposed safe harbor includes an

exception from the exposure requirement during the first five minutes

of trading, as well as the last five minutes of the trading day. The

Commission seeks comment on whether this exception is appropriate.

(14) Some SROs maintain rules regarding excess spread

parameters.118 The Commission seeks comment on the impact of the

proposed rule on such excess spread parameters.

\118\ See, e.g., NASD Manual, Schedule D to the By-Laws, Part V,

Section 2(d), (CCH) para. 1819.

---------------------------------------------------------------------------

(15) The Commission seeks comment on alternative methods by which

price improvement opportunities for customer market orders may be

achieved, and on alternative safe harbor procedures, including reliance

on internal order crossing and intermarket print protection systems.

For example, an alternative may be to permit a specialist or market

maker to stop a customer market order at its proposed execution price

for a short period of time (e.g., 1 minute). If during this time period

the specialist or market maker received a customer market order on the

opposite side of the market from the stopped order, the specialist or

market maker would cross the orders at a price better than the proposed

execution price. In addition, if during this time period a trade in the

stock is reported in another market at a price better than the proposed

execution price, the specialist or market maker would also be required

to execute the customer order at a price better than the proposed

execution price.

The Commission requests comment on whether this alternative would

provide sufficient opportunity for price improvement to be included as

a safe harbor under the rule. Unlike the order exposure safe harbor, it

would not require publication of a quotation reflecting the order, and

may, therefore, provide a simpler process with less impact on quote

variations, while still providing customer orders an opportunity for

better prices based on other internal orders and superior reported

trade prices. At the same time, because the customer order would not be

publicly displayed, this procedure would not result in narrower quotes

or provide an opportunity for greater intermarket order interaction.

The Commission also requests comment on the mechanics of how the

alternate safe harbor should function. First, in the event of an

intervening trade away from the specialist, market maker, or dealer,

should protection be offered at the print price or at a price that is

better than the minimum price variation? Second, how should subsequent

orders received during the period the stop is in effect be handled;

should they be immediately executed at the stop price or should a new

time period be created? Finally, should price protection be offered

only up to the size of the intervening trade (if it is less than the

size of the order) or for the full size of the order?

(16) The Commission seeks comment on alternative procedures under

the proposed safe harbor:

(a) The first alternative would require a specialist or OTC market

maker that receives a customer market order to stop the order at the

price at which it was quoting when the order was received, or if it was

not publicly quoting, at its proposed execution price. Under this

scenario, if the NBBO was 20-20\1/4\, and the market maker was quoting

20-20\1/2\ when it received a customer market order to buy, the market

maker would be allowed to stop the order at 20\1/2\. If, however, the

best offer remained 20\1/4\ at the time of execution, execution at an

inferior stop price would be constrained by best execution principles.

(b) The second alternative would require a specialist or market

maker that receives a customer market order to stop the order if the

bid (for a sell order) or offer (for a buy order) is the specialist's

or market maker's principal quotation. If, however, the bid or offer

represents an agency order, the specialist or market maker would not be

required to stop the incoming market order.

(17) The Commission seeks comment on the liquidity threshold,

specifically:

(a) Whether a selection based on average daily trading volume is

appropriate and, if not, alternative selection criterion that would be

appropriate given the Commission's stated goals;

[[Page 52808]]

(b) Whether the 250 issue cutoff is appropriate 119 and, if

not, a more appropriate cutoff and the basis for that selection; and

\119\ For the quarter beginning April 1995 and ending June 1995,

the 250 stocks with the highest average daily volume on Nasdaq had

an average daily trading volume of 731,000 shares per stock per day.

---------------------------------------------------------------------------

(c) Whether an average daily trading volume threshold should be

applied only to Nasdaq securities or all securities.

(18) In addition, for all markets, the Commission recognizes that

the proposed safe harbor may not be appropriate for stocks which trade

with significant spreads. For example, when a market order to sell is

received for a stock that trades with a bid of 330 and an offer of 334,

it may not be appropriate to narrow the spread to 330-330\1/8\. For

this reason, the Commission is proposing an exemption to the safe

harbor for stocks whose spread is greater than four times the minimum

variation in the stock.120 The Commission seeks comment with

respect to this spread threshold, specifically:

\120\ This exemption would exclude approximately 6% of NYSE

listed stocks and 5% of AMEX listed stocks but no stocks in the 250

Nasdaq stocks that meet the liquidity threshold. If applied to all

Nasdaq securities, this exemption would exclude approximately 7% of

Nasdaq stocks.

---------------------------------------------------------------------------

(a) Whether a spread threshold should be applied, or whether all

market makers and specialists, regardless of the spread, should offer

price improvement under the proposed safe harbor for all stocks; and

(b) Whether the proposed spread threshold of greater than four

times the minimum variation should be higher or lower.

(19) The proposed rules are designed to enhance opportunities for

price improvement of customer orders in light of the existing \1/8\

point minimum trading variation that exists for most stocks in the

market. The Commission understands that, to some extent, the minimum

variation itself may serve as an impediment to quote based competition

and price improvement opportunities. Under the existing scheme, market

participants must pay up the entire \1/8\ point to obtain price

priority. A reduction in the minimum trading variation would lower this

cost and provide additional opportunities for customer limit orders and

market maker quotes to narrow spreads not only in those stocks where

the minimum variation is \1/8\ of a point, but in all stocks.

The Commission recognizes that there are many issues related to a

change in the minimum variation--including, among others, the effect

that a reduction in the \1/8\ point increment might have on the

priority of orders and the liquidity of the markets more generally. In

this regard, the Commission's Division of Market Regulation previously

requested that SROs study these potential costs, as well as the

benefits that might be associated with a system of decimal pricing. The

ultimate goal of such a study would be to determine whether such a

shift would strengthen the competitive posture of the U.S. equity

markets as they position themselves in a global marketplace.121

\121\ See Market 2000, supra note 4 at 18.

---------------------------------------------------------------------------

Notwithstanding the lack of a comprehensive study by the SROs, the

Commission continues to believe that decimal pricing is the next

logical step for the markets to pursue to improve transparency and

provide opportunities for narrower spreads.122 Although the

Commission is not prepared to mandate such a change in the minimum

increment at this time, comment is requested on the costs and benefits

of a change in the minimum variation either relative, or as a

supplement to, the rules being proposed today. Comment is also

requested on whether any reduction in the minimum increment should be

in a finer increment of fractions (e.g., \1/16\ or \1/32\) or decimals

(e.g., $0.10, or $0.05).

\122\ Payment for Order Flow Release, supra note 8.

---------------------------------------------------------------------------

4. Consideration of Proposed Rule's Costs and Benefits

To evaluate fully the impact of the proposed rule, the Commission

requests commenters to provide their views on the costs and benefits

associated with the rule, and any data that may support those views.

The proposed rule would require each OTC market maker or specialist

that accepts a customer market order to provide that order with an

opportunity to receive price improvement when the difference between

the NBBO for the security is greater than the minimum variation by

which the security may be quoted on the principal market for such

security. This rule is intended to enhance best execution opportunities

for customer market orders in all markets. The rule is intended to

encourage quote competition between markets and market participants; to

enhance customer-to-customer order interaction without the intervention

of a specialist or market maker; to improve transparency in all

markets; and provide more opportunities for broker-dealers to satisfy

their best execution obligations.

The Commission acknowledges that the price improvement obligations

would require some market participants to modify their current order

handling and display practices. The Commission seeks comment on the

magnitude of such costs. Further, the Commission recognizes that the

price improvement requirement and direct interaction between customers

may reduce the profitability associated with market making activities.

To the extent that this can be quantified, the Commission seeks comment

as to how much profit market makers would forego if the proposed rule

is adopted.

The Commission envisions that this rule would have significant

benefits for the financial markets and investors in those markets.

Investors are expected to benefit from the enhanced transparency,

improved price competition, the interaction of customer orders without

the intervention of an OTC market maker or specialist, and improved

opportunities to receive better executions, all of which should lower

the cost for investors to trade in the market. Additionally, the

financial markets as a whole should benefit from the proposed rule

since the price discovery process will be enhanced, transparency will

be improved and price competition will be promoted. By their very

nature, these benefits are broad-based and pervasive. Because

incremental amounts on a trade-by-trade basis produce significant

cumulative amounts for the market as a whole, the Commission seeks

guidance on how to represent accurately the savings associated with the

implementation of this rule.

The Commission seeks detailed comment on the following specific

questions:

(1) What would be the necessary system changes and costs associated

with implementation of the proposed rule?

(2) If the proposed rule were to be adopted, what effect would the

interaction of customer orders have on market makers and specialists?

(3) The Commission recognizes that subsequent to the adoption of

the proposed rule, market makers may need to charge commissions for the

handling of market orders. What would be the anticipated level of

commissions for a market order and what would be the overall cost to

the customer?

(4) How should the Commission assess the potential benefits

associated with the narrowing of spreads?

(5) What would be the likely impact of the proposed rule on the

depth of the market and how should it be quantified?

(6) What would be the likely impact on the liquidity of the market

and how should that impact be quantified?

[[Page 52809]]

(7) What degree of customer-to-customer interaction could be

expected if the proposed rule is adopted and what are the savings to

those customers?

III. Statutory Basis

The amendments to Rule 11Ac1-1 and adoption of Rules 11Ac1-4 and

11Ac1-5 are being proposed pursuant to 15 U.S.C. 78 et seq.,

particularly sections 11A, 6, 10(b), 11(a)(2), 11(b), 15A, 15(c) and

23(a)(1); 15 U.S.C. 78k-1, 78f, 78j(b), 78k(a)(2), 78k(b), 78o-3,

78o(c) and 78w(a)(1) (1988).

IV. Summary of the Initial Regulatory Flexibility Analysis

The Commission has prepared an Initial Regulatory Flexibility

Analysis (``IRFA'') in accordance with 5 U.S.C. Section 603 regarding

proposed Rule 11Ac1-4, Rule 11Ac1-5, and amended Rule 11Ac1-1. The

following summarizes the conclusions of the IRFA.

The IRFA uses certain definitions of ``small entities'' adopted by

the Commission for purposes of the Regulatory Flexibility Act. In the

IRFA, the Commission states that regulatory action is proposed to

ensure the display of customer limit orders that are priced better than

the current inside quotes, and to ensure the exposure of customer

market orders when the spread between the NBBO is greater than the

minimum increment by which a security may be quoted. Specifically, by

requiring display, Rule 11Ac1-4 would narrow spreads, increase

competition, and improve the price discovery process. Likewise, by

providing for order exposure, Rule 11Ac1-5 would enhance best execution

opportunities, increase competition, and improve the price discovery

process.

In the IRFA, the Commission states that the amendment to the Quote

Rule is proposed to ensure that market makers in reported securities

and other securities adhere to firm quote reporting obligations.

Specifically, requiring both 19c-3 and non-19c-3 market makers to

communicate quotes if they trade more than 1% of the aggregate trading

volume, and requiring OTC market makers and specialists to display in

their quote orders placed into an electronic communications network

will contribute to price discovery, promote liquidity, enhance

competition among market makers and facilitate the best execution of

customer orders.

The Commission is unable to quantify reasonably the impact that the

proposed rules and amendments would have on small brokers or dealers.

The Commission does not believe it would be practicable to exempt small

entities from the proposed rules and amendments because to do so would

be inconsistent with the Commission's statutory mandate.

A copy of the IRFA analysis may be obtained by contacting Mignon

McLemore, Division of Market Regulation, SEC, 450 Fifth Street NW.,

Washington, DC 20549, (202) 942-0158.

V. Paperwork Reduction Act

Certain provisions of proposed Rule 11Ac1-4 and the proposed

amendments to Rule 11Ac1-1 may contain ``collection of information''

requirements within the meaning of the Paperwork Reduction Act of 1995

(44 U.S.C. 3501 et seq.), and the Commission has submitted them to the

Office of Management and Budget for review in accordance with 44 U.S.C.

3507(d). The title for the collection of information is: ``Proposed

Amendments to Rule 11Ac1-1; Proposed Rule 11Ac1-4.''

The proposed amendments to Rule 11Ac1-1, and in particular the

definition of ``subject security'' under paragraph (a)(25), would

increase the number of OTC market makers who are required under

paragraph (c)(1) of the Quote Rule to communicate their bids, offers,

and quotation sizes to their association which, in turn, disseminate

the information in the form of public quotations pursuant to paragraph

(b); it would also require an exchange that meets the threshold to

disseminate the information in the form of public quotations pursuant

to paragraph (b). This collection of information will be used to ensure

public dissemination of quotations in accordance with the Quote Rule.

The collection of information is necessary to expand the coverage of

existing broker-dealer quotation requirements to include substantial

market makers in non-Rule 19c-3 securities and to improve public

information about the prices they are quoting. The likely respondents

to the proposed collection of information will be the 10 or less third

market makers not already subject to the Quote Rule. They will respond

to the collection of information each time they initially enter and

then update their quotations, estimated to be 120-200 times per trading

day per respondent. The Commission anticipates the collection of

information will result in a negligible additional burden to the NASD

(the association to which the 10 or so market makers would be required

to communicate their bids, offers, and quotation sizes). The collection

of information would require the 10 or so respondents to access Nasdaq

Work Station Level III (the media through which market makers update

their quotations). Because the respondents should already subscribe to

Nasdaq Work Station Level II, and because there is no additional fee

for Level III, the 10 or so respondents would not incur any additional

expense to comply with the collection of information. To the extent

that updating quotations for reporting purposes requires manual entry

on Level III, the Commission estimates an additional clerical burden of

approximately 25.2-42 hours per year for each respondent (based on an

estimated average of 3 seconds for each update). The estimated total

annual reporting burden for a total of 10 respondents combined is 252-

420 hours per year.

In addition, the Commission notes that specialists and OTC market

makers who currently publish quotations for non-Rule 19c-3 securities

pursuant to the voluntary election provisions of the Rule would be

required to do so under the proposed amendments. Because these

specialists and market makers are already publishing quotations, no

additional burden should result from the collection of information.

Similarly, because OTC market makers in Nasdaq SmallCap securities are

already required to publish quotations in accordance with NASD rules,

no additional burden should result to such market makers from the

proposed collection of information.

The Commission is also proposing new Rule 11Ac1-4 which, with

certain exceptions and in certain circumstances, would require

specialists and OTC market makers to change their published quotation

to reflect the price and/or size of a customer limit order which would

improve their published bid or offer. This collection of information

will be used to require generally that market makers reflect

immediately in their bid or offer the price and size of each customer

limit order they hold at a price that would improve their bid or offer

in the security. The collection of information is necessary to provide

a minimum standard for all markets that would require the display of

customer limit orders under certain circumstances.

The likely respondents to the collection of information will be

approximately 500-600 OTC market makers. They will respond to the

collection of information each time they update their quotations in

response to the customer limit orders described above, estimated to

average 30-60 times per trading day per respondent. The Commission

estimates on average for each OTC market maker that the additional

clerical burden for updating

[[Page 52810]]

quotations based on customer limit orders would be 7-13 hours per year

per respondent (based on an estimated average of 3 seconds for each

update). The Commission does not anticipate any significant additional

burden on exchange specialists in light of current exchange order

handling practices. The estimated total annual reporting burden for all

respondents combined is 5,530 hours per year.

Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits

comments to--

(i) Evaluate whether the proposed collection of information is

necessary for the proper performance of the functions of the agency,

including whether the information shall have practical utility;

(ii) Evaluate the accuracy of the agency's estimate of the burden

of the proposed collection of information;

(iii) Enhance the quality, utility, and clarity of the information

to be collected;

(iv) Minimize the burden of collection of information on those who

are to respond, including through the use of automated collection

techniques or other forms of information technology.

Persons desiring to submit comments on the collection of

information requirements should direct them to the Office of Management

and Budget, Attention: Desk Officer for the Securities and Exchange

Commission, Office of Information and Regulatory Affairs, Washington,

DC 20503, and should also send a copy of their comments directly to the

Commission. OMB is required to make a decision concerning the

collections of information between 30 and 60 days after publication, so

a comment to OMB is best assured of having its full effect if OMB

receives it within 30 days of publication.

VI. Effects on Competition

Section 23(a)(2) of the Exchange Act 123 requires the

Commission, in adopting rules under the Exchange Act, to consider any

anti-competitive effects of such rules and to balance these effects

against the regulatory benefits gained in furthering the purposes of

the Exchange Act.

\123\ 15 U.S.C. 78w(a)(2) (1988).

---------------------------------------------------------------------------

The Commission preliminarily views the proposed amendments to Rule

11Ac1-1 and proposed Rules 11Ac1-4 and 11Ac1-5 as causing no burden on

competition unnecessary or inappropriate in furtherance of the purposes

of the Exchange Act. The Commission believes that the proposed rules

are consistent with the principles for the development of the national

market system that Congress specified in the Exchange Act. The

Commission also believes that any burden on competition that the

proposed rules and amendments may impose on the exchanges, Nasdaq and

their members, and applicable proprietary trading systems is necessary

and appropriate.

As noted above, the Commission has asked for comments on the costs

and benefits of each of the proposed rules and amendments. In

addressing those issues, the Commission also requests comment on any

competitive burdens that might result from adoption of the proposed

rules described in this release. In particular (but without

limitation), the Commission requests comment on the effect adoption of

the proposed rules would have on competition among primary exchanges,

regional exchanges and third market makers; among integrated broker-

dealers, wholesale market makers, and specialists; between integrated

broker-dealers and order entry firms; among Nasdaq, exchanges and

proprietary trading systems; and between U.S. broker-dealers, exchanges

and associations and overseas broker-dealers and exchanges.

Text of the Proposed Rules

List of Subjects in 17 CFR Part 240

Confidential business information, Registration of securities

information processors, Securities.

For the reasons set out in the preamble, the Commission proposes to

amend Part 240 of Chapter II of Title 17 of the Code of Federal

Regulations as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF

1934

1. The general authority citation for part 240 is revised to read

as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg,

77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78k, 78k-1, 78l, 78m,

78n, 78o, 78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-

23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.

* * * * *

2. Section 240.11Aa3-1 is amended by revising paragraph (a)(4) to

read as follows:

Sec. 240.11Aa3-1 Dissemination of transaction reports and last sale

data with respect to transactions in reported securities.

(a) Definitions. * * *

(4) The term reported security shall mean any security or class of

securities for which transaction reports are collected, processed and

made available pursuant to an effective transaction reporting plan.

* * * * *

3. Section 240.11Ac1-1 is revised to read as follows:

Sec. 240.11Ac1-1 Dissemination of quotations.

(a) Definitions. For the purposes of this section:

(1) The term aggregate quotation size shall mean the sum of the

quotation sizes of all responsible brokers or dealers who have

communicated on any exchange bids or offers for a covered security at

the same price.

(2) The term association shall mean any association of brokers and

dealers registered pursuant to section 15A of the Act (15 U.S.C. 78o-

3).

(3) The terms best bid and best offer shall mean the highest priced

bid and the lowest priced offer.

(4) The terms bid and offer shall mean the bid price and the offer

price communicated by an exchange member or OTC market maker to any

broker or dealer, or to any customer, at which it is willing to buy or

sell one or more round lots of a covered security, as either principal

or agent, but shall not include indications of interest.

(5) The term consolidated system shall mean the consolidated

transaction reporting system.

(6) The term covered security shall mean any reported security and

any other security for which a transaction report, last sale data or

quotation information is disseminated through an automated quotation

system as described in section 3(a)(51)(A)(ii) of the Act (15 U.S.C.

78c(a)(51)(A)(ii)).

(7) The term effective transaction reporting plan shall have the

meaning provided in Sec. 240.11Aa3-1.

(8) The term exchange market maker shall mean any member of a

national securities exchange (``exchange'') who is registered as a

specialist or market maker pursuant to the rules of such exchange.

(9) The term exchange-traded security shall mean any covered

security or class of covered securities listed and registered, or

admitted to unlisted trading privileges, on an exchange, provided,

however, that securities not listed on any exchange that are traded

pursuant to unlisted trading privileges are excluded.

(10) The term make available, when used with respect to bids,

offers, quotation sizes and aggregate quotation sizes supplied to

quotation vendors by an exchange or association, shall mean to provide

circuit connections at the premises of the exchange or association

supplying such data, or at a common

[[Page 52811]]

location determined by mutual agreement of the exchanges and

associations, for the delivery of such data to quotation vendors.

(11) The term odd-lot shall mean an order for the purchase or sale

of a covered security in an amount less than a round lot.

(12) The term OTC market maker shall mean any dealer who holds

itself out as being willing to buy from and sell to a customer, or

otherwise, a covered security for its own account on a regular or

continuous basis otherwise than on an exchange in amounts of less than

block size.

(13) The term plan processor shall have the meaning provided in

Sec. 240.11Aa3-2.

(14) The term published aggregate quotation size shall mean the

aggregate quotation size calculated by an exchange and displayed by a

quotation vendor on a terminal or other display device at the time an

order is presented for execution to a responsible broker or dealer.

(15) The terms published bid and published offer shall mean the bid

or offer of a responsible broker or dealer for a covered security

communicated by it to its exchange or association pursuant to this

section and displayed by a quotation vendor on a terminal or other

display device at the time an order is presented for execution to such

responsible broker or dealer.

(16) The term published quotation size shall mean the quotation

size of a responsible broker or dealer communicated by it to its

exchange or association pursuant to this section and displayed by a

quotation vendor on a terminal or other display device at the time an

order is presented for execution to such responsible broker or dealer.

(17) The term quotation size, when used with respect to a

responsible broker's or dealer's bid or offer for a covered security,

shall mean:

(i) The number of shares (or units of trading) of that covered

security which such responsible broker or dealer has specified, for

purposes of dissemination to quotation vendors, that it is willing to

buy at the bid price or sell at the offer price comprising its bid or

offer, as either principal or agent; or

(ii) In the event such responsible broker or dealer has not so

specified, a normal unit of trading for that covered security.

(18) The term quotation vendor shall mean any securities

information processor engaged in the business of disseminating to

brokers, dealers or investors on a real-time basis, bids and offers

made available pursuant to this section, whether distributed through an

electronic communications network or displayed on a terminal or other

display device.

(19) The term reported security shall mean any security or class of

securities for which transaction reports are collected, processed and

made available pursuant to an effective transaction reporting plan.

(20) The term responsible broker or dealer shall mean:

(i) When used with respect to bids or offers communicated on an

exchange, any member of such exchange who communicates to another

member on such exchange, at the location (or locations) designated by

such exchange for trading in a covered security, a bid or offer for

such covered security, as either principal or agent; provided, however,

that, in the event two or more members of an exchange have communicated

on such exchange bids or offers for a covered security at the same

price, each such member shall be considered a ``responsible broker or

dealer'' for that bid or offer, subject to the rules of priority and

precedence then in effect on that exchange; and further provided, that

for a bid or offer which is transmitted from one member of an exchange

to another member who undertakes to represent such bid or offer on such

exchange as agent, only the last member who undertakes to represent

such bid or offer as agent shall be considered the ``responsible broker

or dealer'' for that bid or offer; and

(ii) When used with respect to bids and offers communicated by a

member of an association to another broker or dealer or to a customer

otherwise than on an exchange, the member communicating the bid or

offer (regardless of whether such bid or offer is for its own account

or on behalf of another person).

(21) The term revised bid or offer shall mean a market maker's bid

or offer which supersedes its published bid or published offer.

(22) The term revised quotation size shall mean a market maker's

quotation size which supersedes its published quotation size.

(23) The term specified persons, when used in connection with any

notification required to be provided pursuant to paragraph (b)(3) of

this section and any election (or withdrawal thereof) permitted under

paragraph (b)(5) of this section, shall mean:

(i) Each quotation vendor;

(ii) Each plan processor; and

(iii) The processor for the Options Price Reporting Authority (in

the case of a notification for a subject security which is a class of

securities underlying options admitted to trading on any exchange).

(24) The term subject security shall mean:

(i) With respect to an exchange:

(A) Any exchange-traded security other than a security for which

the executed volume of such exchange, during the most recent calendar

quarter, comprised one percent or less of the aggregate trading volume

for such security as reported in the consolidated system; and

(B) Any other covered security for which such exchange has in

effect an election, pursuant to paragraph (b)(5)(i) of this section, to

collect, process, and make available to quotation vendors, bids,

offers, quotation sizes, and aggregate quotation sizes communicated on

such exchange; and

(ii) With respect to a member of an association:

(A) Any exchange-traded security for which such member acts in the

capacity of an OTC market maker unless the executed volume of such

member, during the most recent calendar quarter, comprised one percent

or less of the aggregate trading volume for such security as reported

in the consolidated system; and

(B) Any other covered security for which such member acts in the

capacity of an OTC market maker and has in effect an election, pursuant

to paragraph (b)(5)(ii) of this section, to communicate to its

association bids, offers and quotation sizes for the purpose of making

such bids, offers and quotation sizes available to quotation vendors.

(b) Dissemination requirements for exchanges and associations. (1)

Every exchange and association shall establish and maintain procedures

and mechanisms for collecting bids, offers, quotation sizes and

aggregate quotation sizes from responsible brokers or dealers who are

members of such exchange or association, processing such bids, offers

and sizes, and making such bids, offers and sizes available to

quotation vendors, as follows:

(i) Each exchange shall at all times such exchange is open for

trading, collect, process and make available to quotation vendors the

best bid, the best offer, and aggregate quotation sizes for each

subject security listed or admitted to unlisted trading privileges

which is communicated on any ex

This text is long and has been trimmed here. Open the source document for the complete record.