Self-Regulatory Organizations; New York Stock Exchange, Inc.; Order Granting Approval to Proposed Rule Change Relating to the Exclusion of Competing Market Maker Orders From Trading at No Charge

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-37273; File No. SR-NYSE-95-47]

Self-Regulatory Organizations; New York Stock Exchange, Inc.;

Order Granting Approval to Proposed Rule Change Relating to the

Exclusion of Competing Market Maker Orders From Trading at No Charge

June 4, 1996.

I. Introduction

On December 29, 1995, the New York Stock Exchange, Inc. (``NYSE''

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

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

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

thereunder,\2\ a proposed rule change to exclude orders of nonmember

competing market makers from the NYSE's no charge provision for system

orders of 100 to 2,099 shares.

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

\2\ 17 CFR 240.19b-4.

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The proposed rule change was published for comment in the Federal

Register on January 5, 1996.\3\ The Commission initially received a

total of four comment letters opposing the proposal.\4\ On April 26,

1996, the NYSE submitted its response to these comment letters.\5\

After receiving the NYSE's response, the Commission received four

additional comment letters.\6\ For the reasons discussed below, the

Commission, after careful consideration, has decided to approve the

NYSE's proposal.

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\3\ Securities Exchange Act Release No. 36658 (Dec. 29, 1995),

61 FR 436.

\4\ See letter from John I. Fitzgerald, Executive Vice

President, Legal Affairs and Trading Services, Boston Stock

Exchange, Inc. (``BSE''), to Jonathan G. Katz, Secretary, SEC, dated

February 21, 1996 (``BSE February 21, 1996 Letter''); letter from

George T. Simon, Foley & Lardner, on behalf of the Chicago Stock

Exchange, Incorporated (``CHX''), to Jonathan G. Katz, Secretary,

SEC, dated March 4, 1996 (``CHX March 4, 1996 Letter''); letter from

William W. Uchimoto, First Vice President and General Counsel,

Philadelphia Stock Exchange, Inc. (``Phlx''), to Jonathan G. Katz,

Secretary, SEC, dated February 23, 1996 (``Phlx February 23, 1996

Letter''); letter from David P. Semak, Vice President, Regulation,

Pacific Stock Exchange Incorporate (``PSE''), to Jonathan G. Katz,

Secretary, SEC, dated March 4, 1996 (``PSE March 4, 1996 Letter'').

\5\ See letter from James E. Buck, Senior Vice President and

Secretary, NYSE, to Jonathan Katz, Secretary, SEC, dated April 25,

1996 (``NYSE April 25, 1996 Letter''). Previously, the NYSE had

granted the Commission an extension of 30 days after the date of the

Commission's receipt of the Exchange's response within which to act

on the NYSE's proposal. See letter from James E. Buck, Senior Vice

President and Secretary, NYSE, to Glen Barrentine, SEC, dated March

13, 1996.

\6\ See letter from George W. Mann, Jr., Senior Vice President

and General Counsel, BSE, to Jonathan G. Katz, Secretary, SEC, dated

April 23, 1996 (``BSE April 23, 1996 Letter''); letter from John I.

Fitzgerald, Executive Vice President, Legal Affairs and Trading

Services, BSE, to Jonathan G. Katz, Secretary, SEC, dated May 6,

1996 (``BSE May 6, 1996 Letter''); letter from J. Craig Long, Foley

& Lardner, on behalf of the CHX, to Jonathan G. Katz, Secretary,

SEC, dated May 6, 1996 (``CHX May 6, 1996 Letter''); letter from

William W. Uchimoto, First Vice President and General Counsel, Phlx,

to Jonathan G. Katz, Secretary, SEC, dated May 3, 1996 (``Phlx May

3, 1996 Letter'').

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II. Background and Description of the Proposal

A. Transaction Credits

On November 7, 1995, the NYSE, pursuant to Section 19(b)(3)(A) of

the Act,\7\ filed a rule change with the Commission that made a series

of revisions to the Exchange's equity \8\ transaction fee schedule,

including the exclusion of nonmember competing market makers from the

NYSE's no charge provision for system orders of 100 to 2,099 shares.\9\

Prior to such filing, the NYSE's transaction fee schedule imposed on

all public agency,\10\ equity transactions the following charges:

\7\ 15 U.S.C. 78s(b)(3)(A). Pursuant to Section 19(b)(3)(A), a

proposed rule change may take effect upon filing with the Commission

if designated by the self-regulatory organization as, among other

matters, establishing or changing a due, fee, or other charge

imposed by the self-regulatory organization.

\8\ The NYSE's transaction fee schedule defines the term

``equity'' to include shares, rights, and warrants.

\9\ Securities Exchange Act Release No. 36465 (Nov. 8, 1995), 60

FR 57473 (publishing SR-NYSE-95-38.

\10\ Equity public agency transaction fees and credits do not

apply to principal transactions by NYSE members for their own

accounts. See NYSE Transaction Fee Schedule n.1.

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$0.00265 per share for the first 5,000 shares;

$0.00010 per share for 5,001 to 672,500 shares; and no charge for all

shares in excess of 672,500.

The NYSE's transaction fee schedule also provided for a credit of

$0.30 per order for all orders of 100 to 2,099 shares that were placed

through the NYSE's Common Message Switch (``CMS'')\11\ and an

additional credit of $1.30 for all Individual \12\ or Agency \13\

market orders of 100 to 2,099 shares placed through the NYSE's CMS.

Orders executed by members and member organizations for the account of

a competing market maker,\14\ however, were not eligible for the

additional system credit. This additional system credit was applied on

a monthly basis against the member or member organization's total

transaction charges.

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\11\ The Common Message Switch is a data communications

application that accommodates a wide variety of member firm computer

and technical connections, enabling a member firm to send orders

directly to the appropriate floor booth for execution by the firm's

floor broker or by SuperDot to the appropriate specialist post.

Accordingly, the NYSE's transaction fee schedule provided credits

for SuperDot orders. See Securities Exchange Act Release No. 28655

(Nov. 29, 1990), 55 FR 50260, at n.1 (publishing SR-NYSE-90-54).

\12\ An Individual order is an order for the account of any

customer who is an individual as defined by NYSE Rule 80A. See

Securities Exchange Act Release No. 29866 (Oct. 28, 1991), 56 FR

56432. That rule, in turn, cites Section 11(a)(1)(E) of the Act,

which defines an individual investor as a natural person. See

Securities Exchange Act Release No. 32377 (May 27, 1993), 58 FR

31568, at n.7 (approving NYSE's limitation on the additional system

credit concerning nonmember competing market makers).

\13\ An Agency order is an order for the account of any

customer, other than a natural person, who is a nonmember of

nonmember organization. Id. at n.8.

\14\ The proposed rule change defines a competing market maker

as ``a specialist or market maker registered as such on a registered

stock exchange (other than the NYSE), or a market maker bidding and

offering over-the-counter in a New York Stock Exchange-traded

security.''

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B. Payment for Order Flow

On October 27, 1994, the Commission adopted Rule 11Ac1-3 \15\ and

amendments to Rule 10b-10 \16\ under the Act concerning payment for

order flow practices.\17\ These provisions were designed to improve the

information available to investors about their broker-dealer's order

routing practices and disclose to investors whether the broker-dealer

received market center \18\ inducements for routing unspecified order

flow to a particular market.\19\ In defining payment for order flow,

the Commission took a very broad approach so that all forms or

arrangements whereby a broker-dealer received compensation for

directing order flow to a particular market were included.

Specifically, payment for order flow was designed to include any

credit, rebate, or discount against execution fees that exceeds the fee

charged for executing the order.\20\ As a result, credits received by

NYSE members under the NYSE's transaction fee schedule constituted

[[Page 29439]]

payment for order flow where such credit exceeded the transaction

charged associated with such order.\21\ In response to these new

disclosure requirements, the NYSE decided to revise its transaction fee

schedule so that its members would not be required to comply with Rule

11Ac1-3 \22\ and Rule 10b-10 \23\ regarding disclosure of the receipt

of payment for order flow.\24\

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\15\ 17 CFR 240.11Ac1-3.

\16\ 17 CFR 240.10b-10.

\17\ See Securities Exchange Act Release No. 34902 (Oct. 27,

1994), 59 FR 55006 [hereinafter Payment for Order Flow Release].

\18\ See 17 CFR 240.11Ac1-2(a)(14) (defining ``reporting market

center'').

\19\ See Payment for Order Flow Release, supra note 17.

\20\ See Payment for Order Flow Release, supra note 17.

\21\ For example, under the NYSE's transaction fee schedule,

NYSE members and member organizations were receiving payment for

order flow for certain system orders of 100 to 603 shares. For

orders greater than 603 shares, the NYSE equity transaction charges

exceeded the $1.60 credit granted.

\22\ 17 CFR 240.11Ac1-3.

\23\ 17 CFR 240.10b-10.

\24\ On October 13, 1995, the Commission issued a letter to the

Securities Industry Association granting all registered broker-

dealers a temporary exemption from the confirmation disclosure

requirements of Rule 10b-10(a)(2)(C) and a no-action position

regarding the account opening provisions of Rule 11Ac1-3. This

exemption and no-action position expired on November 5, 1995.

Subsequently, the Commission issued another similar letter to the

NYSE effective from November 6, 1995 to December 31, 1995. See

letter from Brandon Becker, (then) Director, Division of Market

Regulation, SEC, to Edward A. Kwalwasser, Group Executive Vice

President, Regulation, NYSE, dated November 8, 1995.

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C. SR-NYSE-95-38

On November 7, 1995, the NYSE submitted a rule filing pursuant to

Section 19(b)(3)(A) of the Act \25\ that revised its equity transaction

charges, effective January 2, 1996.\26\ Among other things, this

filing: (1) eliminated all SuperDot system credits, (2) reduced the

equity transaction fees on orders for 5,000 shares and under from

$0.00265 per share to $0.0019 per share,\27\ (3) eliminated the equity

transaction charges for SuperDot system orders of 100 to 2,099 shares,

except for orders of competing market makers, and (4) capped monthly

equity transaction fees at $400,000. The Commission published the

notice of filing and immediate effectiveness of this rule change on

November 8, 1995.\28\ Subsequently, the Commission received three

comment letters regarding this rule change.\29\

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\25\ 15 U.S.C. 78s(b)(3)(A). See supra note 7 (detailing which

rule filings may be submitted pursuant to this section for immediate

effectiveness).

\26\ Securities Exchange Act Release No. 36465 (Nov. 8, 1995),

60 FR 57473 (publishing the notice and immediate effectiveness of

SR-NYSE-95-38).

\27\ See supra note 10 (noting that the fees and credits

concerning equity public agency transactions do not apply to

principal transactions by members for their own accounts).

\28\ Securities Exchange Act Release No. 36465 (Nov. 8, 1995),

60 FR 57473.

\29\ See letter from Samuel F. Lek, Chief Executive Officer,

Lek, Schoenau & Company, Inc., to Secretary, SEC, dated November 14,

1995 (opposing the monthly equity transaction fee cap); letter from

William W. Uchimoto, First Vice President and General Counsel, Phlx,

to Jonathan Katz, Secretary, SEC, dated November 27, 1995 (opposing

the disparate treatment of competing market maker orders and

requesting that the NYSE withdraw that portion of the filing and

refile it for notice and action pursuant to Section 19(b)(2) of the

Act); letter from David P. Semak, Vice President of Regulation, PSE,

to Jonathan Katz, Secretary, SEC, dated December 7, 1995 (opposing

the disparate treatment of competing market maker orders and

requesting that the NYSE withdraw that portion of the filing and

refile it for notice and action pursuant to section 19(b)(2) of the

Act).

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D. SR-NYSE-95-46

In response to these comment letters, the Commission requested that

the NYSE withdraw that portion of the filing concerning the exclusion

of competing market maker orders from the NYSE's no charge policy and

resubmit it pursuant to Section 19(b)(1) \30\ for notice and action

pursuant to Section 19(b)(2).\31\ This would provide sufficient time

for the Commission to consider, and interested parties to comment on,

that portion of the filing.\32\ In complying with the Commission's

request, on December 29, 1995, the NYSE submitted two related rule

filings: SR-NYSE-95-46 and the current proposal, SR-NYSE-95-47.

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\30\ 15 U.S.C. 78s(b)(1).

\31\ 15 U.S.C. 78s(b)(2).

\32\ Section 19(b)(2) requires that a notice be published in the

Federal Register for the statutory comment period and provides that

changes pursuant to this section are not effective until the

Commission issues an approval order.

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In SR-NYSE-95-46, the NYSE revised its equity transaction charges,

effective January 2, 1996,\33\ to eliminate the exclusion of competing

market maker orders from the no charge provision for SuperDot system

orders of 100 to 2,099 shares. The Exchange, however, also reserved the

right to collect, retroactive to January 2, 1996, the fees on such

trading in the event the Commission approved SR-NYSE-95-47.\34\ The

Commission published the notice of filing and immediate effectiveness

of this rule change on December 29, 1995.\35\

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\33\ This rule change became effective upon filing with the

Commission pursuant to Section 19(b)(3)(A) of the Act.

\34\ The effect of this rule change was to require members and

member organizations to report competing market maker system orders

of 100 to 2,099 shares to the Exchange. The amount of fees due would

be $0.0019 per share for all such competing market maker orders

executed by NYSE members on the Exchange from January 2, 1996 to the

present.

\35\ Securities Exchange Act Release No. 36659 (Dec. 29, 1995),

61 FR 432.

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E. The Current Proposal

The Exchange now proposes to amend its fee schedule to re-institute

the exclusion of competing market maker SuperDot system orders of 100

to 2,099 shares from the NYSE's no charge policy. This change, in

effect, would impose a charge of $0.0019 per share on competing market

maker SuperDot system orders of 100 to 2,099 shares and, furthermore,

allow the Exchange to collect equity transaction charges on all such

orders that have been executed on the NYSE since January 2, 1996.\36\

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\36\ Currently, the NYSE waives the equity transaction fees for

all SuperDot system orders of 100 to 2,099 shares.

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III. Summary of Comments

The Commission received a total of eight comment letters from the

BSE, the CHX, the PHlx, and the PSE (collectively referred to herein as

the ``commenters'') regarding the exclusion of competing market maker

system orders from the Exchange's no charge provision.\37\ In its

response, the NYSE supports its proposal and responds to the first four

comment letters.\38\ The issues raised by the commenters are discussed

below.

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\37\ See supra notes 4 and 6.

\38\ See supra note 5.

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A. Equitable Allocation of a Reasonable Fee

The commenters believe that the proposal is inconsistent with

Section 6(b)(4) of the Act \39\ because it constitutes an inequitable

allocation of fees \40\ and further assert that the proposal is

inconsistent with Section 6(b)(5)\41\ because it unfairly discriminates

among certain brokers, dealers, and customers,\42\ as well as

compromises the existence of a free and open market.\43\

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\39\ 15 U.S.C. 78f(b)(4). Section 6(b)(4) requires that the

rules of an exchange provide for the equitable allocation of

reasonable dues, fees, and other charges among its members and

issuers and other persons using its facilities.

\40\ See BSE February 21, 1996 Letter, supra note 4; PSE March

4, 1996 Letter, supra note 4.

\41\ 15 U.S.C. 78f(b)(5). Among other things, Section 6(b)(5)

requires that the rules of an exchange be designed to promote just

and equitable principles of trade, to perfect the mechanism of a

free and open market and a national market system, and, in general,

to protect investors and the public interest. Section 6(b)(5) also

requires that the rules of an exchange not be designed to permit

unfair discrimination between customers, issuers, brokers, or

dealers.

\42\ See BSE February 21, 1996 Letter, supra note 4; BSE April

23, 1996 Letter, supra note 6; CHX March 4, 1996 Letter, supra note

4; Phlx February 23, 1996 Letter, supra note 4; PSE March 4, 1996

Letter, supra note 4.

\43\ See BSE February 21, 1996 Letter, supra note 4.

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To support its opposition to the proposal, the CHX explains that

nonmember competing market makers do not receive any trading advantage

on the NYSE Floor that justifies this disparate treatment, and that

this proposal does not provide any benefit to

[[Page 29440]]

the public.\44\ Therefore, the CHX argues, there is no valid

justification or legally sufficient rational basis why nonmember

competing market makers should pay more than all other nonmembers for

such orders.\45\

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\44\ See CHX March 4, 1996 Letter, supra note 4.

\45\ See CHX March 4, 1996 Letter, supra note 4.

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Separately, the Phlx contends that competing market makers will be

required to subsidize all of the NYSE's other system orders of this

size and, therefore, this fee should be cost based.\46\

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\46\ SEE Phlx February 23, 1996 Letter, supra note 4.

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In its response, the NYSE charges that the commenters fundamentally

misread the provisions of the Act dealing with competition in the

national market system (``NMS''). The NYSE argues that the proposal

does not constitute either an inequitable allocation of fees or unfair

discrimination among brokers and dealers because the affected parties

are in direct competition with each other. This competition, the

Exchange asserts, justifies the disparate treatment in this instance

because to require otherwise would obligate the NYSE to subsidize its

competitors.

The CHX characterizes the NYSE's logic as specious. The CHX asserts

that the proposal does not achieve one of its stated purposes, to avoid

subsidizing the NYSE's competitors, because proprietary orders of

regional exchange specialists and third market makers that are

affiliated with a NYSE member are included in the NYSE's no charge

policy. Therefore, the CHX argues that the NYSE's justification is

inadequate because the proposal does subsidize some NYSE

competitors.\47\

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\47\ See CHX May 6, 1996 Letter, supra note 6.

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B. Burden on Competition

The commenters also argue that the proposal is inconsistent with

Section 6(b)(8) \48\ and Section 11A(a)(1)(C) \49\ of the Act because

it raises the costs of competing market makers without sufficient

justification and, therefore, places an unnecessary and inappropriate

burden on competition.\50\ The commenters contend that raising the

costs of competing market makers in this case will harm the depth and

liquidity of the market.\51\ One commenter also believes that it will

reduce price improvement opportunities, impair the ability of competing

market makers to perform their required market making functions, and,

in general, disrupt the equilibrium of the NMS.\52\

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\48\ See BSE February 21, 1996 Letter, supra note 4; BSE April

23, 1996 Letter, supra note 6; CHX March 4, 1996 Letter, supra note

4; CHX May 6, 1996 Letter, supra note 6; Phlx February 23, 1996

Letter, supra note 4; PSE March 4, 1996 Letter, supra note 4.

\49\ See BSE February 21, 1996 Letter, supra note 4; BSE April

23, 1996 Letter, supra note 6; PSE March 4, 1996 Letter, supra note

4.

\50\ See 15 U.S.C. 78f(b)(8) and 78k-1(a)(1)(C). Section 6(b)(8)

prohibits the rules of a national securities exchange from imposing

any burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act. In Section 11A(a)(1)(C),

Congress found that, among other things, it is in the public

interest and appropriate for the protection of investors and the

maintenance of fair and orderly markets to ensure fair competition

among brokers and dealers, among exchange markets, and between

exchange markets and markets other than exchange markets.

\51\ See CHX March 4, 1996 Letter, supra note 4; PSE March 4,

1996 Letter, supra note 4.

\52\ See PSE March 4, 1996 Letter, supra note 4.

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Several commenters also claim the impetus for this filing is

similar to a prior American Stock Exchange, Inc. (``Amex'') competing

dealer rule proposal that was eventually withdrawn. In analogizing the

NYSE proposal to the prior Amex proposal, the commenters claim the NYSE

is seeking to implement rules that disadvantage its competition for

purely competitive reasons.\53\

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\53\ See BSE February 21, 1996 Letter, supra note 4; CHX March

4, 1996 Letter, supra note 4; Phlx February 23, 1996 Letter, supra

note 4; Phlx May 3, 1996 Letter, supra note 6. In its competing

dealer filing, the Amex proposed that orders for a competing dealer

would: (1) yield priority and parity to all other off-floor orders,

(2) accept parity with orders for an account of an Amex specialist,

and (3) be excluded from the Amex's order routing system, the Post

Execution Reporting System (``PER''). The Amex subsequently amended

this proposal in December 1991, among other things, to: (1) provide

that orders for the account of a competing dealer that better the

existing market do not have to yield priority and parity to off-

floor orders, (2) withdraw the portion of the proposal that would

have placed orders for the account of a competing dealer on parity

with orders for the account of an Amex specialist, and (3) request

that the Commission temporarily defer its consideration of the

proposed prohibition of competing dealer access to PER. See

Securities Exchange Act Release No. 30161 (Jan. 7, 1992), 57 FR 1502

(File No. SR-Amex-90-29). The Amex thereafter withdrew this filing

at the request of Commission staff. See Division of Market

Regulation, SEC, Market 2000, An Examination of Current Equity

Market Developments Study III-11 (Jan. 1994) [hereinafter Market

2000] (recommending that the Amex amend or withdraw SR-Amex-90-29).

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The NYSE argues that the proposal does not impose an inappropriate

burden on competition because competing market makers already have

cost-free access to the NYSE through the Intermarket Trading System

(``ITS'').\54\ The NYSE characterizes ITS as a carefully-constructed

\55\ market linkage that has evolved over the past twenty years to

successfully balance the goals enumerated in Section 11A(a)(1)(D) of

the Act.\56\

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\54\ ITS provides facilities and procedures for: (1) the display

of composite quotation information at each participant market so

that brokers can readily determine the best available price for a

particular security, (2) the execution of orders between broker-

dealers at respective ITS market centers, and (3) the coordination

of market openings among the linked markets.

Brokers may execute orders in other ITS market centers by

entering a ``commitment to trade'' into their ITS computer terminal.

Currently, the Amex, the BSE, the Chicago Board Options Exchange,

Incorporated, the CHX, The Cincinnati Stock Exchange, the National

Association of Securities Dealers, Inc., the NYSE, the Phlx, and the

PSE are all ITS participants. See Market 2000, supra note 53, at

Appendix II (providing the history of ITS).

\55\ The NYSE notes that, in addition to itself and other

markets, all of the commenters were involved in the development of

ITS and that this development was supervised by the Commission. See

also Market 2000, supra note 53, at Appendix II.

\56\ 15 U.S.C. 78k-1(a)(1)(D) (finding that the linking of all

markets will foster efficiency, enhance competition, increase the

information available to brokers, dealers, and investors, facilitate

the offsetting of investors' orders, and contribute to the best

execution of such orders).

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By utilizing ITS, the NYSE explains, competing market makers still

can lay off their excess positions and interact with trading interest

on the NYSE. In support of this argument, the NYSE states that the

commenters' ITS commitments executed on the Exchange during the first

three months of 1996 accounted for over twenty-one percent of the total

share volume reported by the commenters during this time period.

As further support that the filing does not impose an inappropriate

burden on competition, the NYSE notes that this proposal seeks to

maintain the prior relationship between member proprietary and

nonmember competing market maker activities in Exchange-listed

securities.\57\ The Exchange asserts that although the proposal

replaces the credit system with a discount system, it maintains the

status quo because the economic effect is unchanged.

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\57\ According to the prior fee schedule, neither order type was

eligible for the NYSE's additional system credit. See supra note 10.

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Finally, the NYSE argues that the proposed fee for competing market

maker orders is lower than the fee structure previously in effect and,

therefore, does not impose an inappropriate burden on competition. The

NYSE emphasizes that the proposal lowers the fee charged from $0.00265

per share to $0.0019 per share \58\ and, in any event, the amount

charged is nominal.\59\

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\58\ Without adjusting for the lost system credit, the NYSE

represents this as a reduction of 28%. See NYSE April 25, 1996

Letter, supra note 5.

\59\ The greatest differential exists between a nonmember

competing market maker system order of 2,099 shares and another

system order of 2,099 shares that qualifies for the NYSE's no charge

policy. Under these circumstances, the competing market maker order

would incur a charge of $3.99 (2,099 shares * $0.0019 per share),

while the other order would incur no fees at all. In underscoring

its argument that this fee is nominal, the NYSE points out that for

a $30 stock the $3.99 fee would represent .006% of the $62,970 value

of the trade. See NYSE April 25, 1996 Letter, supra note 5.

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[[Page 29441]]

In commenting further on the proposal, the BSE, the CHX, and the

Phlx refute the NYSE's claim that ITS provides adequate access to the

NYSE's market.\60\ They claim that ITS is too limited in its

capabilities. The CHX adds that its specialists choose to ignore free

ITS access and pay for access to the NYSE's SuperDot system simply

because SuperDot is better; \61\ while the BSE asserts that its

specialists are forced to use SuperDot because ITS commitments do not

have the same status as orders on the NYSE and do not have any standing

in the trading crowd.\62\

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\60\ See BSE May 6, 1996 Letter, supra note 6; CHX May 6, 1996

Letter, supra note 6; Phlx May 3, 1996 Letter, supra note 6.

\61\ See CHX May 6, 1996 Letter, supra note 6.

\62\ See BSE May 6, 1996 Letter, supra note 6.

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C. Proposed Order Handling Rules \63\

Finally, the BSE urges the Commission to consider the possible

impact this proposal will have in conjunction with the Commission's

``Proposed Limit Order Rule'' \64\ and ``Proposed Price Improvement

Rule.'' \65\ The BSE is concerned that a NYSE specialist availing

itself of the proposed rules' exceptions concerning the immediate

delivery of an Order to another market maker or system would be charged

a different fee than a BSE specialist doing likewise.

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\63\ On October 10, 1995, the Commission proposed two rules and

amendments to a rule to improve the handling and execution of

customer orders. The Proposed Limit Order Rule, Proposed Rule 11Ac1-

4, would require covered market makers to immediately reflect in

their bid or offer the price and size of each customer limit order

they hold in a covered security at a price that would improve their

bid or offer in the security unless an exception applies. The

Proposed Price Improvement Rule, Proposed Rule 11Ac1-5, would

require each specialist or OTC market maker in a covered security

that accepts a customer market order to provide that order with an

opportunity for price improvement unless an exception applies. Both

of these rules contain an exception for orders that are delivered

immediately to a market maker or system that complies with the

requirements of the applicable rule with respect to that order. See

Securities Exchange Act Release No. 36310 (Oct. 10, 1995), 60 FR

52792 (publishing File No. S7-30-95 for comment); Proposed 11Ac1-

4(c)(5); Proposed 11Ac1-5(e)(4).

\64\ See BSE February 21, 1996 Letter, supra note 4.

\65\ See BSE April 23, 1996 Letter, supra note 6.

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The NYSE did not address this issue in its response.

D. Antitrust Considerations \66\

The Phlx also requests the Commission to consider the possible

antitrust implications this proposal presents.\67\ The Phlx contends

that the NYSE enjoys a ``strategic dominance'' and that the antitrust

law's ``essential facility'' doctrine is germane to the Commission's

analysis of this proposal. In support of this argument, the Phlx claims

the proposal effectively and inappropriately excludes competing market

makers equal access to the primary market simply because they are

competitors.

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\66\ See infra notes 101, 102 (discussing the applicability of

the antitrust laws and the essential facility doctrine).

\67\ See Phlx February 23, 1996 Letter, supra note 4.

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The NYSE disputes the Phlx's premise that the NYSE is an essential

facility. The NYSE supports its position by asserting that: (1) the

NYSE is not a monopoly (as evidenced by the existence of multiple other

securities markets in the United States) and (2) competing market

makers will continue to have two forms of access to the NYSE's market--

``one free and another at near-zero price.'' \68\

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\68\ See NYSE April 25, 1996 Letter, supra note 5.

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IV. Discussion

Under Section 19(b)(2) of the Act,\69\ the Commission must approve

the NYSE's proposed rule change if it finds that the proposed rule

change is consistent with the requirements of the Act and the rules

thereunder applicable to a national securities exchange. If the

Commission is unable to make that finding, it must institute

proceedings to consider whether to disapprove the proposed rule change.

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\69\ 15 U.S.C. 78s(b)(2).

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The statutory requirements relevant to such a determination are

found, for the most part, in Section 6(b) of the Act.\70\ That section

delineates the purposes the NYSE's rules should be designed to achieve.

Those purposes or objectives, which take the form of positive goals,

such as investor protection, or prohibitions, such as those against

unfair discrimination or inappropriate burdens on competition, are

stated in the form of broad and elastic concepts. They afford the

Commission considerable discretion to use its judgment and knowledge in

determining whether a proposed rule complies with the requirements of

the Act.\71\ Furthermore, the subsections of Section 6(b) \72\ must be

read with reference to one another and to other provisions of the

Act.\73\ Within this legal framework, the Commission must weigh and

balance the strengths and weaknesses of a proposed rule, assess the

views and arguments of others, and make predictive judgments about the

consequences of approving the proposed rule.\74\

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\70\ 15 U.S.C. 78f(b).

\71\ Bradford National Clearing Corp. v. Securities and Exchange

Commission, 590 F.2d 1085 (D.C. Cir. 1978).

\72\ 15 U.S.C. 78f(b).

\73\ See Securities Exchange Act Release No. 17371 (Dec. 12,

1980), 45 FR 83707, 83715-19 (interpreting identical provisions of

Section 15A(b)).

\74\ Id.

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With this in mind, and after careful consideration of all of the

comments received, the Commission has determined to approve the

proposed rule change. For the reasons discussed below, the Commission

finds that the proposed rule change is consistent with the requirements

of the Act and the rules and regulations thereunder applicable to a

national securities exchange.

In particular, the Commission finds that the proposal is consistent

with the Section 6(b)(4) requirement that the rules of an exchange

provide for the equitable allocation of reasonable fees among its

members; \75\ the Section 6(b)(5) \76\ requirements that the rules of

an exchange be designed to perfect the national market system, and, in

general, to protect investors and the public interest; and not designed

to permit unfair discrimination between brokers, dealers, and

customers; as well as the Section 6(b)(8) \77\ requirement that the

rules of an exchange not impose any burden on competition that is not

necessary or appropriate in furtherance of the purposes of the Act.

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\75\ 15 U.S.C. 78f(b)(4).

\76\ 15 U.S.C. 78f(b)(5).

\77\ 15 U.S.C. 78f(b)(8).

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A. The Proposal

The NYSE's original proposal, SR-NYSE-95-38, instituted a discount

fee system that excluded orders of nonmember competing market makers

from the NYSE's no charge provision for system orders of 100 to 2,099

shares. Instead, these orders would have been subject to a fee of

$0.0019 per share.

This modified the NYSE's previous system--a credit fee system. The

credit system imposed a charge of $0.00265 per share for the first

5,000 shares on all equity public agency transactions.\78\ If such an

order was for 100 to 2,099 shares and was placed through the NYSE's

CMS, it earned the NYSE member a credit of $0.30 per order. If this

also was an Individual or Agency market order, the NYSE member was

granted an additional credit of $1.30.\79\ Orders executed by members

and member organizations for the account of

[[Page 29442]]

a competing market maker, however, were not eligible for the additional

system credit.

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\78\ See supra note 10 (noting that the fees and credits

concerning equity public agency transactions do not apply to

principal transactions by members for their own accounts).

\79\ See supra notes 12 and 13 (defining Individual and Agency

orders).

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Prior to the effective date of the discount system, the NYSE

suspended the effectiveness of the exclusion concerning competing

market maker orders.\80\ Publication of the exclusion for public

comment provided additional time for the Commission to consider, and

interested parties to comment on, that portion of the filing. With this

filing, the NYSE seeks approval to implement the discount system as

originally filed.

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\80\ See (publishing the notice and immediate effectiveness of

SR-NYSE-95-46).

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B. Section 6(b)(4) \81\

Several commenters have argued that the proposal violates section

6(b)(4).\82\ The Commission disagrees and finds that the proposal

constitutes an equitable allocation of a reasonable fee.

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\81\ See surpa note 39 (listing the requirements of Section

6(b)(4)).

\82\ 15 U.S.C. 78f(b)(4).

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The Commission believes the proposed fee is reasonable because it

generally is a fee reduction. The Commission notes that the NTSE's new

discount system generally grants competing market maker orders a cost

savings over the prior credit system.\83\ The Commission believes the

fee is an equitable allocation within the meaning of Section 6(b)(4)

because, although the fee distinguishes between the orders of nonmember

competing market makers and all other orders executed on the NYSE, it

does not do so in a manner that imposes a significant cost burden on

the nonmember competing market maker orders. In addition, the

Commission is unable to conclude that the fee is not reasonable because

nonmember competing market makers will be able to continue the same

level of trading activity on the NYSE as before this fee was

implemented, except that it now will be at a lower cost.

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\83\ Under most circumstances, the fee imposed on competing

market maker orders has been reduced.

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The following illustrates this fact:

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

Credit Discount

Shares System System Savings

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

100................................ $(0.04) $0.19 $-0.23

400................................ 0.76 0.76 0.00

500................................ 1.03 0.95 0.08

1,000.............................. 2.35 1.90 0.45

1,500.............................. 3.68 2.85 0.83

2,099.............................. 5.26 3.99 1.27

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The Commission emphasizes, however, that whether a proposed fee can

be deemed an equitable allocation of a reasonable fee depends on the

facts and circumstances under which the proposal is being made. In

evaluating such a proposal, the Commission necessarily would weigh and

balance all of the relevant factors. These may include, among others,

whether the proposed fee is an increase or a decrease, who is subject

to the fee, the basis for any classification being drawn, the potential

impact on competition, and how any disparate treatment will impact the

goals of the Act.\84\

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\84\ Of course, any fee proposal must be found to meet all

applicable statutory standards.

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C. Section 6(b)(5) \85\ and Section 6(b)(8) \86\

The commenters also argue that it is inappropriate for the NYSE to

exclude competing market maker orders from the NYSE's no charge policy

because it will deny the Exchange's competitors effective access to the

NYSE's market, harm the depth and liquidity of the market, disrupt the

balance of competition in the NMS, and hamper competing market makers'

ability to compete.

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\85\ See supra note 41 (listing the requirements of Section

6(b)(5)).

\86\ See supra note 50 (listing the requirements of Section

6(b)(8)).

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1. National Market System

The commenters allege that ITS, although providing them with free

access to the NYSE, is not an effective substitute for access to

SuperDot. In evaluating the role of ITS in the NMS, the Commission

recognizes that the design of ITS is limited in scope. ITS is not a

complete intermarket linkage.\87\ ITS does not provide order-by-order

routing of customer orders, a consolidated limit order book, or

automated or default based execution systems; it does not guarantee

price and time priority. Rather, ITS utilizes communications and

technological components of other NMS facilities so that trading

interest in various market centers can be identified and accessed. It

also provides uniform trading rules governing transactions in exchange-

listed securities.\88\ These functionalities benefit the markets,

broker-dealers, and investors by reducing fragmentation, increasing

opportunities to secure the best execution of customer orders, ensuring

effective competition among qualified markets, and, in general,

furthering the purposes of the NMS established by Congress in Section

11A of the Act.\89\

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\87\ See Market 2000, supra note 53, at Appendix II-12. The

Commission previously has encouraged all ITS participants to

continue to improve the system.

\88\ See 15 U.S.C. 78k-1(a)(1)(D) (finding that the linkage of

all markets will foster efficiency, enhance competition, increase

the information available to brokers, dealers, and investors,

facilitate the offsetting of investors' orders, and contribute to

the best execution of such orders).

\89\ See Market 2000, supra note 53, at Appendix II-11.

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ITS provides an avenue for competing market makers to lay off their

excess positions and interact with trading interest on the NYSE, fee-

free. The Commission believes that ITS will continue to provide an

alternative means by which competing market makers can access the NYSE.

In addition, competing market makers will continue to have access to

the NYSE through SuperDot.

Because access to the NYSE will not be more restrictive under the

proposed rule change, and because competing market makers can avail

themselves of ITS, the Commission does not believe the proposal will

harm the depth and liquidity of the market. Moreover, the Commission

notes that the depth and liquidity of any particular security is

dependent on numerous variables, such as the degree of customer buying

and selling interest in the security and the quality and capitalization

of the issuer.\90\ Hence, the Commission believes it is unlikely that

the cost imposed on competing market makers under the NYSE fee schedule

will have

[[Page 29443]]

a significant impact on the willingness of these market makers to

contribute to the depth and liquidity of NYSE listed securities.

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\90\ See Market 2000 supra note 53, at Study II 8-10 (discussing

quote competition between the regional exchanges and the NYSE). See

also Market 2000, supra note 53, at Study II-8 (finding that in 1992

over 92% of the regional exchanges' volume derived from issues

traded pursuant to unlisted trading privileges, rather than in

issues where the regional exchanges are the primary market).

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2. Disparate Treatment of Competing Market Maker Orders \91\

In determining that disparate treatment of competing market makers

is not inconsistent with the Act in this instance, the Commission

believes three aspects of the proposal are particularly significant.

First, the new fee schedule generally represents a fee reduction.

Second, the NYSE is attempting to maintain the status quo that existed

under the previous fee structure. Third, the parties are competitors in

the NMS.

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\91\ The Commission does not intend this proposal to establish a

precedent to permit a primary market to make distinctions in the

treatment of orders on its Floor as a means to discriminate unfairly

against its competitors. Orders for the account of nonmember

competing market makers will continue to be treated in the same way

as other Agency orders. See supra note 13 (defining Agency order).

For example, the proposal does not effect any change in routing to

the NYSE market; in the priority such orders receive on the Floor;

or in surveillance by the NYSE. Therefore, this proposal is

distinguishable from the one proposed by the Amex in SR-Amex-90-29.

See Securities Exchange Act Release No. 32377 (May 27, 1993), 58 FR

31568 (utilizing similar reasons for distinguishing SR-Amex-90-29

from the NYSE's limitation of its additional system credit).

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First, as noted previously, this proposal generally reduces the fee

heretofore imposed on competing market maker orders.\92\ The Commission

is unable to conclude that reducing competing market makers' fees on

most of their SuperDot system orders will have a significant, negative

impact on the competitors' ability to perform their market making

functions.

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\92\ See supra note 83.

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Second, the Commission has due regard for the NYSE's proffered

intent to maintain the status quo. The Exchange decided to change from

a credit system to a discount system in response to the Commission's

regulatory initiatives addressing the practice of payment for order

flow, and the NYSE has stated that excluding orders of competing market

makers from its no charge policy is intended ``to maintain the current

relationship between member proprietary and nonmember market maker

activities in Exchange-listed securities.'' \93\ Orders of competing

market makers were not entitled to the same fee treatment as other

orders in the prior fee schedule. This proposal does not alter this

result.\94\

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\93\ See NYSE April 25, 1996 Letter, supra note 5.

\94\ Given that the fee imposed on competing market maker orders

is being reduced from its prior level in most instances, the

Commission does not believe that a predatory motive is the impetus

for this filing. Contra Phlx February 23, 1996 Letter, supra note 4.

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Finally, the Commission does not believe that this fee change

imposes an unnecessary burden on competition. Fair competition in the

NMS does not require free access in all instances to a competitor's

systems.\95\ Fair competition must take into consideration all of the

relevant facts and circumstances. To find otherwise would negate the

benefits of belonging to a membership organization. Also, it is

important to note that membership carries with it certain duties,

responsibilities, and costs not applicable to nonmembers.\96\ Thus, in

the circumstances presented by this filing, it is not inconsistent with

fair competition for the NYSE to charge competing market maker orders a

reasonable fee when utilizing systems whose development has been

financed by NYSE members.

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\95\ This is especially true in light of the fact that other

means of access to the NYSE market exist.

\96\ See Securities Exchange Act Release No. 32377 (May 27,

1993), 58 FR 31568 (noting that the NYSE Specialist System Charge

was used to partially fund the NYSE's credit system).

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For all of the above reasons, the Commission finds that the NYSE

proposal is consistent with Section 6(b)(5) \97\ and Section 6(b)(8)

\98\ of the Act.

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\97\ 15 U.S.C. 78f(b)(5).

\98\ 15 U.S.C. 78f(b)(8).

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D. Proposed Order Handling Rules \99\

The BSE is concerned that BSE specialists availing themselves of

exceptions in the Proposed Limit Order Rule and in the Proposed Price

Improvement Rule concerning the immediate delivery of an order to a

market maker or system complying with the applicable rule would be

charged a different fee than a NYSE member complying with the same

exception.\100\

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\99\ See supra note 63 (describing the Commission's proposed

order handling rules).

\100\ The fifth exception to the Proposed Limit Order Rule

applies to any customer limit order ``that is delivered immediately

to an exchange or association sponsored system that displays limit

orders and complies with the requirements of [the Proposed Limit

Order Rule] with respect to that order.'' The fourth exception to

the Proposed Price Improvement Rule applies to any customer market

order ``that is delivered immediately to another specialist or OTC

market maker that complies with the display requirements of [the

Proposed Price Improvement Rule] with respect to that order.'' See

Securities Exchange Act Release No. 36310 (Oct. 10, 1995), 60 FR

52792 (publishing File No. S7-30-95 for comment).

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The BSE's comments in this connection are premature inasmuch as the

Commission has not taken final action on the proposed rules referred to

by the BSE. The Commission notes, however, that the Proposed Limit

Order Rule would allow a specialist or market maker to display the

limit order in its own quote; execute the limit order; or send the

order to another market maker or system that would display the order in

conformity with the rule. Thus, a competing market maker would have two

alternatives to sending the order to another market or system.

Similarly, the Proposed Price Improvement Rule provides market makers

with an alternative to sending their orders to another market center.

E. Antitrust Law's Essential Facility Doctrine \101\

The Phlx urges the Commission to apply the antitrust law's

essential facility doctrine because, in the Phlx's opinion, the NYSE is

an essential facility.\102\ The Commission declines to do so in this

case because, as noted previously, the NYSE is not denying the use of

its facilities to its competitors.\103\ Competing market makers still

have two forms of access to the NYSE--one free (ITS) and the order at a

reduced rate (SuperDot).

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\101\ In Silver v. New York Stock Exchange, the Supreme Court

ruled that certain instances of self-regulation that fall within the

scope and purposes of the Act could protect an exchange against an

antitrust claim. Silver, 373 U.S. 341, 360-61 (1963). In Thill

Securities Corporation v. New York Stock Exchange, the U.S. Court of

Appeals for the Seventh Circuit interpreted this ruling to allow the

securities laws to act as an implied repealer of the antitrust laws,

but only to the minimum extent necessary to make the securities laws

work. Thill, 433 F.2d 264, 268 (7th Cir. 1970), cert. denied, 401

U.S. 994 (1971). In determining when such antitrust immunity is

applicable, one court explained, ``Where the concededly self-

regulatory rule or practice complained of is within the explicit

mandate of the Exchange Act and also is actively reviewed by the

Commission, that body may and appropriately should itself consider

the policies of both the antitrust and the securities laws.'' Jacobi

v. Bache & Co., Inc., 377 F. Supp. 86, 92 (S.D.N.Y. 1974), aff'd,

520 F.2d 1231 (2d Cir. 1975), cert. denied, 423 U.S. 1053 (1976).

\102\ The essential facility doctrine, also called the

``bottleneck principle,'' requires the owner of a facility that

cannot practicably be duplicated by would-be competitors to share

this facility on fair terms. Hecht v. Pro-Football, Inc., 570 F.2d

982, 992 (D.C. Cir. 1977), cert. denied, 436 U.S. 956 (1978). In

determining if a facility is ``essential'' under the Sherman Act,

courts look to whether ``duplication of the facility would be

economically infeasible'' and if ``denial of its use inflicts a

severe handicap on potential [or current] market entrants.'' Twin

Laboratories, Inc. v. Weider Health & Fitness, 900 F. 2d 566, 568-69

(2d Cir. 1990) (citing Hecht); MCI Communications Corp. v. American

Telephone & Telegraph Co., 708 F.2d 1081, 1132-33 (7th Cir.)

(requiring ``(1) control of the essential facility by a monopolist;

(2) a competitor's inability practically or reasonably to duplicate

the essential facility; (3) the denial of the use of the facility to

a competitor; and (4) the feasibility of providing the facility''),

cert. denied, 464 U.S. 891 (1983).

\103\ In finding that the NYSE is not denying the use of its

facilities to its competitors, the Commission does not reach the

issue of whether the NYSE is, in fact, an essential facility.

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In addition, the Commission notes the competitive environment in

which

[[Page 29444]]

today's market makers operate.\104\ For example, the NYSE faces

significant competition for orders in NYSE stocks from the regional

stock exchanges,\105\ third market makers,\106\ proprietary trading

systems (``PTSs''),\107\ and foreign markets.\108\ Modern technology

has facilitated this competition and should continue to do so in the

future.\109\

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\104\ See Market 2000, supra note 53, at 6-12 (providing an

overview of the intense competition that exists in the U.S. equity

market); Market 2000, supra note 53, at Exhibit 18 (charting the

NYSE's percentage of Consolidated Tape trades in NYSE stocks from

1976 to 1992).

\105\ The regional stock exchanges captured 20% of the orders in

NYSE stocks during the first six months of 1993. Market 2000, supra

note 53, at 8.

\106\ OTC trading of exchange-listed securities is commonly

known as the ``third market.'' In 1989, the third market garnered

3.2% of reported NYSE share volume and 5% of reported trade volume.

By 1993, third market volume had more than doubled to 7.4% of

reported NYSE reported share volume and 9.3% of reported trade

volume. Market 2000, supra note 53, at 9.

\107\ A PTS is a type of automated trading system that typically

is a screen-based system sponsored by broker-dealers. PTSs are not

operated as or affiliated with self-regulatory organizations but

instead are operated as independent businesses. Participation in

these systems may be limited to institutional investors, broker-

dealers, specialists, and other market professionals.

Although most PTS volume is in Nasdaq securities, PTSs handled

about 1.4% of the volume in NYSE stocks in the first six months of

1993. Market 2000, supra note 53, at 8, Study II 12-13.

\108\ Although exact numbers are not available, the Commission

estimates that foreign market trading in NYSE stocks amounts to

approximately seven million shares per day. See Market 2000, supra

note 53, at 10-11.

\109\ See Market 2000, supra note 53, at 8-10 (noting that

automated systems allow the regional stock exchanges, third market

makers, and PTSs to compete for order flow with the primary

markets).

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V. Conclusion

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

Act,\110\ that the proposed rule change (SR-NYSE-95-47) is approved.

\110\ 15 U.S.C. 78s(b)(2).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\111\

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\111\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland

Deputy Secretary

[FR Doc. 96-14590 Filed 6-7-96; 8:45 am]

BILLING CODE 8010-01-M