Self-Regulatory Organizations; New York Stock Exchange LLC; Order Approving Proposed Rule Change and Amendment Nos. 1 and 2 Thereto To Provide Floor Brokers With the Ability To Enter Discretionary Instructions and/or Pegging Instructions With Respect to Floor Broker Agency Interest Files (e-Quotes), 60208-60216 [E6-16888]
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60208
Federal Register / Vol. 71, No. 197 / Thursday, October 12, 2006 / Notices
Number SR–NYSE–2006–74 on the
subject line.
SECURITIES AND EXCHANGE
COMMISSION
Paper Comments
[Release No. 34–54577; File No. SR–NYSE–
2006–36]
• Send paper comments in triplicate
to Nancy M. Morris, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090.
Self-Regulatory Organizations; New
York Stock Exchange LLC; Order
Approving Proposed Rule Change and
Amendment Nos. 1 and 2 Thereto To
Provide Floor Brokers With the Ability
All submissions should refer to File
To Enter Discretionary Instructions
Number SR–NYSE–2006–74. This file
and/or Pegging Instructions With
number should be included on the
Respect to Floor Broker Agency
subject line if e-mail is used. To help the Interest Files (e-Quotes)
Commission process and review your
October 5, 2006.
comments more efficiently, please use
only one method. The Commission will I. Introduction
post all comments on the Commission’s
On May 16, 2006, the New York Stock
Internet Web site (https://www.sec.gov/
Exchange LLC (‘‘NYSE’’ or ‘‘Exchange’’)
rules/sro.shtml). Copies of the
filed with the Securities and Exchange
submission, all subsequent
Commission (‘‘Commission’’), pursuant
to Section 19(b)(1) of the Securities
amendments, all written statements
Exchange Act of 1934 (‘‘Act’’) 1 and Rule
with respect to the proposed rule
19b–4 thereunder,2 a proposed rule
change that are filed with the
change to provide floor brokers with the
Commission, and all written
ability to enter discretionary and
communications relating to the
pegging instructions with respect to
proposed rule change between the
Commission and any person, other than their floor broker agency interest files.
On June 14, 2006 and July 11, 2006,
those that may be withheld from the
NYSE filed Amendment Nos. 1 3 and 2 4
public in accordance with the
to the proposed rule change,
provisions of 5 U.S.C. 552, will be
respectively. The proposed rule change,
available for inspection and copying in
as amended, was published for
the Commission’s Public Reference
comment in the Federal Register on July
Room. Copies of such filing also will be 21, 2006.5 The Commission received six
available for inspection and copying at
comment letters from three
the principal office of the NYSE. All
commenters.6 On September 13, 2006,
comments received will be posted
the Exchange filed a response to the
without change; the Commission does
comment letters.7 This order approves
not edit personal identifying
the proposed rule change, as amended.
information from submissions. You
II. Background
should submit only information that
On March 22, 2006, the Commission
you wish to make available publicly. All
approved NYSE’s proposal to establish
submissions should refer to File
Number SR–NYSE–2006–74 and should a Hybrid Market, which will alter the
Exchange’s market structure from a
be submitted on or before November 2,
floor-based auction market with limited
2006.
automated order interaction to a more
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.16
Nancy M. Morris,
Secretary.
[FR Doc. E6–16847 Filed 10–11–06; 8:45 am]
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U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 In Amendment No. 1, NYSE proposed
additional changes and clarifications to the
proposal.
4 Amendment No. 2 supersedes and replaces the
original rule change and Amendment No. 1 in their
entirety.
5 See Securities and Exchange Act Release No.
54150 (July 14, 2006), 71 FR 41496.
6 See Letters from George Rutherfurd, Consultant,
dated June 22, 2006 (‘‘Rutherfurd I’’), August 3,
2006 (‘‘Rutherfurd II’’) and September 21, 2006
(‘‘Rutherfurd Letter III’’); Warren Meyers, President,
Independent Brokers Action Committee, dated
August 11, 2006 (‘‘IBAC Letter’’); and Junius W.
Peake, Monfort Distinguished Emeritus Professor of
Finance, Kenneth W. Monfort College of Business,
dated August 18, 2006 (‘‘Peake Letter I’’) and
October 3, 2006 (‘‘Peake Letter II’’).
7 See Letter from Mary Yeager, Secretary, NYSE,
to Nancy Morris, Secretary, Commission, dated
September 13, 2006 (‘‘Response to Comments’’).
automated market with limited floorbased auction market availability.8 To
create its Hybrid Market, NYSE changed
its rules to permit its floor members to
participate in the market electronically.
For example, specialists will have the
ability to manually and systematically
place in a separate file (‘‘specialist
interest file’’) within the Display Book
system 9 their proprietary interest at
prices at or outside the Exchange best
bid or offer (‘‘BBO’’). In addition,
specialists will establish algorithms
(‘‘Specialist Algorithm’’) 10 to send
messages via an Exchange-owned
application program interface to quote
and trade for their proprietary
accounts.11
As approved in the Hybrid Market
Order, floor brokers will represent their
customers’ orders electronically in a
separate file in the Display Book system
(‘‘floor broker agency interest file’’) at
multiple prices at or outside the
Exchange BBO (‘‘e-Quotes’’). As
approved, e-Quotes can participate in
automatic executions at the Exchange
BBO or outside the Exchange BBO
during a sweep. E-Quotes may not,
however, initiate trades with incoming
orders at prices better than the Exchange
BBO. Accordingly, the Exchange now
proposes additional changes that it
believes will further replicate
electronically the manner in which floor
brokers represent their customers’
orders on the floor. Specifically, NYSE
proposes to provide floor brokers with
the ability to enter discretionary
instructions as to the size and/or price
at which their e-Quotes may trade (‘‘dQuotes’’).12 In addition, the Exchange
proposes to provide floor brokers with
the ability to set their e-Quotes and dQuotes to peg to the Exchange BBO so
that their e-Quotes or d-Quotes would
be available for execution at the BBO as
the Exchange BBO changes (‘‘pegging’’).
1 15
2 17
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8 See Securities and Exchange Act Release No.
53539, 71 FR 16353 (March 31, 2006) (‘‘Hybrid
Market Order’’).
9 The Display Book system (‘‘Display Book
system’’) is an order management and execution
facility. The Display Book system receives and
displays orders to the specialists, contains the
customer limit order display book (‘‘Book’’), and
provides a mechanism to execute and report
transactions and publish the results to the
Consolidated Tape. In addition, the Display Book
system is connected to a variety of Exchange
systems for the purposes of comparison,
surveillance, and reporting information to
customers and other market data and national
market systems, i.e., the Intermarket Trading
System, the Consolidated Tape Association,
Consolidated Quotation System, etc.
10 See NYSE Rule 104(b).
11 See NYSE Rule 104(e).
12 NYSE also refers to d-Quotes as ‘‘discretionary
e-Quotes’’ in its proposed rule text.
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Federal Register / Vol. 71, No. 197 / Thursday, October 12, 2006 / Notices
III. Description of the Proposal
A. Proposed Discretionary Instructions
for e-Quotes
The Exchange proposes NYSE Rule
70.25 to permit floor brokers to enter
discretionary instructions with respect
to the size and/or price at which the eQuote would trade through the d-Quote
functionality.13 Unlike e-Quotes, dQuotes would provide floor brokers
with the means to express a price range
within which they are willing to
actively trade at prices at or better than
the BBO. The discretionary instructions
would relate to the price at which the
d-Quote could trade and the number of
shares to which the discretionary price
instructions would apply.14
The discretionary instructions would
only be active when the e-Quote is at or
joins the existing Exchange BBO or
would establish a new Exchange BBO.15
Furthermore, discretionary instructions
would be active for automatic
executions only, and not active with
respect to the opening or closing
transactions on the Exchange.16 NYSE
would also apply the discretionary
instructions of a d-Quote only if all the
d-Quoting prerequisites are met;
otherwise, the d-Quote would be
handled as a regular e-Quote
(notwithstanding the fact that the floor
broker has designated the e-Quote as a
d-Quote).17 For instance, to qualify as a
d-Quote, the e-Quote would be required
to have a discretionary price range.18
Furthermore, the floor brokers must
comply with the requirements for eQuotes, as approved in the Hybrid
Market, with regard to d-Quotes,
including the requirement that floor
brokers be present in the Crowd when
they have placed interest in their floor
broker agency interest files.19
Floor brokers would be permitted to
have multiple d-Quotes, with different
price and size instructions, on the same
side of the market. Such multiple dQuotes would not compete with each
other for execution priority; rather, the
trading volume would be allocated by
floor broker, not the number of d-Quotes
participating in an execution.20
Discretionary instructions would apply
to both displayed and/or reserve
13 See
proposed NYSE Rule 70.25(a)(i).
proposed NYSE Rule 70.25(a)(i).
15 See proposed NYSE Rule 70.25(a)(ii).
16 See proposed NYSE Rule 70.25(a)(iii).
17 See proposed NYSE Rule 70.25(a)(iv). For
example, if the d-Quote is not at the Exchange BBO,
it would not exercise its discretionary instructions
and accordingly, would function like an e-Quote
instead.
18 See proposed NYSE Rule 70.25(a)(iv).
19 See proposed NYSE Rule 70.25(a)(v).
20 See proposed NYSE Rule 70.25(a)(vi).
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interest.21 The specialist on the floor
and the Specialist Algorithm would not
have access to the discretionary
instructions entered by floor brokers
with respect to their e-Quotes.22
1. Discretionary Price Instructions
NYSE proposes to provide floor
brokers with the ability to set a
discretionary price range within the
Exchange BBO to designate the prices at
which their customers are willing to
trade.23 The floor brokers’ e-Quote must
be represented in the Exchange BBO for
discretionary pricing to be utilized. The
price discretion set by the floor broker
would be used to initiate or participate
in a trade with an incoming order that
is capable of trading at a price within
the Exchange BBO and the discretionary
price range.24
Floor brokers may also specify
whether their discretionary price
instructions would apply to all or only
a portion of their d-Quotes. If price
discretion is provided for only a portion
of a d-Quote, the residual would be
treated as an e-Quote.25 Finally, when
price discretion is used, NYSE proposes
that the shares executed from the dQuote be decremented from reserve size
first, if any, and then from its displayed
size.26
2. Discretionary Size Instructions
In addition to discretionary price
instructions, a floor broker may enter
discretionary size instructions.
Discretionary size instructions designate
the portion of the e-Quote to which the
discretionary price instructions would
apply.27 Floor broker may also specify a
minimum and/or maximum size of
contra side volume with which it would
be willing to trade using price
discretion.28
NYSE proposes that its systems would
only consider NYSE displayed interest
to determine whether the size of the
contra side volume is within the dQuote’s discretionary size range. Contra
21 See
proposed NYSE Rule 70.25(a)(vii).
proposed NYSE Rule 70.25(a)(viii).
23 See proposed NYSE Rule 70.25(b)(i).
24 See proposed NYSE Rule 70.25(b)(i). The
minimum price range for a d-Quote would be the
minimum price variation set forth in NYSE Rule 62,
currently $0.01 for equity securities and $0.10 for
equity securities trading at a price of $100,000 or
greater. See proposed NYSE Rule 70.25(b)(ii) and
NYSE Rules 62.10 and 62.20.
25 See proposed NYSE Rule 70.25(b)(iii).
26 See proposed NYSE Rule 70.25(b)(iv).
27 See proposed NYSE Rule 70.25(c)(i).
28 See proposed NYSE Rule 70.25(c)(ii).
According to the Exchange, this should allow for
more specific order management by preventing the
d-Quote from trading with opposite side interest
that the floor broker has judged to be too little or
too great in the context of the order or orders it is
managing.
22 See
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60209
side reserve and other interest at the
possible execution price would not be
considered.29 Interest displayed by
other market centers at the price at
which a d-Quote could trade would not
be considered by Exchange systems
when determining if the d-Quote’s
minimum and/or maximum size range
is met, unless the Floor broker
electronically designates that such away
volume should be included in this
determination.30 Once the total amount
of a floor broker’s discretionary volume
has been executed, the d-Quote’s
discretionary price instructions would
become inactive, and the remainder of
such d-Quote would be treated as an eQuote.31
3. Executions of d-Quotes
NYSE stated that the goal of
discretionary e-Quoting is to secure the
largest execution for the d-Quote, using
the least amount of price discretion.
Accordingly, d-Quotes may improve the
execution price of incoming orders.
However, if no discretion is necessary to
accomplish a trade, none would be
used.32 In addition, future executions
that could occur, such as those resulting
from the execution of elected contra
side CAP–DI orders, would not be
considered in determining when, and to
what extent, price discretion would be
necessary to accomplish a trade.33
Pursuant to the proposed rules, dQuotes would automatically execute
against a contra side order that enters
the Display Book system, if the order’s
price is within the discretionary price
range, and the order’s size meets any
minimum or maximum size
requirements that have been set for the
d-Quote.34 If there are multiple dQuotes from different floor brokers on
the same side of the market with the
same discretionary price instructions,
then such d-Quotes would trade on
parity, after interest entitled to priority
is executed.35 Multiple d-Quotes from
different floor brokers on the same side
of the market also would compete for an
execution, with the most aggressive
price range establishing the execution
price. If an incoming order remains
unfilled at that price, executions within
the less aggressive price range would
29 See proposed NYSE Rule 70.25(c)(iii).
However, an increase or reduction in the size
associated with a particular price that brings the
contra side volume within a d-Quote’s minimum/
maximum discretionary size parameter would
trigger an execution of that d-Quote. See proposed
NYSE Rule 70.25(c)(v).
30 See proposed NYSE Rule 70.25(c)(iv).
31 See proposed NYSE Rule 70.25(c)(vi).
32 See proposed NYSE Rule 70.25(d)(i).
33 See proposed NYSE Rule 70.25(d)(i)(A).
34 See proposed NYSE Rule 70.25(d)(ii).
35 See proposed NYSE Rule 70.25(d)(iii).
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Federal Register / Vol. 71, No. 197 / Thursday, October 12, 2006 / Notices
then occur.36 In addition, d-Quotes
would compete with same-side
specialist algorithmic trading messages
that seek to trade with incoming
orders.37 If the price of d-Quotes and
specialist trading messages are the same,
d-Quotes and the specialist messages
would trade on parity.38
D-Quotes from floor brokers on the
opposite sides of the market could trade
with each other. In these circumstances,
the d-Quote that arrived at the Display
Book system last would use the most
discretion necessary to effect a trade.39
All executions involving d-Quotes must
comply with Rule 611 under Regulation
NMS (‘‘Reg. NMS’’).40 Accordingly,
when a protected bid or offer, as defined
in Reg. NMS,41 is published by another
market center at a price that is better
than the price at which contra side dQuotes could trade, the amount of
discretion necessary to permit a trade on
the Exchange that is consistent with
Rule 611 would be used, or such portion
of the d-Quote as is necessary would be
automatically routed in accordance with
Rule 611 in order to permit a trade to
occur on the Exchange.42
D-Quotes also could provide price
improvement to, and trade with, an
incoming contra side specialist
algorithmic trading message to ‘‘hit bid/
take offer,’’ just as they could with any
other marketable incoming interest.43 DQuotes may initiate sweeps in
accordance with and to the extent
provided by NYSE Rules 1000–1004,
but only to the extent of their price and
volume discretion. They also could
participate in sweeps initiated by other
orders, but, in such cases, their
discretionary instructions would not be
active.44 Finally, d-Quotes would not
trade at a price that would trigger a
liquidity replenishment point (‘‘LRP’’),
as defined in NYSE Rule 1000.45
Accordingly, a sweep involving a d36 See
proposed NYSE Rule 70.25(d)(iv).
NYSE Rule 104(b). Specialists are limited
in the instances in which they may trade with
incoming orders.
38 See proposed NYSE Rules 70.25(d)(v) and
104(c)(ix).
39 See proposed NYSE Rule 70.25(d)(vi).
40 See Rule 611 of Reg. NMS, 17 CFR 242.611 and
proposed NYSE Rule 70.25(d)(vii).
41 See Rule 600(b)(57) of Reg. NMS, 17 CFR
242.600(b)(57).
42 See proposed NYSE Rule 70.25(d)(vi)(A).
43 See proposed NYSE Rule 70.25(d)(viii).
44 See proposed NYSE Rule 70.25(d)(ix).
45 LRPs are pre-determined price points that
would halt automatic executions for varying
periods depending on the price and remaining size,
if any, of an automatic execution order. See NYSE
Rule 1000. The Commission notes that NYSE has
proposed to amend its LRPs. See Securities
Exchange Act Release No. 54520 (September 27,
2006), 71 FR 57590 (September 29, 2006).
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broker for a pegging e-Quote or d-Quote
to sell is the Exchange best offer and all
other interest at that price cancels or is
B. Pegging
executed, the pegging e-Quote or dNYSE proposes to allow its floor
Quote would remain displayed at that
brokers to enter instructions with regard best offer price.55
to their e-Quotes so that they would
Floor brokers may establish price
‘‘peg’’ the Exchange BBO. A pegging
ranges for an e-Quote or d-Quote,
instruction may be added as a separate
beyond which the pegging function
type of discretionary instruction and
would not be available. Specifically, the
may be active along with discretionary
floor broker can set a ‘‘quote price,’’
price instructions. Specifically, under
which would be the lowest price to
the proposed rules, a floor broker could
which a buy e-Quote or d-Quote could
set an e-Quote, other than a tickpeg or the highest price to which a sell
sensitive e-Quote, to be available for
e-Quote or d-Quote could peg.56 The
execution at the Exchange best bid (for
floor broker may also set a ‘‘ceiling
an e-Quote that represents a buy order)
price,’’ which is the highest price to
or at the Exchange best offer (for an ewhich a buy side e-Quote or d-Quote
Quote that represents a sell order) as the could peg 57 and a ‘‘floor price,’’ which
Exchange BBO changes, so long as the
is the lowest price to which a sell side
Exchange BBO is at or within the ee-Quote or d-Quote could peg.58 The
Quote’s limit price.47 A floor broker
quote, ceiling, and floor price may be at
could similarly employ pegging for its
a price other than the limit price of the
d-Quotes.48
order being e-Quoted or d-Quoted, but
The Exchange proposes that pegging
may not be inconsistent with the order’s
be active only when auto-quoting is
limit.59
active.49 Pegging interest would trade on
Under the proposed rules, as long as
parity with other interest at the BBO
the Exchange best bid (offer) is at or
after the interest entitled to priority has
within the pegging price range selected
been executed. Pegging is reactive.
by the floor broker with respect to a
Accordingly, a pegging e-Quote or dbuy-side (sell-side) e-Quote or d-Quote,
Quote would not establish the Exchange the pegging e-Quote or d-Quote would
BBO as result of pegging,50 and
join such best bid (offer) as it is auto
therefore could not establish price
quoted.60 If the floor broker does not
priority by pegging. The existence of
designate a pegging range, but has
pegging instructions, however, would
instructed that its e-Quote or d-Quote
not preclude an e-Quote or d-Quote
should peg, the e-Quote or d-Quote
from having priority.51
would peg to the Exchange best bid
E-Quotes and d-Quotes with pegging
(offer) as long as such bid (offer) is
instructions will only peg other nonwithin the limit of the order that is
pegging interest.52 Further, an e-Quote
being e-Quoted or d-Quoted.61
or d-Quote would not be able to sustain
Furthermore, as an e-Quote or dthe Exchange BBO as a result of pegging, Quote pegs, its discretionary price
if there is no other non-pegged interest
range, if any, would move along with it,
at that price, and such price is not the
subject to any floor or ceiling price set
e-Quote’s or d-Quote’s limit price.53
by the floor broker.62 In addition, if the
Specifically, if the lowest quotable price Exchange best bid is higher than the
established by the floor broker for a
ceiling price of a pegging buy-side epegging e-Quote or d-Quote to buy is the Quote or d-Quote, the e-Quote or dExchange best bid, and all other interest Quote would remain at its quote price
at that price cancels or is executed, the
or the highest price at which there is
pegging e-Quote or d-Quote would
other interest within its pegging price
remain displayed at that best bid
range, whichever is higher (consistent
price.54 Similarly, if the highest
with the limit price of the order
quotable price established by the floor
underlying the e-Quote or d-Quote).63
Similarly, if the Exchange best offer is
46 See proposed NYSE Rule 70.25(d)(ix)(A).
lower than the floor price of a pegging
47 See proposed NYSE Rule 70.26(i).
sell-side e-Quote or d-Quote, the e48 See proposed NYSE Rule 70.26(ii).
Quote or d-Quote would remain at its
Quote would always stop at least one
cent before an LRP is reached.46
49 See proposed NYSE Rule 70.26(iii). The
Exchange represented that this means when the
Autoquote System is active. Telephone
conversation between Nancy Reich, Vice President,
Office of the General Counsel, NYSE, and Kelly
Riley, Assistant Director, Division of Market
Regulation, Commission, on October 4, 2006.
50 See proposed NYSE Rule 70.26(v).
51 See proposed NYSE Rule 70.26(vi).
52 See proposed NYSE Rule 70.26(vii).
53 See proposed NYSE Rule 70.26(viii).
54 See proposed NYSE Rule 70.26(viii)(A).
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55 See
proposed NYSE Rule 70.26(viii)(B).
proposed NYSE Rule 70.26(ix)(A).
57 See proposed NYSE Rule 70.26(ix)(B).
58 See proposed NYSE Rule 70.26(ix)(C).
59 See proposed NYSE Rule 70.26(ix)(D).
60 See proposed NYSE Rule 70.26(x). See also
note 49, supra.
61 See proposed NYSE Rule 70.26(xi).
62 See proposed NYSE Rule 70.26(xii).
63 See proposed NYSE Rule 70.26(xii)(A).
56 See
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Federal Register / Vol. 71, No. 197 / Thursday, October 12, 2006 / Notices
quote price or the lowest price at which
there is other interest within its pegging
price range, whichever is lower
(consistent with the limit price of the
order underlying the e-Quote or dQuote).64 However, if the Exchange BBO
returns to a price within the pegging
price range selected by the floor broker,
the e-Quote or d-Quote would once
again peg to the Exchange BBO.65
Finally, a floor broker may specify the
minimum and/or maximum size of same
side volume to which its e-Quote or dQuote would peg.66 Other pegging eQuote or d-Quote volume would not be
considered in determining whether the
volume parameters set by the floor
broker have been met.67
C. Other Proposed Changes
1. NYSE Rule 70.20
The Exchange also proposes to amend
NYSE Rule 70.20(j)(i) to specify that eQuotes could participate in the closing
trade, in accordance with the policies
and procedures of the Exchange and
NYSE Rule 70.20(k) to specify that
during the close, a floor broker’s reserve
interest, if any, would be added to the
size of its e-Quoted interest.
2. NYSE Rule 123(e)
The Exchange proposes to add certain
required terms regarding e-Quotes, dQuotes, and pegging instructions as part
of its Rule 123, which requires the entry
of certain order information into the
Exchange’s Front End Systemic Capture
System before such order can be
represented.
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3. NYSE Rule 1000(d)
The Exchange proposes to amend
NYSE Rule 1000(d)(iii)(A) to specify
that d-Quotes will participate in sweeps
in the manner specified in proposed
NYSE Rule 70.25(d)(ix).
D. Implementation
As explained in the Response to
Comments, NYSE proposes to
implement the proposal in Phases 3 and
4 of the Hybrid Market in two parts.68
The first part, which would be
implemented as part of Phase 3 of the
Hybrid Market, would provide the
pegging and d-Quote functionality with
respect to the ability to trade with
marketable orders. The second part,
which would provide the d-Quote
functionality with opposite-side interest
anywhere in its discretionary range, is
scheduled for implementation in Phase
64 See
proposed NYSE Rule 70.26(xii)(B).
proposed NYSE Rule 70.26(xii)(C).
66 See proposed NYSE Rule 70.26(xiii).
67 See proposed NYSE Rule 70.26(xiii).
68 See Response to Comments.
65 See
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4 of the Hybrid Market. Phase 3 is
currently scheduled to commence on or
about October 6, 2006 and is expected
to be completed in early-December
2006. Phase 4 is expected to begin in
December 2006, immediately following
the completion of Phase 3.
IV. Summary of Comments
The Commission received a total of
six comment letters from three
commenters on the proposed rule
change 69 and NYSE filed the Response
to Comments.70 One commenter
generally supported NYSE’s proposal.71
The other two commenters did not
support the proposal and raised specific
concerns about the proposal.
One commenter argued that the
proposal raises significant market
structure issues because he believes that
it will allow hidden orders to compete
directly with transparent market
interest.72 This commenter argues that
the proposal would allow hidden order
trading,73 which makes the markets less
transparent to those who seek liquidity
and denies executions to those who post
liquidity. Further, the commenter
argued that hidden order trading would
render meaningless the notion of
published quotes or the national best
bid/offer (‘‘NBBO’’) because of the
existence of hidden immediately
executable market interest available
between the published quote. The
commenter believes that these results
are inconsistent with the principles of
Section 11A of the Act 74 and the
Commission’s Reg. NMS in that they
compromise the notion that a fully
transparent market is the fairest for all
investors.75 This commenter also argued
that the d-Quote proposal would hinder
the price discovery process. By hiding
interest willing to trade at a specified
price, investors will not be able to make
fully informed pricing decisions for
their orders.
The commenter disagreed with
NYSE’s representation that the proposal
replicated the manner in which floor
brokers act on behalf of their customers
69 See
supra note 6.
supra note 7.
71 See IBAC Letter.
72 See Rutherfurd Letter I.
73 The commenter disagrees with the NYSE’s
classification of d-Quotes as discretionary order
instructions. The commenter argues that d-Quotes
are actually conditional limit orders that will be
automatically and immediately executed upon the
satisfaction of the specified terms entered by the
floor broker. See also Peake Letters I and II.
74 15 U.S.C. 78k–1.
75 This commenter urges the Commission to issue
a concept release on hidden order trading to
consider the implications on market transparency,
published quotations, public limit order protection,
and price discovery processes. See Rutherfurd
Letter I.
70 See
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60211
in the physical auction market.76 The
commenter acknowledged that floor
brokers have always provided inbetween-the-published-quote executions
on the floor but that in the physical
auction, the decision of the floor broker
to participate in an execution is made
on a trade-by-trade basis after contra
side orders arrive in the crowd. The
commenter argued that in the auction
‘‘everything is transparent.’’ 77 While
floor brokers may hold discretionary
orders that are not known to the public,
these orders are not active until the floor
broker makes a public bid (offer) that is
known to all in the trading crowd. After
a floor broker makes its bid (offer)
public in the crowd, other brokers or the
specialist can compete by bidding
higher (offering lower). Thus, the
commenter argued, ‘‘everything is
transparent, as the previously ‘hidden’
discretionary order must be disclosed
prior to the trade, and even after it is
disclosed, is not guaranteed an
opportunity to trade if competing
market participants then bid higher
(offer lower).’’ 78
According to the commenter, the dQuote, however, would allow floor
brokers to enter into an automated
system better prices that are always
available for immediate execution and
because they are not disclosed, other
market participants are not able to
compete with them to provide an even
better priced execution. The commenter
argues that the proposal gives floor
brokers a time/place advantage because
they can react to what is placed in the
Book. The commenter believes that this
time/place advantage is more troubling
than what floor members on the
Exchange currently possess because it is
not mitigated by transparency at the
point of sale like it is in the current
auction market.79 Finally, the
commenter noted investors do not enjoy
the same informational benefit of
knowing the prices at which floor
brokers’ customers are willing to trade.
If they did, the commenter argued, they
would be able to make the decision of
how to price their own orders and thus,
would be able to compete with the floor
brokers’ customers.
The commenter also argues that the
proposal was inconsistent with Sections
6(b)(5) 80 and 11A 81 of the Act.82 The
commenter argues that by giving floor
brokers the exclusive ability to enter
76 See
77 See
Rutherfurd Letters I and III.
Rutherfurd Letter III.
78 Id.
79 See
Rutherfurd Letters I and III.
U.S.C. 78f(b)(5).
81 15 U.S.C. 78k–1.
82 See Rutherfurd Letters I, II and III.
80 15
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discretionary instructions, the NYSE
proposal is inconsistent with Section
6(b)(5) of the Act, which states that an
exchange’s rules cannot be designed to
‘‘permit unfair discrimination between
customers, issuers, brokers or dealers
* * *’’ 83 In addition, the commenter
argues that by requiring members to use
floor brokers to enter discretionary
instructions, the proposal is
inconsistent with Section 11A(a)(1)(C)(i)
of the Act,84 which reflects Congress’
belief that it is in the public interest and
appropriate for the protection of
investors and the maintenance of a fair
and orderly market to assure the
‘‘economically efficient execution of
securities transactions.’’ This
commenter argued that NYSE’s proposal
is a ‘‘direct impediment to economically
efficient execution of securities
transactions’’ because upstairs members
can, and should be permitted to,
exercise their own judgment and put
discretionary instructions on their own
orders without having to incur the
significant additional expense of using a
floor broker. This commenter believes
that floor brokers will merely perform a
clerical function of inputting an order
with specific conditions and that the
NYSE systems will thereafter represent
and execute the order.
The commenter disagreed with
NYSE’s representation that the proposal
would give floor brokers a means to
compete with specialists’ algorithmic
trading and quoting. The commenter
believes that specialist algorithmic
trading on parity with interest
represented by floor brokers is
inconsistent with Section 11A of the
Act 85 and argues the floor broker dQuotes do not rectify this problem with
specialist trading in the Hybrid Market.
Specifically, the commenter cites
Section 11A(a)(1)(C)(v) of the Act,86
which reflects Congress’ belief that
investors’ orders should have the
opportunity to be executed without the
participation of a dealer.87
Another commenter argued that floor
brokers should continue to be allowed
to object to specialists’ trading on parity
when opening or increasing a position,
83 The commenter also argues that the proposal is
anticompetitive because it benefits one class of
market participants (floor brokers) at the expense of
other market participants. See Rutherfurd Letter III.
See also Peake Letter II. Another commenter argues
that all market participants should have access to
the ‘‘national market system.’’ See Peake Letter I.
84 15 U.S.C. 78k–1(a)(1)(C)(i).
85 15 U.S.C. 78k–1.
86 15 U.S.C. 78k–1(a)(1)(C)(v).
87 See Rutherfurd Letter I. See also Peake Letter
II. The commenter also argues that specialists
trading on parity with investors’ orders represented
by floor brokers is inconsistent with the specialists’
negative obligation. See Rutherfurd Letter I.
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in order to closely replicate the present
auction market.88 Finally, this
commenter urged that d-Quotes and
specialist algorithms be phased-in
together.
NYSE’s Response
NYSE believes that its proposal does
replicate the manner in which floor
brokers represent customer orders in the
current auction market. Specifically,
NYSE believes that d-Quotes are
necessary to ensure that floor brokers
are able to perform a function similar to
that which they perform today as the
markets become faster and more
automated. NYSE believes that the
proposal should allow floor brokers to
electronically replicate the order
management decisions they make
regarding the representation of customer
orders. According to NYSE, investors
that use floor brokers would not be able
to access the market in the manner they
do today. NYSE argues that the
proposed discretionary instructions and
pegging ability will allow floor brokers
to use their judgment and expertise in
managing their customers’ orders in a
faster, automated market.
In response to the comment that dQuotes would negatively impact price
discovery and provide informational
advantages to floor brokers, NYSE noted
that d-Quote function is similar to
proposals by other markets that permit
non-displayed orders that trade between
the quote.89 Furthermore, NYSE
believes that d-Quotes would replicate
that which occurs in the manual auction
market and would not provide more or
less information than is currently
available in the Exchange’s market.
According to NYSE, the d-Quote is ‘‘as
transparent as any other floor brokerrepresented order that is not fully
displayed in accordance with long
established trading practices, SEC rules
and regulations and NYSE rules and
regulations.’’ Because the Hybrid Market
would continue to involve the
interaction of floor brokers representing
their customer’s orders, limit orders on
the Display Book system, and the
specialist’s dealer interest, NYSE
believes that the price discovery
88 See IBAC Letter. See also Rutherfurd Letter III
(stating that if the specialist is permitted to trade
on parity, the Commission should demand that
NYSE allow a floor broker objection mechanism in
the Hybrid Market so that floor brokers could
protect the public).
89 NYSE believes that these types of orders were
approved in response to market participants’
preference for order and customer anonymity,
despite the typical argument that such anonymity
could be detrimental to other market participants.
See Response to Comments. But see Rutherfurd
Letter III (arguing that NYSE is not replicating
hidden order (reserve) trading that is conducted in
other markets).
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mechanism would continue to exist.
NYSE argues that d-Quotes would
‘‘merely enhance the ability of floor
brokers to effectively represent their
customers’ orders in the automated
portion of the Hybrid Market’’ and they
do not replace order interaction or the
price discovery process.90
In response the commenter’s
suggestion that d-Quotes would create
price uncertainty, NYSE also believes
that d-Quotes would provide investors
with a better opportunity for price
improvement and would moderate
volatility by providing liquidity and
better price continuity.91 NYSE believes
that d-Quotes would attract liquidity
from incoming orders seeking the
opportunity for a better priced and/or
larger sized transaction that could result
from an increase in competition
between specialists and other floor
brokers’ d-Quotes.92
With respect to the concern that dQuotes would create an ‘‘unlevel
informational playing field,’’ NYSE
noted while investors that use floor
brokers would gain the benefits of dQuotes, the d-Quotes do not create an
unequal or unfair advantage for any
market participant. NYSE pointed out
that specialists and their algorithms
would not know about any discretionary
instructions, and floor brokers would
have access only to information about
their own agency interest, not to other
broker’s files.93 NYSE refuted one
commenter’s suggestion that limit
orders on the Book would have access
to less information as a result of dQuotes by representing that investors
entering limit orders would be privy to
the same information as is currently
available to them, which, NYSE points
out, does not presently include
knowledge of a floor broker’s decisions
90 But see Rutherfurd Letter III. Disagreeing with
NYSE’s response, this commenter argued that floor
broker and specialist interest could not promote
price discovery when such interest is entirely
hidden.
91 See Response to Comments. But see Rutherfurd
Letter III. This commenter objected to NYSE’s
position that d-Quotes would provide increased
opportunities for price improvement, arguing
instead that the e/d-Quote ‘‘overhangs’’ the market
and is pre-programmed to trade automatically. The
commenter claims, therefore, that the e/d-Quote is,
in actuality, the ‘‘real’’, non-discretionary NYSE
market that is willing to trade at such hidden price.
Rather than receiving price improvement, the
incoming order is merely receiving an execution at
the real, pre-existing NYSE price.
92 But see Rutherfurd Letter III (arguing that e/dQuotes could not attract liquidity or enhance
competition when they are hidden).
93 NYSE also indicated that neither the specialist
on the floor nor the specialist algorithmic trading
system would have access to any of the
discretionary instructions entered by the floor
broker in connection with the d-Quotes. See
Response to Comments.
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regarding order management, until after
such decisions are affected.
With respect to the commenters’
implication that d-Quotes would
disadvantage limit orders on the Book
by denying executions to those who
post liquidity, NYSE responded that the
principles of priority and parity at the
NYSE BBO would not be changed with
the introduction of the d-Quote.94
Accordingly, a limit order with priority
at the BBO on the same side of the dQuote would trade first in any execution
at the quote. Furthermore, NYSE stated
that d-Quotes would not force nor cause
limit orders to accept different or worse
prices than what their limits dictate.
NYSE explained that because
discretionary pricing would allow dQuotes to trade at prices in between the
quote where there are no public limit
orders, d-Quotes would provide price
improvement to an incoming order
capable of trading at such better price
and would not negatively impact the
limit order displayed at a worse price.
If the commenter was implying that the
person entering the limit order would
have entered his or her limit order at the
better price had he or she known there
were other market participants
interested in trading at such price,
NYSE responded that nothing prevented
the limit order from being entered at
such better price at the outset.95
Furthermore, NYSE believes that
nothing in the securities laws or
Exchange rules require that every
market participant fully disclose their
interest at the best price possible;
instead, customers are permitted to
choose from a variety of options,
including the order management
provided by floor brokers.
In response to commenters’
suggestion that floor brokers should
retain the right to exclude specialists
from trading on parity when increasing
a position with respect to automatic
executions, NYSE noted that this
provision was approved in the Hybrid
Market Order. To the extent that floor
brokers wish to prevent specialists from
trading on parity with their orders in the
Hybrid Market, NYSE stated that floor
brokers could send those orders for
execution through SuperDot.96 In
94 See
Response to Comments.
see Rutherfurd Letter III (arguing that
participants entering public limit orders could only
react to publicly available information).
96 NYSE believes this solution was supported by
floor brokers who worked with the Exchange in
designing the e-Quote. See Response to Comments.
But see Rutherfurd Letter III (arguing that NYSE’s
response is not providing a feasible means for a
floor broker to protect its public customer from
unnecessary specialist competition since, as a
practical matter, floor brokers would not be able to
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95 But
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response to a commenter’s objection to
NYSE’s proposal to deactivate the
discretionary instructions of a d-Quote
during a sweep that is initiated by other
orders,97 NYSE stated that this
amendment recognizes that when a dQuote is participating in a sweep, as
opposed to initiating a sweep,
employing the discretionary pricing
instructions of the d-Quote would not
provide additional value to the
customer being d-Quoted.98
With regard to the comments on the
Exchange’s proposed implementation
schedule,99 NYSE acknowledged that,
given the complexity of the software
developed for the d-Quote functionality
and the extensive system changes
required to enable increased automatic
execution capabilities, it has not been
able to launch all of these initiatives at
the same time.100 NYSE explained that
floor brokers had requested the dQuoting functionality well after the
design of e-Quoting was completed and
the necessary programming changes
were scheduled. As a result, d-Quoting
was initially slated for implementation
as part of the last phase of the Hybrid
Market. However, in response to
requests from floor brokers, NYSE
claimed that it has made every effort to
move d-Quote implementation forward
as much as possible. In addition, NYSE
stated that it would be adding to the
upcoming software releases a number of
other changes recently requested by
floor brokers, designed to improve the
efficiency of the devices they use to
access the market. Furthermore, NYSE
maintained that the rollout of d-Quotes
is timed to a program that provides
ample training and trading practice for
floor brokers using the new
functionality. Accordingly, NYSE
believes that the sheer volume of system
and other required software changes,
coupled with the need for appropriate
training, mandates that the Exchange
implement d-Quoting in two parts.101
Finally, NYSE believes that the phasein process would be sensitive to the
varied needs of all market participants
affected by the introduction of these
complex changes, and that thorough and
proper broker training and preparation
for the d-Quote is essential, as it
protects the broker from making
unintended trading errors.
participate in the Hybrid Market if they were to
send their orders through SuperDot).
97 See IBAC Letter.
98 See Response to Comments.
99 See IBAC Letter.
100 See Response to Comments.
101 See Section III., D. for a complete discussion
of the two-part implementation.
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V. Discussion
After careful review and
consideration of the comments, the
Commission finds that the proposed
rule change, as amended, is consistent
with the requirements of the Act and the
rules and regulations thereunder
applicable to a national securities
exchange and, in particular, with the
requirements of Section 6(b) of the
Act.102 Specifically, the Commission
finds that approval of the proposed rule
change, as amended, is consistent with
Section 6(b)(5) of the Act 103 in that the
proposal is designed to promote just and
equitable principles of trade, to foster
cooperation and coordination with
persons engaged in regulating, clearing,
settling, processing information with
respect to, and facilitating transactions
in securities, to remove impediments to
and perfect the mechanism of a free and
open market and a national market
system, and, in general, to protect
investors and the public interest.
Further, the Commission believes that
the proposed rule change, as amended,
is consistent with Section 11A(a)(1)(C)
of the Act,104 in which Congress found
that it is in the public interest and
appropriate for the protection of
investors and the maintenance of fair
and orderly markets to assure: (1)
Economically efficient execution of
securities transactions; (2) fair
competition among brokers and dealers
and among exchange markets, and
between exchange markets, and markets
other than exchange markets; (3) the
availability to brokers, dealers, and
investors of information with respect to
quotations and transactions in
securities; (4) the practicability of
brokers executing investors’ orders in
the best markets; and (5) an opportunity
for investors’ orders to be executed
without the participation of a dealer.
Currently in the NYSE auction, floor
brokers represent their customers’
orders for execution. For many orders,
floor brokers have discretion to
determine the price at which their
customers’ orders should be executed,
subject to their agency obligations and
best execution requirements. As the
NYSE market becomes more automated,
NYSE and its floor brokers have
considered how floor brokers can
continue to represent their customers in
a meaningful fashion. NYSE continues
to believe that its physical auction on
the floor will play an important role in
102 15 U.S.C. 78f(b). In approving this proposal,
the Commission has considered the proposed rules’
impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
103 15 U.S.C. 78f(b)(5).
104 15 U.S.C. 78k–1(a)(1)(C).
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its market even as automated execution
expands.
In the Hybrid Market, as approved,
NYSE made provisions to allow its floor
brokers to represent their customers in
the electronic portion of the market.
NYSE, however, also placed restrictions
on their activities to reflect the
continued role of the auction on the
floor. Specifically, NYSE requires its
floor brokers to be in the ‘‘Crowd’’ when
representing customers electronically so
that they can be available to represent
their customers should the market move
to the floor.
With this current proposal, NYSE
proposes to give floor brokers more tools
with which to represent their customers.
NYSE represents that the discretionary
instructions that it has proposed are
intended to replicate the manner in
which floor brokers represent orders in
the auction. In addition, NYSE stated
that d-Quotes will enable floor brokers
to compete with other participants in an
automated market place, including
specialists, and may enhance the quality
of order execution on the Exchange.
As discussed above, d-Quotes will
enable floor brokers to place within the
Display Book system, in a manner that
is not displayed, the prices and sizes at
which their customers are willing to
trade if a contra side order arrives in the
market. The d-Quote could enable floor
brokers to better compete with other
market participants, and possibly
enhance the quality of order execution
on the Exchange. The Commission
believes that the Exchange’s proposed dQuote functionality is broadly
consistent with the requirements of the
Act, and within the realm of business
judgment generally left to the discretion
of individual markets.
The pegging function will enable floor
brokers to remain in the Exchange BBO
as the quote moves. As the markets
become more electronic it may be very
difficult for a floor broker to effectively
manually adjust the prices of its
customers’ orders in the Display Book
system. The Commission believes that
the proposed pegging function should
provide floor brokers with the ability to
track the quote as it changes, thereby
providing floor brokers with an
additional tool to offer liquidity at the
Exchange BBO, once the Exchange shifts
from the manual auction market to a
faster, predominantly electronic market.
The pegging function also is designed to
help them continuously meet one of the
requirements for using the d-Quote—
namely, maintaining an e-Quote at the
NYSE BBO. Accordingly, the
Commission finds that the proposal to
implement a pegging function for floor
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brokers is consistent with the
requirements of the Act.
Accordingly, the Commission finds that
the proposal is consistent with the Act.
A. Comments
2. Informational Advantages for Floor
Brokers
In the proposal, the Exchange states
that it is intending to replicate, in the
Hybrid Market, the manner in which
floor brokers utilize their judgment in
quoting and trading on behalf of their
customers’ orders in the auction market.
One commenter questions whether the
proposal actually replicates the auction
market.106 The commenter believes that
the proposal would introduce a new
manner of trading that is unfair to
public limit orders and provides
informational advantages to floor
brokers. The commenter believes that
the proposal would replicate the time
and place advantage enjoyed by floor
brokers in the auction market, without
maintaining the counterbalance of the
auction market’s transparency of bids
and offers, and the requirement that
orders cannot trade before they are
exposed to the market. Further, the
commenter argued that floor brokers
could enter their d-Quotes with full
knowledge of the public limit orders,
while public investors would not be
provided reciprocal knowledge of the dQuotes. Thus, the commenter believes
that public investors are inappropriately
denied the ability to change their limit
prices in response to the trading
instructions attached to d-Quotes.
In the Response to Comments, the
Exchange noted that, without d-Quotes,
investors that use floor brokers to
represent their orders would not be able
to access the Hybrid Market in a similar
manner to which they access the
auction market today. The Exchange
believes that it designed the proposal to
closely replicate the auction market in
an electronic environment.
Further, the Exchange responds that
in today’s auction market, orders that
are held and represented by floor
brokers are not transparent. The
Exchange represented that it designed
the proposal to permit floor brokers to
make the same types of trading
decisions for the orders they hold in the
Crowd today. The Exchange believes the
1. Transparency
One commenter argued that the
proposal would have an adverse impact
on transparency because the
discretionary instructions would not be
disclosed to the public. The commenter
argued that by not disclosing d-Quotes
to the public, the Exchange was making
its market less transparent to investors
who seek liquidity and would be
denying executions to investors who
post liquidity. According to the
commenter, the proposal would lessen
incentives to post liquidity by allowing
d-Quotes to trade despite the existence
of displayed limit orders.
The commenter also argued that the
lack of transparency of the d-Quotes
would negatively impact the price
discovery process by lessening the
usefulness of the NBBO. The commenter
argued that investors would be denied
complete information about the current
state of the prices and sizes at which
other investors are willing to trade.
Unlike the current auction where,
according to the commenter, only
interest that is disclosed is permitted to
participate in an execution, d-Quotes
will participate in an execution if their
terms are fulfilled without disclosure to
other market participants who may be
willing to trade at the same or better
price.
The Commission notes that it has
never required complete disclosure of
all trading interest, and that it has
permitted the use of undisplayed order
types. Today, for example, floor brokers
may hold significant trading interest
that may be available for execution that
is not broadly disclosed, but that may
participate in a transaction on the
Exchange.
NYSE has proposed a means by which
floor brokers can continue to represent
customers without having to disclose
the customers’ entire orders. Floor
brokers will be able to adjust their dQuotes to reflect their customers’
investment strategies.
The Commission believes that NYSE
has designed its proposal to allow floor
brokers to represent their customers in
a manner similar to how they operate in
the auction market. The Commission
believes that the proposal is not likely
to substantially reduce transparency
because these orders are not currently
displayed. The Commission also notes
that it has approved similar undisplayed
order types for use by other markets.105
105 See Securities Exchange Act Release Nos.
47467 (March 7, 2003), 68 FR 12134 (March 13,
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Fmt 4703
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2003) (approving pegging orders in Pacific
Exchange, Inc.) and 48798 (November 17, 2003), 68
FR 66147 (November 25, 2003) (approving pegging
orders in Nasdaq Stock Market, Inc.); and 44983
(October 25, 2001), 66 FR 55225 (November 1, 2001)
(approving discretionary orders in Pacific
Exchange, Inc.) and 49085 (January 15, 2004), 69 FR
3412 (January 23, 2004) (approving discretionary
orders in Nasdaq Stock Market, Inc.). See also
Securities Exchange Act Release No. 54511
(September 26, 2006), 71 FR 58460 (October 3,
2006) (approving passive liquidity order in NYSE
Arca, Inc.).
106 See Rutherfurd Letters I and III.
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proposal would not substantially alter
the amount of information currently
available on the Exchange. Specialists
and floor brokers would not have access
to information about d-Quotes entered
by other floor brokers. The Exchange
also stated that public investors entering
limit orders would have the same
amount of information as is currently
available, which does not include
knowledge of floor broker trading
interest. Likewise, floor brokers would
not have any more market information
on the Exchange than they do today.
Accordingly, the Commission does
not believe that the proposal would
provide floor brokers with an
inappropriate informational advantage
or reduce the amount of information
that is currently publicly available.
3. Section 11A of the Act
One commenter argued that the
proposal was inconsistent with Section
6(b) of the Act and Section
11A(a)(1)(C)(i) of the Act 107 because the
commenter believes that the proposal is
unfairly discriminatory and anticompetitive.108 Specifically, the
commenter argues that because the
proposal would provide floor brokers
with an exclusive right to enter dQuotes, the proposal unfairly
discriminates against customers who do
not use floor brokers, and places a
burden on competition that is not
necessary in furtherance of the purposes
of the Act. Further, the commenter
argues that the proposal inhibits the
economically efficient execution of
orders, which Section 11A(a)(1)(C)(i) of
the Act 109 states is a goal of the national
market system. The commenter notes
that, under the proposal, investors who
seek to utilize discretionary instructions
would be forced to pay a floor broker,
who the commenter argues, then merely
performs the clerical function of
entering the order into the Exchange
system for execution. The commenter
believes that institutional investors
should be free to exercise their own
judgment without the requirement to
employ any third parties. The
commenter also noted that all market
participants should have a fair
opportunity to trade and trading should
not be conducted with unnecessary
human intervention.
The Commission notes that today if
investors wish to have their orders
represented in the NYSE auction
market, they must either send their
order to the Book for representation by
a specialist or send their order to a floor
107 15
U.S.C. 78k–1(a)(1)(C)(i).
Rutherfurd Letters I and III.
109 15 U.S.C. 78k–1(a)(1)(C)(i).
108 See
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broker for representation.110 In the
Hybrid Market, NYSE has decided to
retain a role for its floor members in its
market. The commenter stated that he
believed that ‘‘pure electronic trading is
not only defensible but highly
desirable’’ and thus, appears to
fundamentally disagree with the market
structure that NYSE has developed.
However, Congress clearly
contemplated that the markets should
be able to compete through the adoption
of different market models.111
NYSE has sought to replicate its
current market in a more electronic
manner, yet while retaining some
distinctive features of its floor. As the
Commission indicated in the Hybrid
Market Order, the Exchange has a
degree of flexibility to develop its
market model so long as it does so
within the framework of the Act.
The Commission believes that the
proposal is broadly consistent with
Section 11A of the Act in that it
incorporates features that may provide
investors with the opportunity to
receive economically efficient execution
of their securities transactions and
promote fair and orderly markets.112
The Commission believes that while dQuotes would not be displayed, they
could provide benefits to the market
such as increased liquidity and
improved prices. The Commission notes
that undisplayed d-Quotes would never
execute ahead of a displayed order that
is at the same or better price.
A significant feature of the d-Quote is
to potentially offer public investors a
means, through the use of floor brokers,
to compete with specialists in providing
price improvement to incoming
marketable orders. The Commission
believes that d-Quote could provide
meaningful competition to the specialist
in providing price improvement, and
thus promote competition on the
Exchange floor.
Accordingly, the Commission does
not believe that the proposal is
inconsistent with Section 11A of the
Act.113
110 Small marketable limit orders can be
automatically executed in Direct+.
111 As Congress noted when it adopted the 1975
Act Amendments that it was ‘‘not the intention of
the bill to force all markets for all securities into
a single mold.’’ See S. Rep. No. 94–75, 94th Cong.,
1st Sess. 7 (1975). Congress instructed the
Commission to seek to ‘‘enhance competition and
to allow economic forces, interacting with a fair
regulatory field, to arrive at appropriate variation in
practices and services. It would obviously be
contrary to this purpose to compel elimination of
differences between types of markets or types of
firms that might be competition-enhancing. Id.
112 15 U.S.C. 78k–1.
113 15 U.S.C. 78k–1.
PO 00000
Frm 00109
Fmt 4703
Sfmt 4703
60215
4. Sweeps
In the Hybrid Market, once an auto ex
order trades with interest at the
Exchange BBO, the remainder, if any,
would automatically sweep the Display
Book system by trading with liquidity
outside the BBO. Under the proposal, dQuotes could also participate in sweeps
initiated by other orders, but their
discretionary instructions would not be
active.114 One commenter believes that
a sweep initiated by other orders should
not deactivate the discretionary
instructions.115 The Exchange responds
that when a d-Quote is participating in
a sweep, the discretionary functions
would not provide additional value to
the customer.
The Commission believes that the
Exchange has some latitude to
determine the types of functions that it
believes would be most attractive to its
market participants. Accordingly, the
Commission believes that the treatment
of d-Quote in sweeps is reasonable and
broadly consistent with the
requirements of the Act.
5. Implementation
The Exchange proposes to implement
the d-Quote proposal in two parts, in
Phase 3 and Phase 4 of the Hybrid
Market implementation. One
commenter argued that d-Quote should
be implemented at the same time as the
Specialist Algorithms, because the
commenter believes that the proposal is
necessary to maintain market
balance.116 The commenter believes that
implementing the Specialist Algorithms
first would risk a mass exodus of
volume from the Exchange. In the
Response to Comments, the Exchange
stated that, due to the complexities of
the system changes required by the
implementation of the Hybrid Market,
the Exchange is not able to launch the
proposal at the same time as the
Specialist Algorithms.
The Commission believes that the
Exchange’s proposed implementation
schedule is reasonable and consistent
with the requirements of the Act. The
Commission notes that Phase 3 is when
the Exchange anticipates switching to a
substantially more automated market,
and believes that the proposed staggered
implementation schedule is reasonably
designed to allow the Exchange to
adequately test the changes to its
systems.
VI. Conclusion
For the foregoing reasons, the
Commission finds that the proposed
114 See
proposed NYSE Rule 70.25(d)(ix).
IBAC Letter.
116 See IBAC Letter.
115 See
E:\FR\FM\12OCN1.SGM
12OCN1
60216
Federal Register / Vol. 71, No. 197 / Thursday, October 12, 2006 / Notices
rule change, as amended, is consistent
with the Act and the rules and
regulations thereunder applicable to a
national securities exchange, and, in
particular, with Section 6(b)(5) of the
Act117 and Section 11A of the Act.118
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,119 that the
proposed rule change (SR–NYSE–2006–
36) and Amendment Nos. 1 and 2 are
approved.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.120
Nancy M. Morris,
Secretary.
[FR Doc. E6–16888 Filed 10–11–06; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–54578; File No. SR–NYSE–
2006–82]
Self-Regulatory Organizations; New
York Stock Exchange LLC; Notice of
Filing and Order Granting Accelerated
Approval of a Proposed Rule Change
Relating to A Pilot Until 10/31/06 to Put
Into Operation Certain Rule Changes
Pending Before the Securities and
Exchange Commission to Coincide
With the Exchange’s Implementation of
Phase 3 of the NYSE HYBRID
MARKETSM
October 5, 2006.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’),1 and Rule 19b-4 thereunder,2
notice is hereby given that on October
5, 2006 the New York Stock Exchange
LLC (‘‘NYSE’’ or ‘‘Exchange’’) filed with
the Securities and Exchange
Commission (‘‘Commission’’ or ‘‘SEC’’)
the proposed rule change as described
in Items I and II below, which Items
have been prepared by the Exchange.
The Commission is publishing this
notice and order to solicit comments on
the proposed rule change from
interested persons and to approve the
proposed rule change on an accelerated
basis.
rwilkins on PROD1PC63 with NOTICES
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange is proposing a pilot (the
‘‘Pilot’’) to put into operation certain
rule changes pending before the
117 15
U.S.C. 78f(b)(5).
U.S.C. 78k–1.
119 15 U.S.C. 78s(b)(2).
120 17 CFR 200.30–3(a)(12).
1 15 U.S.C 78s(b)(1).
2 17 CFR 240.19b–4.
16:21 Oct 11, 2006
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission, the
NYSE included statements concerning
the purpose of, and basis for, the
proposed rule change and discussed any
comments it received on the proposed
rule change. The text of these statements
may be examined at the places specified
in Item III below. The NYSE has
prepared summaries, set forth in
Sections A, B, and C below, of the most
significant aspects of such statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
The Commission approved the Hybrid
Market on March 22, 2006.4 The
approved rules did not become effective
immediately; rather they are being
implemented in a series of phases over
a period of time.
Implementation of Phase 1 of the
Hybrid Market, which focused primarily
on the ability of Floor brokers to
electronically represent their customers’
interest (‘‘e-Quote’’), was substantially
completed on April 5, 2006.
Phase 2 of the Hybrid Market focused
primarily on the ability of specialists to
use their algorithmic systems to quote
and trade. The installation of software
necessary to implement Phase 2 of the
Hybrid Market has been installed Floorwide. Some specialist firms have been
in the process of readying their systems
to quote and trade with receipt of order
information, while others have begun
quoting with receipt of such
information. Phase 2 will continue to
become operational concurrently with
the roll out of Phase 3. In addition,
beginning June 21, 2006, specialists
were permitted to algorithmically quote
(‘‘s-Quote’’) in their specialty securities,
without the receipt of order information
3 The Hybrid Market was approved on March 22,
2006. See Securities Exchange Act Release No.
53539 (March 22, 2006), 71 FR 16353 (March 31,
2006) (SR–NYSE–2004–05) (‘‘Hybrid Market
Order’’).
4 Id.
118 15
VerDate Aug<31>2005
Commission to coincide with the
Exchange’s implementation of NYSE
HYBRID MARKETSM (‘‘Hybrid
Market’’) 3 Phase 3 for the securities
identified in Exhibit 3 of its filing. The
text of the proposed rule change is
available on NYSE’s Web site (https://
www.nyse.com), at the principal office
of the Exchange, and at the
Commission’s Public Reference Room.
Jkt 211001
PO 00000
Frm 00110
Fmt 4703
Sfmt 4703
as such orders are entering Exchange
systems.5 Starting August 15, 2006,
specialists were permitted to send
algorithmically-generated trading
messages to interact with the Exchange
quotation (‘‘hit bid/take offer’’), also
without receipt of order information as
such orders are entering Exchange
systems.6
Phase 3 of the Hybrid Market, as
approved, includes implementation of
the following features:
• Automatic routing of orders to
automated markets posting better bids
and offers in accordance with
Regulation NMS;
• Availability of NYSE IOC orders for
automatic executions;
• Use of indicators to identify NYSE
quotations that are not immediately
available for automatic execution;
• Implementation of gap quoting
requirements;
• Elimination of 1,099 size restriction
for automatic executions and increase in
size eligibility for automatic executions
to 1 million shares; 7
• Elimination of 30-second restriction
on the entry of auto ex orders on orders
from the same person;
• Availability of automatic executions
through the close;
• Elimination of Direct+ availability
only to straight limit orders;
• Elimination of Direct+ suspensions
due to price (i.e., a trade at a price that
would be more than five cents from the
last trade in the stock on the Exchange);
• Elimination of Direct+ suspensions
due to size (i.e., a 100-share published
bid or offer);
• Conversion of marketable limit
orders to auto ex orders; and
• Automatic executions of market
orders.8
The Exchange intends to begin
implementation of Phase 3 on October
6, 2006. The Exchange has proposed
changes to some of the rules already
approved for implementation in Phase
3 9 as well as moving the
implementation of sweeps and liquidity
replenishment points (‘‘LRPs’’)
5 See Securities Exchange Act Release No. 54024
(June 21, 2006), 71 FR 36849 (June 28, 2006) (SR–
NYSE–2006–44). This is effective until Phase 2 is
fully implemented.
6 See Securities Exchange Act Release No. 54316
(August 15, 2006), 71 FR 48569 (August 21, 2006)
(SR–NYSE–2006–59). This is effective until Phase
2 is fully implemented.
7 See Securities Exchange Act Release No. 54520
(September 27, 2006), 71 FR 57590 (September 29,
2006) (SR–NYSE–2006–65) (proposing to amend
several Exchange Rules to clarify certain definitions
and systemic processes (‘‘Omnibus Filing’’)).
8 Id.
9 See Omnibus Filing.
E:\FR\FM\12OCN1.SGM
12OCN1
]]>Agencies
[Federal Register Volume 71, Number 197 (Thursday, October 12, 2006)]
[Notices]
[Pages 60208-60216]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-16888]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-54577; File No. SR-NYSE-2006-36]
Self-Regulatory Organizations; New York Stock Exchange LLC; Order
Approving Proposed Rule Change and Amendment Nos. 1 and 2 Thereto To
Provide Floor Brokers With the Ability To Enter Discretionary
Instructions and/or Pegging Instructions With Respect to Floor Broker
Agency Interest Files (e-Quotes)
October 5, 2006.
I. Introduction
On May 16, 2006, the New York Stock Exchange LLC (``NYSE'' or
``Exchange'') filed with the Securities and Exchange Commission
(``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 provide floor brokers with the ability to enter
discretionary and pegging instructions with respect to their floor
broker agency interest files. On June 14, 2006 and July 11, 2006, NYSE
filed Amendment Nos. 1 \3\ and 2 \4\ to the proposed rule change,
respectively. The proposed rule change, as amended, was published for
comment in the Federal Register on July 21, 2006.\5\ The Commission
received six comment letters from three commenters.\6\ On September 13,
2006, the Exchange filed a response to the comment letters.\7\ This
order approves the proposed rule change, as amended.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ In Amendment No. 1, NYSE proposed additional changes and
clarifications to the proposal.
\4\ Amendment No. 2 supersedes and replaces the original rule
change and Amendment No. 1 in their entirety.
\5\ See Securities and Exchange Act Release No. 54150 (July 14,
2006), 71 FR 41496.
\6\ See Letters from George Rutherfurd, Consultant, dated June
22, 2006 (``Rutherfurd I''), August 3, 2006 (``Rutherfurd II'') and
September 21, 2006 (``Rutherfurd Letter III''); Warren Meyers,
President, Independent Brokers Action Committee, dated August 11,
2006 (``IBAC Letter''); and Junius W. Peake, Monfort Distinguished
Emeritus Professor of Finance, Kenneth W. Monfort College of
Business, dated August 18, 2006 (``Peake Letter I'') and October 3,
2006 (``Peake Letter II'').
\7\ See Letter from Mary Yeager, Secretary, NYSE, to Nancy
Morris, Secretary, Commission, dated September 13, 2006 (``Response
to Comments'').
---------------------------------------------------------------------------
II. Background
On March 22, 2006, the Commission approved NYSE's proposal to
establish a Hybrid Market, which will alter the Exchange's market
structure from a floor-based auction market with limited automated
order interaction to a more automated market with limited floor-based
auction market availability.\8\ To create its Hybrid Market, NYSE
changed its rules to permit its floor members to participate in the
market electronically. For example, specialists will have the ability
to manually and systematically place in a separate file (``specialist
interest file'') within the Display Book system \9\ their proprietary
interest at prices at or outside the Exchange best bid or offer
(``BBO''). In addition, specialists will establish algorithms
(``Specialist Algorithm'') \10\ to send messages via an Exchange-owned
application program interface to quote and trade for their proprietary
accounts.\11\
---------------------------------------------------------------------------
\8\ See Securities and Exchange Act Release No. 53539, 71 FR
16353 (March 31, 2006) (``Hybrid Market Order'').
\9\ The Display Book system (``Display Book system'') is an
order management and execution facility. The Display Book system
receives and displays orders to the specialists, contains the
customer limit order display book (``Book''), and provides a
mechanism to execute and report transactions and publish the results
to the Consolidated Tape. In addition, the Display Book system is
connected to a variety of Exchange systems for the purposes of
comparison, surveillance, and reporting information to customers and
other market data and national market systems, i.e., the Intermarket
Trading System, the Consolidated Tape Association, Consolidated
Quotation System, etc.
\10\ See NYSE Rule 104(b).
\11\ See NYSE Rule 104(e).
---------------------------------------------------------------------------
As approved in the Hybrid Market Order, floor brokers will
represent their customers' orders electronically in a separate file in
the Display Book system (``floor broker agency interest file'') at
multiple prices at or outside the Exchange BBO (``e-Quotes''). As
approved, e-Quotes can participate in automatic executions at the
Exchange BBO or outside the Exchange BBO during a sweep. E-Quotes may
not, however, initiate trades with incoming orders at prices better
than the Exchange BBO. Accordingly, the Exchange now proposes
additional changes that it believes will further replicate
electronically the manner in which floor brokers represent their
customers' orders on the floor. Specifically, NYSE proposes to provide
floor brokers with the ability to enter discretionary instructions as
to the size and/or price at which their e-Quotes may trade (``d-
Quotes'').\12\ In addition, the Exchange proposes to provide floor
brokers with the ability to set their e-Quotes and d-Quotes to peg to
the Exchange BBO so that their e-Quotes or d-Quotes would be available
for execution at the BBO as the Exchange BBO changes (``pegging'').
---------------------------------------------------------------------------
\12\ NYSE also refers to d-Quotes as ``discretionary e-Quotes''
in its proposed rule text.
---------------------------------------------------------------------------
[[Page 60209]]
III. Description of the Proposal
A. Proposed Discretionary Instructions for e-Quotes
The Exchange proposes NYSE Rule 70.25 to permit floor brokers to
enter discretionary instructions with respect to the size and/or price
at which the e-Quote would trade through the d-Quote functionality.\13\
Unlike e-Quotes, d-Quotes would provide floor brokers with the means to
express a price range within which they are willing to actively trade
at prices at or better than the BBO. The discretionary instructions
would relate to the price at which the d-Quote could trade and the
number of shares to which the discretionary price instructions would
apply.\14\
---------------------------------------------------------------------------
\13\ See proposed NYSE Rule 70.25(a)(i).
\14\ See proposed NYSE Rule 70.25(a)(i).
---------------------------------------------------------------------------
The discretionary instructions would only be active when the e-
Quote is at or joins the existing Exchange BBO or would establish a new
Exchange BBO.\15\ Furthermore, discretionary instructions would be
active for automatic executions only, and not active with respect to
the opening or closing transactions on the Exchange.\16\ NYSE would
also apply the discretionary instructions of a d-Quote only if all the
d-Quoting prerequisites are met; otherwise, the d-Quote would be
handled as a regular e-Quote (notwithstanding the fact that the floor
broker has designated the e-Quote as a d-Quote).\17\ For instance, to
qualify as a d-Quote, the e-Quote would be required to have a
discretionary price range.\18\ Furthermore, the floor brokers must
comply with the requirements for e-Quotes, as approved in the Hybrid
Market, with regard to d-Quotes, including the requirement that floor
brokers be present in the Crowd when they have placed interest in their
floor broker agency interest files.\19\
---------------------------------------------------------------------------
\15\ See proposed NYSE Rule 70.25(a)(ii).
\16\ See proposed NYSE Rule 70.25(a)(iii).
\17\ See proposed NYSE Rule 70.25(a)(iv). For example, if the d-
Quote is not at the Exchange BBO, it would not exercise its
discretionary instructions and accordingly, would function like an
e-Quote instead.
\18\ See proposed NYSE Rule 70.25(a)(iv).
\19\ See proposed NYSE Rule 70.25(a)(v).
---------------------------------------------------------------------------
Floor brokers would be permitted to have multiple d-Quotes, with
different price and size instructions, on the same side of the market.
Such multiple d-Quotes would not compete with each other for execution
priority; rather, the trading volume would be allocated by floor
broker, not the number of d-Quotes participating in an execution.\20\
Discretionary instructions would apply to both displayed and/or reserve
interest.\21\ The specialist on the floor and the Specialist Algorithm
would not have access to the discretionary instructions entered by
floor brokers with respect to their e-Quotes.\22\
---------------------------------------------------------------------------
\20\ See proposed NYSE Rule 70.25(a)(vi).
\21\ See proposed NYSE Rule 70.25(a)(vii).
\22\ See proposed NYSE Rule 70.25(a)(viii).
---------------------------------------------------------------------------
1. Discretionary Price Instructions
NYSE proposes to provide floor brokers with the ability to set a
discretionary price range within the Exchange BBO to designate the
prices at which their customers are willing to trade.\23\ The floor
brokers' e-Quote must be represented in the Exchange BBO for
discretionary pricing to be utilized. The price discretion set by the
floor broker would be used to initiate or participate in a trade with
an incoming order that is capable of trading at a price within the
Exchange BBO and the discretionary price range.\24\
---------------------------------------------------------------------------
\23\ See proposed NYSE Rule 70.25(b)(i).
\24\ See proposed NYSE Rule 70.25(b)(i). The minimum price range
for a d-Quote would be the minimum price variation set forth in NYSE
Rule 62, currently $0.01 for equity securities and $0.10 for equity
securities trading at a price of $100,000 or greater. See proposed
NYSE Rule 70.25(b)(ii) and NYSE Rules 62.10 and 62.20.
---------------------------------------------------------------------------
Floor brokers may also specify whether their discretionary price
instructions would apply to all or only a portion of their d-Quotes. If
price discretion is provided for only a portion of a d-Quote, the
residual would be treated as an e-Quote.\25\ Finally, when price
discretion is used, NYSE proposes that the shares executed from the d-
Quote be decremented from reserve size first, if any, and then from its
displayed size.\26\
---------------------------------------------------------------------------
\25\ See proposed NYSE Rule 70.25(b)(iii).
\26\ See proposed NYSE Rule 70.25(b)(iv).
---------------------------------------------------------------------------
2. Discretionary Size Instructions
In addition to discretionary price instructions, a floor broker may
enter discretionary size instructions. Discretionary size instructions
designate the portion of the e-Quote to which the discretionary price
instructions would apply.\27\ Floor broker may also specify a minimum
and/or maximum size of contra side volume with which it would be
willing to trade using price discretion.\28\
---------------------------------------------------------------------------
\27\ See proposed NYSE Rule 70.25(c)(i).
\28\ See proposed NYSE Rule 70.25(c)(ii). According to the
Exchange, this should allow for more specific order management by
preventing the d-Quote from trading with opposite side interest that
the floor broker has judged to be too little or too great in the
context of the order or orders it is managing.
---------------------------------------------------------------------------
NYSE proposes that its systems would only consider NYSE displayed
interest to determine whether the size of the contra side volume is
within the d-Quote's discretionary size range. Contra side reserve and
other interest at the possible execution price would not be
considered.\29\ Interest displayed by other market centers at the price
at which a d-Quote could trade would not be considered by Exchange
systems when determining if the d-Quote's minimum and/or maximum size
range is met, unless the Floor broker electronically designates that
such away volume should be included in this determination.\30\ Once the
total amount of a floor broker's discretionary volume has been
executed, the d-Quote's discretionary price instructions would become
inactive, and the remainder of such d-Quote would be treated as an e-
Quote.\31\
---------------------------------------------------------------------------
\29\ See proposed NYSE Rule 70.25(c)(iii). However, an increase
or reduction in the size associated with a particular price that
brings the contra side volume within a d-Quote's minimum/maximum
discretionary size parameter would trigger an execution of that d-
Quote. See proposed NYSE Rule 70.25(c)(v).
\30\ See proposed NYSE Rule 70.25(c)(iv).
\31\ See proposed NYSE Rule 70.25(c)(vi).
---------------------------------------------------------------------------
3. Executions of d-Quotes
NYSE stated that the goal of discretionary e-Quoting is to secure
the largest execution for the d-Quote, using the least amount of price
discretion. Accordingly, d-Quotes may improve the execution price of
incoming orders. However, if no discretion is necessary to accomplish a
trade, none would be used.\32\ In addition, future executions that
could occur, such as those resulting from the execution of elected
contra side CAP-DI orders, would not be considered in determining when,
and to what extent, price discretion would be necessary to accomplish a
trade.\33\
---------------------------------------------------------------------------
\32\ See proposed NYSE Rule 70.25(d)(i).
\33\ See proposed NYSE Rule 70.25(d)(i)(A).
---------------------------------------------------------------------------
Pursuant to the proposed rules, d-Quotes would automatically
execute against a contra side order that enters the Display Book
system, if the order's price is within the discretionary price range,
and the order's size meets any minimum or maximum size requirements
that have been set for the d-Quote.\34\ If there are multiple d-Quotes
from different floor brokers on the same side of the market with the
same discretionary price instructions, then such d-Quotes would trade
on parity, after interest entitled to priority is executed.\35\
Multiple d-Quotes from different floor brokers on the same side of the
market also would compete for an execution, with the most aggressive
price range establishing the execution price. If an incoming order
remains unfilled at that price, executions within the less aggressive
price range would
[[Page 60210]]
then occur.\36\ In addition, d-Quotes would compete with same-side
specialist algorithmic trading messages that seek to trade with
incoming orders.\37\ If the price of d-Quotes and specialist trading
messages are the same, d-Quotes and the specialist messages would trade
on parity.\38\
---------------------------------------------------------------------------
\34\ See proposed NYSE Rule 70.25(d)(ii).
\35\ See proposed NYSE Rule 70.25(d)(iii).
\36\ See proposed NYSE Rule 70.25(d)(iv).
\37\ See NYSE Rule 104(b). Specialists are limited in the
instances in which they may trade with incoming orders.
\38\ See proposed NYSE Rules 70.25(d)(v) and 104(c)(ix).
---------------------------------------------------------------------------
D-Quotes from floor brokers on the opposite sides of the market
could trade with each other. In these circumstances, the d-Quote that
arrived at the Display Book system last would use the most discretion
necessary to effect a trade.\39\ All executions involving d-Quotes must
comply with Rule 611 under Regulation NMS (``Reg. NMS'').\40\
Accordingly, when a protected bid or offer, as defined in Reg. NMS,\41\
is published by another market center at a price that is better than
the price at which contra side d-Quotes could trade, the amount of
discretion necessary to permit a trade on the Exchange that is
consistent with Rule 611 would be used, or such portion of the d-Quote
as is necessary would be automatically routed in accordance with Rule
611 in order to permit a trade to occur on the Exchange.\42\
---------------------------------------------------------------------------
\39\ See proposed NYSE Rule 70.25(d)(vi).
\40\ See Rule 611 of Reg. NMS, 17 CFR 242.611 and proposed NYSE
Rule 70.25(d)(vii).
\41\ See Rule 600(b)(57) of Reg. NMS, 17 CFR 242.600(b)(57).
\42\ See proposed NYSE Rule 70.25(d)(vi)(A).
---------------------------------------------------------------------------
D-Quotes also could provide price improvement to, and trade with,
an incoming contra side specialist algorithmic trading message to ``hit
bid/take offer,'' just as they could with any other marketable incoming
interest.\43\ D-Quotes may initiate sweeps in accordance with and to
the extent provided by NYSE Rules 1000-1004, but only to the extent of
their price and volume discretion. They also could participate in
sweeps initiated by other orders, but, in such cases, their
discretionary instructions would not be active.\44\ Finally, d-Quotes
would not trade at a price that would trigger a liquidity replenishment
point (``LRP''), as defined in NYSE Rule 1000.\45\ Accordingly, a sweep
involving a d-Quote would always stop at least one cent before an LRP
is reached.\46\
---------------------------------------------------------------------------
\43\ See proposed NYSE Rule 70.25(d)(viii).
\44\ See proposed NYSE Rule 70.25(d)(ix).
\45\ LRPs are pre-determined price points that would halt
automatic executions for varying periods depending on the price and
remaining size, if any, of an automatic execution order. See NYSE
Rule 1000. The Commission notes that NYSE has proposed to amend its
LRPs. See Securities Exchange Act Release No. 54520 (September 27,
2006), 71 FR 57590 (September 29, 2006).
\46\ See proposed NYSE Rule 70.25(d)(ix)(A).
---------------------------------------------------------------------------
B. Pegging
NYSE proposes to allow its floor brokers to enter instructions with
regard to their e-Quotes so that they would ``peg'' the Exchange BBO. A
pegging instruction may be added as a separate type of discretionary
instruction and may be active along with discretionary price
instructions. Specifically, under the proposed rules, a floor broker
could set an e-Quote, other than a tick-sensitive e-Quote, to be
available for execution at the Exchange best bid (for an e-Quote that
represents a buy order) or at the Exchange best offer (for an e-Quote
that represents a sell order) as the Exchange BBO changes, so long as
the Exchange BBO is at or within the e-Quote's limit price.\47\ A floor
broker could similarly employ pegging for its d-Quotes.\48\
---------------------------------------------------------------------------
\47\ See proposed NYSE Rule 70.26(i).
\48\ See proposed NYSE Rule 70.26(ii).
---------------------------------------------------------------------------
The Exchange proposes that pegging be active only when auto-quoting
is active.\49\ Pegging interest would trade on parity with other
interest at the BBO after the interest entitled to priority has been
executed. Pegging is reactive. Accordingly, a pegging e-Quote or d-
Quote would not establish the Exchange BBO as result of pegging,\50\
and therefore could not establish price priority by pegging. The
existence of pegging instructions, however, would not preclude an e-
Quote or d-Quote from having priority.\51\
---------------------------------------------------------------------------
\49\ See proposed NYSE Rule 70.26(iii). The Exchange represented
that this means when the Autoquote System is active. Telephone
conversation between Nancy Reich, Vice President, Office of the
General Counsel, NYSE, and Kelly Riley, Assistant Director, Division
of Market Regulation, Commission, on October 4, 2006.
\50\ See proposed NYSE Rule 70.26(v).
\51\ See proposed NYSE Rule 70.26(vi).
---------------------------------------------------------------------------
E-Quotes and d-Quotes with pegging instructions will only peg other
non-pegging interest.\52\ Further, an e-Quote or d-Quote would not be
able to sustain the Exchange BBO as a result of pegging, if there is no
other non-pegged interest at that price, and such price is not the e-
Quote's or d-Quote's limit price.\53\ Specifically, if the lowest
quotable price established by the floor broker for a pegging e-Quote or
d-Quote to buy is the Exchange best bid, and all other interest at that
price cancels or is executed, the pegging e-Quote or d-Quote would
remain displayed at that best bid price.\54\ Similarly, if the highest
quotable price established by the floor broker for a pegging e-Quote or
d-Quote to sell is the Exchange best offer and all other interest at
that price cancels or is executed, the pegging e-Quote or d-Quote would
remain displayed at that best offer price.\55\
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\52\ See proposed NYSE Rule 70.26(vii).
\53\ See proposed NYSE Rule 70.26(viii).
\54\ See proposed NYSE Rule 70.26(viii)(A).
\55\ See proposed NYSE Rule 70.26(viii)(B).
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Floor brokers may establish price ranges for an e-Quote or d-Quote,
beyond which the pegging function would not be available. Specifically,
the floor broker can set a ``quote price,'' which would be the lowest
price to which a buy e-Quote or d-Quote could peg or the highest price
to which a sell e-Quote or d-Quote could peg.\56\ The floor broker may
also set a ``ceiling price,'' which is the highest price to which a buy
side e-Quote or d-Quote could peg \57\ and a ``floor price,'' which is
the lowest price to which a sell side e-Quote or d-Quote could peg.\58\
The quote, ceiling, and floor price may be at a price other than the
limit price of the order being e-Quoted or d-Quoted, but may not be
inconsistent with the order's limit.\59\
---------------------------------------------------------------------------
\56\ See proposed NYSE Rule 70.26(ix)(A).
\57\ See proposed NYSE Rule 70.26(ix)(B).
\58\ See proposed NYSE Rule 70.26(ix)(C).
\59\ See proposed NYSE Rule 70.26(ix)(D).
---------------------------------------------------------------------------
Under the proposed rules, as long as the Exchange best bid (offer)
is at or within the pegging price range selected by the floor broker
with respect to a buy-side (sell-side) e-Quote or d-Quote, the pegging
e-Quote or d-Quote would join such best bid (offer) as it is auto
quoted.\60\ If the floor broker does not designate a pegging range, but
has instructed that its e-Quote or d-Quote should peg, the e-Quote or
d-Quote would peg to the Exchange best bid (offer) as long as such bid
(offer) is within the limit of the order that is being e-Quoted or d-
Quoted.\61\
---------------------------------------------------------------------------
\60\ See proposed NYSE Rule 70.26(x). See also note 49, supra.
\61\ See proposed NYSE Rule 70.26(xi).
---------------------------------------------------------------------------
Furthermore, as an e-Quote or d-Quote pegs, its discretionary price
range, if any, would move along with it, subject to any floor or
ceiling price set by the floor broker.\62\ In addition, if the Exchange
best bid is higher than the ceiling price of a pegging buy-side e-Quote
or d-Quote, the e-Quote or d-Quote would remain at its quote price or
the highest price at which there is other interest within its pegging
price range, whichever is higher (consistent with the limit price of
the order underlying the e-Quote or d-Quote).\63\ Similarly, if the
Exchange best offer is lower than the floor price of a pegging sell-
side e-Quote or d-Quote, the e-Quote or d-Quote would remain at its
[[Page 60211]]
quote price or the lowest price at which there is other interest within
its pegging price range, whichever is lower (consistent with the limit
price of the order underlying the e-Quote or d-Quote).\64\ However, if
the Exchange BBO returns to a price within the pegging price range
selected by the floor broker, the e-Quote or d-Quote would once again
peg to the Exchange BBO.\65\
---------------------------------------------------------------------------
\62\ See proposed NYSE Rule 70.26(xii).
\63\ See proposed NYSE Rule 70.26(xii)(A).
\64\ See proposed NYSE Rule 70.26(xii)(B).
\65\ See proposed NYSE Rule 70.26(xii)(C).
---------------------------------------------------------------------------
Finally, a floor broker may specify the minimum and/or maximum size
of same side volume to which its e-Quote or d-Quote would peg.\66\
Other pegging e-Quote or d-Quote volume would not be considered in
determining whether the volume parameters set by the floor broker have
been met.\67\
---------------------------------------------------------------------------
\66\ See proposed NYSE Rule 70.26(xiii).
\67\ See proposed NYSE Rule 70.26(xiii).
---------------------------------------------------------------------------
C. Other Proposed Changes
1. NYSE Rule 70.20
The Exchange also proposes to amend NYSE Rule 70.20(j)(i) to
specify that e-Quotes could participate in the closing trade, in
accordance with the policies and procedures of the Exchange and NYSE
Rule 70.20(k) to specify that during the close, a floor broker's
reserve interest, if any, would be added to the size of its e-Quoted
interest.
2. NYSE Rule 123(e)
The Exchange proposes to add certain required terms regarding e-
Quotes, d-Quotes, and pegging instructions as part of its Rule 123,
which requires the entry of certain order information into the
Exchange's Front End Systemic Capture System before such order can be
represented.
3. NYSE Rule 1000(d)
The Exchange proposes to amend NYSE Rule 1000(d)(iii)(A) to specify
that d-Quotes will participate in sweeps in the manner specified in
proposed NYSE Rule 70.25(d)(ix).
D. Implementation
As explained in the Response to Comments, NYSE proposes to
implement the proposal in Phases 3 and 4 of the Hybrid Market in two
parts.\68\ The first part, which would be implemented as part of Phase
3 of the Hybrid Market, would provide the pegging and d-Quote
functionality with respect to the ability to trade with marketable
orders. The second part, which would provide the d-Quote functionality
with opposite-side interest anywhere in its discretionary range, is
scheduled for implementation in Phase 4 of the Hybrid Market. Phase 3
is currently scheduled to commence on or about October 6, 2006 and is
expected to be completed in early-December 2006. Phase 4 is expected to
begin in December 2006, immediately following the completion of Phase
3.
---------------------------------------------------------------------------
\68\ See Response to Comments.
---------------------------------------------------------------------------
IV. Summary of Comments
The Commission received a total of six comment letters from three
commenters on the proposed rule change \69\ and NYSE filed the Response
to Comments.\70\ One commenter generally supported NYSE's proposal.\71\
The other two commenters did not support the proposal and raised
specific concerns about the proposal.
---------------------------------------------------------------------------
\69\ See supra note 6.
\70\ See supra note 7.
\71\ See IBAC Letter.
---------------------------------------------------------------------------
One commenter argued that the proposal raises significant market
structure issues because he believes that it will allow hidden orders
to compete directly with transparent market interest.\72\ This
commenter argues that the proposal would allow hidden order
trading,\73\ which makes the markets less transparent to those who seek
liquidity and denies executions to those who post liquidity. Further,
the commenter argued that hidden order trading would render meaningless
the notion of published quotes or the national best bid/offer
(``NBBO'') because of the existence of hidden immediately executable
market interest available between the published quote. The commenter
believes that these results are inconsistent with the principles of
Section 11A of the Act \74\ and the Commission's Reg. NMS in that they
compromise the notion that a fully transparent market is the fairest
for all investors.\75\ This commenter also argued that the d-Quote
proposal would hinder the price discovery process. By hiding interest
willing to trade at a specified price, investors will not be able to
make fully informed pricing decisions for their orders.
---------------------------------------------------------------------------
\72\ See Rutherfurd Letter I.
\73\ The commenter disagrees with the NYSE's classification of
d-Quotes as discretionary order instructions. The commenter argues
that d-Quotes are actually conditional limit orders that will be
automatically and immediately executed upon the satisfaction of the
specified terms entered by the floor broker. See also Peake Letters
I and II.
\74\ 15 U.S.C. 78k-1.
\75\ This commenter urges the Commission to issue a concept
release on hidden order trading to consider the implications on
market transparency, published quotations, public limit order
protection, and price discovery processes. See Rutherfurd Letter I.
---------------------------------------------------------------------------
The commenter disagreed with NYSE's representation that the
proposal replicated the manner in which floor brokers act on behalf of
their customers in the physical auction market.\76\ The commenter
acknowledged that floor brokers have always provided in-between-the-
published-quote executions on the floor but that in the physical
auction, the decision of the floor broker to participate in an
execution is made on a trade-by-trade basis after contra side orders
arrive in the crowd. The commenter argued that in the auction
``everything is transparent.'' \77\ While floor brokers may hold
discretionary orders that are not known to the public, these orders are
not active until the floor broker makes a public bid (offer) that is
known to all in the trading crowd. After a floor broker makes its bid
(offer) public in the crowd, other brokers or the specialist can
compete by bidding higher (offering lower). Thus, the commenter argued,
``everything is transparent, as the previously `hidden' discretionary
order must be disclosed prior to the trade, and even after it is
disclosed, is not guaranteed an opportunity to trade if competing
market participants then bid higher (offer lower).'' \78\
---------------------------------------------------------------------------
\76\ See Rutherfurd Letters I and III.
\77\ See Rutherfurd Letter III.
\78\ Id.
---------------------------------------------------------------------------
According to the commenter, the d-Quote, however, would allow floor
brokers to enter into an automated system better prices that are always
available for immediate execution and because they are not disclosed,
other market participants are not able to compete with them to provide
an even better priced execution. The commenter argues that the proposal
gives floor brokers a time/place advantage because they can react to
what is placed in the Book. The commenter believes that this time/place
advantage is more troubling than what floor members on the Exchange
currently possess because it is not mitigated by transparency at the
point of sale like it is in the current auction market.\79\ Finally,
the commenter noted investors do not enjoy the same informational
benefit of knowing the prices at which floor brokers' customers are
willing to trade. If they did, the commenter argued, they would be able
to make the decision of how to price their own orders and thus, would
be able to compete with the floor brokers' customers.
---------------------------------------------------------------------------
\79\ See Rutherfurd Letters I and III.
---------------------------------------------------------------------------
The commenter also argues that the proposal was inconsistent with
Sections 6(b)(5) \80\ and 11A \81\ of the Act.\82\ The commenter argues
that by giving floor brokers the exclusive ability to enter
[[Page 60212]]
discretionary instructions, the NYSE proposal is inconsistent with
Section 6(b)(5) of the Act, which states that an exchange's rules
cannot be designed to ``permit unfair discrimination between customers,
issuers, brokers or dealers * * *'' \83\ In addition, the commenter
argues that by requiring members to use floor brokers to enter
discretionary instructions, the proposal is inconsistent with Section
11A(a)(1)(C)(i) of the Act,\84\ which reflects Congress' belief that it
is in the public interest and appropriate for the protection of
investors and the maintenance of a fair and orderly market to assure
the ``economically efficient execution of securities transactions.''
This commenter argued that NYSE's proposal is a ``direct impediment to
economically efficient execution of securities transactions'' because
upstairs members can, and should be permitted to, exercise their own
judgment and put discretionary instructions on their own orders without
having to incur the significant additional expense of using a floor
broker. This commenter believes that floor brokers will merely perform
a clerical function of inputting an order with specific conditions and
that the NYSE systems will thereafter represent and execute the order.
---------------------------------------------------------------------------
\80\ 15 U.S.C. 78f(b)(5).
\81\ 15 U.S.C. 78k-1.
\82\ See Rutherfurd Letters I, II and III.
\83\ The commenter also argues that the proposal is
anticompetitive because it benefits one class of market participants
(floor brokers) at the expense of other market participants. See
Rutherfurd Letter III. See also Peake Letter II. Another commenter
argues that all market participants should have access to the
``national market system.'' See Peake Letter I.
\84\ 15 U.S.C. 78k-1(a)(1)(C)(i).
---------------------------------------------------------------------------
The commenter disagreed with NYSE's representation that the
proposal would give floor brokers a means to compete with specialists'
algorithmic trading and quoting. The commenter believes that specialist
algorithmic trading on parity with interest represented by floor
brokers is inconsistent with Section 11A of the Act \85\ and argues the
floor broker d-Quotes do not rectify this problem with specialist
trading in the Hybrid Market. Specifically, the commenter cites Section
11A(a)(1)(C)(v) of the Act,\86\ which reflects Congress' belief that
investors' orders should have the opportunity to be executed without
the participation of a dealer.\87\
---------------------------------------------------------------------------
\85\ 15 U.S.C. 78k-1.
\86\ 15 U.S.C. 78k-1(a)(1)(C)(v).
\87\ See Rutherfurd Letter I. See also Peake Letter II. The
commenter also argues that specialists trading on parity with
investors' orders represented by floor brokers is inconsistent with
the specialists' negative obligation. See Rutherfurd Letter I.
---------------------------------------------------------------------------
Another commenter argued that floor brokers should continue to be
allowed to object to specialists' trading on parity when opening or
increasing a position, in order to closely replicate the present
auction market.\88\ Finally, this commenter urged that d-Quotes and
specialist algorithms be phased-in together.
---------------------------------------------------------------------------
\88\ See IBAC Letter. See also Rutherfurd Letter III (stating
that if the specialist is permitted to trade on parity, the
Commission should demand that NYSE allow a floor broker objection
mechanism in the Hybrid Market so that floor brokers could protect
the public).
---------------------------------------------------------------------------
NYSE's Response
NYSE believes that its proposal does replicate the manner in which
floor brokers represent customer orders in the current auction market.
Specifically, NYSE believes that d-Quotes are necessary to ensure that
floor brokers are able to perform a function similar to that which they
perform today as the markets become faster and more automated. NYSE
believes that the proposal should allow floor brokers to electronically
replicate the order management decisions they make regarding the
representation of customer orders. According to NYSE, investors that
use floor brokers would not be able to access the market in the manner
they do today. NYSE argues that the proposed discretionary instructions
and pegging ability will allow floor brokers to use their judgment and
expertise in managing their customers' orders in a faster, automated
market.
In response to the comment that d-Quotes would negatively impact
price discovery and provide informational advantages to floor brokers,
NYSE noted that d-Quote function is similar to proposals by other
markets that permit non-displayed orders that trade between the
quote.\89\ Furthermore, NYSE believes that d-Quotes would replicate
that which occurs in the manual auction market and would not provide
more or less information than is currently available in the Exchange's
market. According to NYSE, the d-Quote is ``as transparent as any other
floor broker-represented order that is not fully displayed in
accordance with long established trading practices, SEC rules and
regulations and NYSE rules and regulations.'' Because the Hybrid Market
would continue to involve the interaction of floor brokers representing
their customer's orders, limit orders on the Display Book system, and
the specialist's dealer interest, NYSE believes that the price
discovery mechanism would continue to exist. NYSE argues that d-Quotes
would ``merely enhance the ability of floor brokers to effectively
represent their customers' orders in the automated portion of the
Hybrid Market'' and they do not replace order interaction or the price
discovery process.\90\
---------------------------------------------------------------------------
\89\ NYSE believes that these types of orders were approved in
response to market participants' preference for order and customer
anonymity, despite the typical argument that such anonymity could be
detrimental to other market participants. See Response to Comments.
But see Rutherfurd Letter III (arguing that NYSE is not replicating
hidden order (reserve) trading that is conducted in other markets).
\90\ But see Rutherfurd Letter III. Disagreeing with NYSE's
response, this commenter argued that floor broker and specialist
interest could not promote price discovery when such interest is
entirely hidden.
---------------------------------------------------------------------------
In response the commenter's suggestion that d-Quotes would create
price uncertainty, NYSE also believes that d-Quotes would provide
investors with a better opportunity for price improvement and would
moderate volatility by providing liquidity and better price
continuity.\91\ NYSE believes that d-Quotes would attract liquidity
from incoming orders seeking the opportunity for a better priced and/or
larger sized transaction that could result from an increase in
competition between specialists and other floor brokers' d-Quotes.\92\
---------------------------------------------------------------------------
\91\ See Response to Comments. But see Rutherfurd Letter III.
This commenter objected to NYSE's position that d-Quotes would
provide increased opportunities for price improvement, arguing
instead that the e/d-Quote ``overhangs'' the market and is pre-
programmed to trade automatically. The commenter claims, therefore,
that the e/d-Quote is, in actuality, the ``real'', non-discretionary
NYSE market that is willing to trade at such hidden price. Rather
than receiving price improvement, the incoming order is merely
receiving an execution at the real, pre-existing NYSE price.
\92\ But see Rutherfurd Letter III (arguing that e/d-Quotes
could not attract liquidity or enhance competition when they are
hidden).
---------------------------------------------------------------------------
With respect to the concern that d-Quotes would create an ``unlevel
informational playing field,'' NYSE noted while investors that use
floor brokers would gain the benefits of d-Quotes, the d-Quotes do not
create an unequal or unfair advantage for any market participant. NYSE
pointed out that specialists and their algorithms would not know about
any discretionary instructions, and floor brokers would have access
only to information about their own agency interest, not to other
broker's files.\93\ NYSE refuted one commenter's suggestion that limit
orders on the Book would have access to less information as a result of
d-Quotes by representing that investors entering limit orders would be
privy to the same information as is currently available to them, which,
NYSE points out, does not presently include knowledge of a floor
broker's decisions
[[Page 60213]]
regarding order management, until after such decisions are affected.
---------------------------------------------------------------------------
\93\ NYSE also indicated that neither the specialist on the
floor nor the specialist algorithmic trading system would have
access to any of the discretionary instructions entered by the floor
broker in connection with the d-Quotes. See Response to Comments.
---------------------------------------------------------------------------
With respect to the commenters' implication that d-Quotes would
disadvantage limit orders on the Book by denying executions to those
who post liquidity, NYSE responded that the principles of priority and
parity at the NYSE BBO would not be changed with the introduction of
the d-Quote.\94\ Accordingly, a limit order with priority at the BBO on
the same side of the d-Quote would trade first in any execution at the
quote. Furthermore, NYSE stated that d-Quotes would not force nor cause
limit orders to accept different or worse prices than what their limits
dictate. NYSE explained that because discretionary pricing would allow
d-Quotes to trade at prices in between the quote where there are no
public limit orders, d-Quotes would provide price improvement to an
incoming order capable of trading at such better price and would not
negatively impact the limit order displayed at a worse price. If the
commenter was implying that the person entering the limit order would
have entered his or her limit order at the better price had he or she
known there were other market participants interested in trading at
such price, NYSE responded that nothing prevented the limit order from
being entered at such better price at the outset.\95\ Furthermore, NYSE
believes that nothing in the securities laws or Exchange rules require
that every market participant fully disclose their interest at the best
price possible; instead, customers are permitted to choose from a
variety of options, including the order management provided by floor
brokers.
---------------------------------------------------------------------------
\94\ See Response to Comments.
\95\ But see Rutherfurd Letter III (arguing that participants
entering public limit orders could only react to publicly available
information).
---------------------------------------------------------------------------
In response to commenters' suggestion that floor brokers should
retain the right to exclude specialists from trading on parity when
increasing a position with respect to automatic executions, NYSE noted
that this provision was approved in the Hybrid Market Order. To the
extent that floor brokers wish to prevent specialists from trading on
parity with their orders in the Hybrid Market, NYSE stated that floor
brokers could send those orders for execution through SuperDot.\96\ In
response to a commenter's objection to NYSE's proposal to deactivate
the discretionary instructions of a d-Quote during a sweep that is
initiated by other orders,\97\ NYSE stated that this amendment
recognizes that when a d-Quote is participating in a sweep, as opposed
to initiating a sweep, employing the discretionary pricing instructions
of the d-Quote would not provide additional value to the customer being
d-Quoted.\98\
With regard to the comments on the Exchange's proposed
implementation schedule,\99\ NYSE acknowledged that, given the
complexity of the software developed for the d-Quote functionality and
the extensive system changes required to enable increased automatic
execution capabilities, it has not been able to launch all of these
initiatives at the same time.\100\ NYSE explained that floor brokers
had requested the d-Quoting functionality well after the design of e-
Quoting was completed and the necessary programming changes were
scheduled. As a result, d-Quoting was initially slated for
implementation as part of the last phase of the Hybrid Market. However,
in response to requests from floor brokers, NYSE claimed that it has
made every effort to move d-Quote implementation forward as much as
possible. In addition, NYSE stated that it would be adding to the
upcoming software releases a number of other changes recently requested
by floor brokers, designed to improve the efficiency of the devices
they use to access the market. Furthermore, NYSE maintained that the
rollout of d-Quotes is timed to a program that provides ample training
and trading practice for floor brokers using the new functionality.
Accordingly, NYSE believes that the sheer volume of system and other
required software changes, coupled with the need for appropriate
training, mandates that the Exchange implement d-Quoting in two
parts.\101\ Finally, NYSE believes that the phase-in process would be
sensitive to the varied needs of all market participants affected by
the introduction of these complex changes, and that thorough and proper
broker training and preparation for the d-Quote is essential, as it
protects the broker from making unintended trading errors.
---------------------------------------------------------------------------
\96\ NYSE believes this solution was supported by floor brokers
who worked with the Exchange in designing the e-Quote. See Response
to Comments. But see Rutherfurd Letter III (arguing that NYSE's
response is not providing a feasible means for a floor broker to
protect its public customer from unnecessary specialist competition
since, as a practical matter, floor brokers would not be able to
participate in the Hybrid Market if they were to send their orders
through SuperDot).
\97\ See IBAC Letter.
\98\ See Response to Comments.
\99\ See IBAC Letter.
\100\ See Response to Comments.
\101\ See Section III., D. for a complete discussion of the two-
part implementation.
---------------------------------------------------------------------------
V. Discussion
After careful review and consideration of the comments, the
Commission finds that the proposed rule change, as amended, is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities exchange
and, in particular, with the requirements of Section 6(b) of the
Act.\102\ Specifically, the Commission finds that approval of the
proposed rule change, as amended, is consistent with Section 6(b)(5) of
the Act \103\ in that the proposal is designed to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general, to
protect investors and the public interest. Further, the Commission
believes that the proposed rule change, as amended, is consistent with
Section 11A(a)(1)(C) of the Act,\104\ in which Congress found that it
is in the public interest and appropriate for the protection of
investors and the maintenance of fair and orderly markets to assure:
(1) Economically efficient execution of securities transactions; (2)
fair competition among brokers and dealers and among exchange markets,
and between exchange markets, and markets other than exchange markets;
(3) the availability to brokers, dealers, and investors of information
with respect to quotations and transactions in securities; (4) the
practicability of brokers executing investors' orders in the best
markets; and (5) an opportunity for investors' orders to be executed
without the participation of a dealer.
---------------------------------------------------------------------------
\102\ 15 U.S.C. 78f(b). In approving this proposal, the
Commission has considered the proposed rules' impact on efficiency,
competition, and capital formation. 15 U.S.C. 78c(f).
\103\ 15 U.S.C. 78f(b)(5).
\104\ 15 U.S.C. 78k-1(a)(1)(C).
---------------------------------------------------------------------------
Currently in the NYSE auction, floor brokers represent their
customers' orders for execution. For many orders, floor brokers have
discretion to determine the price at which their customers' orders
should be executed, subject to their agency obligations and best
execution requirements. As the NYSE market becomes more automated, NYSE
and its floor brokers have considered how floor brokers can continue to
represent their customers in a meaningful fashion. NYSE continues to
believe that its physical auction on the floor will play an important
role in
[[Page 60214]]
its market even as automated execution expands.
In the Hybrid Market, as approved, NYSE made provisions to allow
its floor brokers to represent their customers in the electronic
portion of the market. NYSE, however, also placed restrictions on their
activities to reflect the continued role of the auction on the floor.
Specifically, NYSE requires its floor brokers to be in the ``Crowd''
when representing customers electronically so that they can be
available to represent their customers should the market move to the
floor.
With this current proposal, NYSE proposes to give floor brokers
more tools with which to represent their customers. NYSE represents
that the discretionary instructions that it has proposed are intended
to replicate the manner in which floor brokers represent orders in the
auction. In addition, NYSE stated that d-Quotes will enable floor
brokers to compete with other participants in an automated market
place, including specialists, and may enhance the quality of order
execution on the Exchange.
As discussed above, d-Quotes will enable floor brokers to place
within the Display Book system, in a manner that is not displayed, the
prices and sizes at which their customers are willing to trade if a
contra side order arrives in the market. The d-Quote could enable floor
brokers to better compete with other market participants, and possibly
enhance the quality of order execution on the Exchange. The Commission
believes that the Exchange's proposed d-Quote functionality is broadly
consistent with the requirements of the Act, and within the realm of
business judgment generally left to the discretion of individual
markets.
The pegging function will enable floor brokers to remain in the
Exchange BBO as the quote moves. As the markets become more electronic
it may be very difficult for a floor broker to effectively manually
adjust the prices of its customers' orders in the Display Book system.
The Commission believes that the proposed pegging function should
provide floor brokers with the ability to track the quote as it
changes, thereby providing floor brokers with an additional tool to
offer liquidity at the Exchange BBO, once the Exchange shifts from the
manual auction market to a faster, predominantly electronic market. The
pegging function also is designed to help them continuously meet one of
the requirements for using the d-Quote--namely, maintaining an e-Quote
at the NYSE BBO. Accordingly, the Commission finds that the proposal to
implement a pegging function for floor brokers is consistent with the
requirements of the Act.
A. Comments
1. Transparency
One commenter argued that the proposal would have an adverse impact
on transparency because the discretionary instructions would not be
disclosed to the public. The commenter argued that by not disclosing d-
Quotes to the public, the Exchange was making its market less
transparent to investors who seek liquidity and would be denying
executions to investors who post liquidity. According to the commenter,
the proposal would lessen incentives to post liquidity by allowing d-
Quotes to trade despite the existence of displayed limit orders.
The commenter also argued that the lack of transparency of the d-
Quotes would negatively impact the price discovery process by lessening
the usefulness of the NBBO. The commenter argued that investors would
be denied complete information about the current state of the prices
and sizes at which other investors are willing to trade. Unlike the
current auction where, according to the commenter, only interest that
is disclosed is permitted to participate in an execution, d-Quotes will
participate in an execution if their terms are fulfilled without
disclosure to other market participants who may be willing to trade at
the same or better price.
The Commission notes that it has never required complete disclosure
of all trading interest, and that it has permitted the use of
undisplayed order types. Today, for example, floor brokers may hold
significant trading interest that may be available for execution that
is not broadly disclosed, but that may participate in a transaction on
the Exchange.
NYSE has proposed a means by which floor brokers can continue to
represent customers without having to disclose the customers' entire
orders. Floor brokers will be able to adjust their d-Quotes to reflect
their customers' investment strategies.
The Commission believes that NYSE has designed its proposal to
allow floor brokers to represent their customers in a manner similar to
how they operate in the auction market. The Commission believes that
the proposal is not likely to substantially reduce transparency because
these orders are not currently displayed. The Commission also notes
that it has approved similar undisplayed order types for use by other
markets.\105\ Accordingly, the Commission finds that the proposal is
consistent with the Act.
---------------------------------------------------------------------------
\105\ See Securities Exchange Act Release Nos. 47467 (March 7,
2003), 68 FR 12134 (March 13, 2003) (approving pegging orders in
Pacific Exchange, Inc.) and 48798 (November 17, 2003), 68 FR 66147
(November 25, 2003) (approving pegging orders in Nasdaq Stock
Market, Inc.); and 44983 (October 25, 2001), 66 FR 55225 (November
1, 2001) (approving discretionary orders in Pacific Exchange, Inc.)
and 49085 (January 15, 2004), 69 FR 3412 (January 23, 2004)
(approving discretionary orders in Nasdaq Stock Market, Inc.). See
also Securities Exchange Act Release No. 54511 (September 26, 2006),
71 FR 58460 (October 3, 2006) (approving passive liquidity order in
NYSE Arca, Inc.).
---------------------------------------------------------------------------
2. Informational Advantages for Floor Brokers
In the proposal, the Exchange states that it is intending to
replicate, in the Hybrid Market, the manner in which floor brokers
utilize their judgment in quoting and trading on behalf of their
customers' orders in the auction market. One commenter questions
whether the proposal actually replicates the auction market.\106\ The
commenter believes that the proposal would introduce a new manner of
trading that is unfair to public limit orders and provides
informational advantages to floor brokers. The commenter believes that
the proposal would replicate the time and place advantage enjoyed by
floor brokers in the auction market, without maintaining the
counterbalance of the auction market's transparency of bids and offers,
and the requirement that orders cannot trade before they are exposed to
the market. Further, the commenter argued that floor brokers could
enter their d-Quotes with full knowledge of the public limit orders,
while public investors would not be provided reciprocal knowledge of
the d-Quotes. Thus, the commenter believes that public investors are
inappropriately denied the ability to change their limit prices in
response to the trading instructions attached to d-Quotes.
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\106\ See Rutherfurd Letters I and III.
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In the Response to Comments, the Exchange noted that, without d-
Quotes, investors that use floor brokers to represent their orders
would not be able to access the Hybrid Market in a similar manner to
which they access the auction market today. The Exchange believes that
it designed the proposal to closely replicate the auction market in an
electronic environment.
Further, the Exchange responds that in today's auction market,
orders that are held and represented by floor brokers are not
transparent. The Exchange represented that it designed the proposal to
permit floor brokers to make the same types of trading decisions for
the orders they hold in the Crowd today. The Exchange believes the
[[Page 60215]]
proposal would not substantially alter the amount of information
currently available on the Exchange. Specialists and floor brokers
would not have access to information about d-Quotes entered by other
floor brokers. The Exchange also stated that public investors entering
limit orders would have the same amount of information as is currently
available, which does not include knowledge of floor broker trading
interest. Likewise, floor brokers would not have any more market
information on the Exchange than they do today.
Accordingly, the Commission does not believe that the proposal
would provide floor brokers with an inappropriate informational
advantage or reduce the amount of information that is currently
publicly available.
3. Section 11A of the Act
One commenter argued that the proposal was inconsistent with
Section 6(b) of the Act and Section 11A(a)(1)(C)(i) of the Act \107\
because the commenter believes that the proposal is unfairly
discriminatory and anti-competitive.\108\ Specifically, the commenter
argues that because the proposal would provide floor brokers with an
exclusive right to enter d-Quotes, the proposal unfairly discriminates
against customers who do not use floor brokers, and places a burden on
competition that is not necessary in furtherance of the purposes of the
Act. Further, the commenter argues that the proposal inhibits the
economically efficient execution of orders, which Section
11A(a)(1)(C)(i) of the Act \109\ states is a goal of the national
market system. The commenter notes that, under the proposal, investors
who seek to utilize discretionary instructions would be forced to pay a
floor broker, who the commenter argues, then merely performs the
clerical function of entering the order into the Exchange system for
execution. The commenter believes that institutional investors should
be free to exercise their own judgment without the requirement to
employ any third parties. The commenter also noted that all market
participants should have a fair opportunity to trade and trading should
not be conducted with unnecessary human intervention.
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\107\ 15 U.S.C. 78k-1(a)(1)(C)(i).
\108\ See Rutherfurd Letters I and III.
\109\ 15 U.S.C. 78k-1(a)(1)(C)(i).
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The Commission notes that today if investors wish to have their
orders represented in the NYSE auction market, they must either send
their order to the Book for representation by a specialist or send
their order to a floor broker for representation.\110\ In the Hybrid
Market, NYSE has decided to retain a role for its floor members in its
market. The commenter stated that he believed that ``pure electronic
trading is not only defensible but highly desirable'' and thus, appears
to fundamentally disagree with the market structure that NYSE has
developed. However, Congress clearly contemplated that the markets
should be able to compete through the adoption of different market
models.\111\
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\110\ Small marketable limit orders can be automatically
executed in Direct+.
\111\ As Congress noted when it adopted the 1975 Act Amendments
that it was ``not the intention of the bill to force all markets for
all securities into a single mold.'' See S. Rep. No. 94-75, 94th
Cong., 1st Sess. 7 (1975). Congress instructed the Commission to
seek to ``enhance competition and to allow economic forces,
interacting with a fair regulatory field, to arrive at appropriate
variation in practices and services. It would obviously be contrary
to this purpose to compel elimination of differences between types
of markets or types of firms that might be competition-enhancing.
Id.
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NYSE has sought to replicate its current market in a more
electronic manner, yet while retaining some distinctive features of its
floor. As the Commission indicated in the Hybrid Market Order, the
Exchange has a degree of flexibility to develop its market model so
long as it does so within the framework of the Act.
The Commission believes that the proposal is broadly consistent
with Section 11A of the Act in that it incorporates features that may
provide investors with the opportunity to receive economically
efficient execution of their securities transactions and promote fair
and orderly markets.\112\ The Commission believes that while d-Quotes
would not be displayed, they could provide benefits to the market such
as increased liquidity and improved prices. The Commission notes that
undisplayed d-Quotes would never execute ahead of a displayed order
that is at the same or better price.
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\112\ 15 U.S.C. 78k-1.
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A significant feature of the d-Quote is to potentially offer public
investors a means, through the use of floor brokers, to compete with
specialists in providing price improvement to incoming marketable
orders. The Commission believes that d-Quote could provide meaningful
competition to the specialist in providing price improvement, and thus
promote competition on the Exchange floor.
Accordingly, the Commission does not believe that the proposal is
inconsistent with Section 11A of the Act.\113\
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\113\ 15 U.S.C. 78k-1.
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4. Sweeps
In the Hybrid Market, once an auto ex order trades with interest at
the Exchange BBO, the remainder, if any, would automatically sweep the
Display Book system by trading with liquidity outside the BBO. Under
the proposal, d-Quotes could also participate in sweeps initiated by
other orders, but their discretionary instructions would not be
active.\114\ O
