Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing and Order Granting Accelerated Approval to Proposed Rule Change, as Amended, Relating to Exchange Rule 104.10 (“Dealings by Specialists”), 71221-71230 [E6-20886]

Download as PDF Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–NYSE–2006–104 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, Station Place, 100 F Street, NE., Washington, DC 20549–1090. SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54860; File No. SR NYSE– 2006–76] Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing and Order Granting Accelerated Approval to Proposed Rule Change, as Amended, Relating to Exchange Rule 104.10 (‘‘Dealings by Specialists’’) December 1, 2006. I. Introduction On September 22, 2006, the New York Stock Exchange LLC (‘‘NYSE’’ or ‘‘Exchange’’) filed with the Securities All submissions should refer to File and Exchange Commission Number SR–NYSE–2006–104. This file (‘‘Commission’’), pursuant to Section number should be included on the 19(b)(1) of the Securities Exchange Act subject line if e-mail is used. To help the of 1934 (‘‘Act’’) 1 and Rule 19b–4 Commission process and review your thereunder,2 a proposed rule change to comments more efficiently, please use amend specialist stabilization only one method. The Commission will requirements set forth in NYSE Rule post all comments on the Commission’s 104.10 (‘‘Dealings by Specialists’’). The proposed rule change was published for Internet Web site (https://www.sec.gov/ comment in the Federal Register on rules/sro.shtml). Copies of the September 28, 2006.3 The Commission submission, all subsequent received five comment letters 4 from one amendments, all written statements commenter and two comment response with respect to the proposed rule letters from NYSE.5 On October 25, change that are filed with the 2006, NYSE filed Amendment No. 1 to Commission, and all written the proposed rule change.6 This notice communications relating to the and order approves the proposed rule proposed rule change between the change, as modified by Amendment No. Commission and any person, other than 1, on an accelerated basis.7 those that may be withheld from the II. Description of the Proposal public in accordance with the provisions of 5 U.S.C. 552, will be NYSE Rule 104 governs specialist available for inspection and copying in dealings and includes, among other the Commission’s Public Reference things, restrictions upon specialists’ Room. Copies of such filing also will be ability to trade as a dealer in the stocks available for inspection and copying at in which he or she is registered. Under the principal office of NYSE. All NYSE Rule 104(a), specialists are not permitted to effect transactions on the comments received will be posted Exchange for their proprietary accounts without change; the Commission does in any security in which the specialist not edit personal identifying information from submissions. You 1 15 U.S.C. 78s(b)(1). should submit only information that 2 17 CFR 240.19b–4. you wish to make available publicly. All 3 See Securities Exchange Act Release No. 54504 submissions should refer to File (September 26, 2006), 71 FR 57011 (‘‘Stabilization Number SR–NYSE–2006–104 and Proposal’’). 4 See letters from George Rutherfurd to the should be submitted on or before Commission, dated October 11, 2006 (‘‘Rutherfurd December 29, 2006. sroberts on PROD1PC70 with NOTICES For the Commission, by the Division of Market Regulation, pursuant to delegated authority.13 Florence E. Harmon, Deputy Secretary. [FR Doc. E6–20885 Filed 12–7–06; 8:45 am] BILLING CODE 8011–01–P 13 17 CFR 200.30–3(a)(12). VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 Letter I’’); October 20, 2006 (‘‘Rutherfurd Letter II’’); October 26, 2006 (‘‘Rutherfurd Letter III’’); November 2, 2006 (‘‘Rutherfurd Letter IV’’); and November 14, 2006 (‘‘Rutherfurd Letter V’’). 5 See letters from Mary Yeager, Assistant Secretary, NYSE, to Nancy M. Morris, Secretary, Commission, dated November 6, 2006 (‘‘NYSE Letter I’’) and November 29, 2006 (‘‘NYSE Letter II’’). 6 For a description of Amendment No. 1, see Section II.D., infra. 7 The proposed rule change, as amended by Amendment No. 1, was approved on a temporary, pilot basis in File No. SR–NYSE–2006–82. See Securities Exchange Release No. 54578 (October 5, 2006), 71 FR 60216 (October 12, 2006) (‘‘Phase 3 Pilot’’). PO 00000 Frm 00102 Fmt 4703 Sfmt 4703 71221 is registered, ‘‘unless such dealings are reasonably necessary to permit such specialist to maintain a fair and orderly market * * *’’ This restriction is known as the ‘‘negative obligation.’’ In particular, NYSE Rules 104.10(5) and (6) expand upon the negative obligation with regard to specific types of proprietary transactions. These sections further define the instances when a specialist is restricted in his or her ability to trade in relation to the direction of the market. A. Current Specialist Stabilization Rules Specifically, current NYSE Rule 104.10(5)(i) provides that specialist proprietary transactions are to be effected in a reasonable and orderly manner in relation to the general market, the market in a particular stock, and the adequacy of the specialist’s position to the immediate and reasonably anticipated needs of the market. The rule further provides that, unless it is to render the specialist’s position in a stock adequate for current or reasonably anticipated needs of the market, a specialist should not effect a non-stabilizing transaction (i.e., a transaction with the trend of price movement) for the specialist’s account when acquiring or increasing a position. In this regard, the rule restricts specialists from purchasing stock at a price above the last sale (in the same trading session) and purchasing more than 50% of the stock offered on a ‘‘zero plus tick,’’ i.e., at the same price as the last sale, when such last sale price was higher than the previous, differently priced sale in the stock on the Exchange. Specialists are, however, permitted to effect these types of transactions with Floor Official approval or in less active markets where such transactions are an essential part of a proper course of dealings and where the amount of stock involved and the price change, if any, are normal in relation to the market. NYSE Rule 104.10(6) sets forth the specialist’s stabilization requirements when liquidating or reducing a position. This rule provides that such trades should be effected in a reasonable and orderly manner in relation to the condition of the general market, the market in the particular security, and the adequacy of the specialist’s position to meet the immediate and anticipated needs of the market in the security. Specialists are permitted to liquidate or reduce a position by selling stock on a ‘‘direct minus tick,’’ i.e., selling stock at a price lower than the price of the last sale on the Exchange, or by purchasing stock on a ‘‘direct plus tick,’’ i.e., at a price higher than the price of the last E:\FR\FM\08DEN1.SGM 08DEN1 71222 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices sale on the Exchange, if such transaction is reasonably necessary and the specialist has obtained Floor Official approval. After such direct tick liquidating transactions and after proprietary liquidating sales on ‘‘zero minus ticks’’ and proprietary liquidating purchases on ‘‘zero plus ticks,’’ specialists are required to re-enter the market on the opposite side in an appropriate amount, where the imbalance of supply and demand indicates that immediately succeeding transactions may result in lower (following specialist’s sale) or higher (following specialist’s purchase) prices.8 Pursuant to NYSE Rule 104.10(b)(7), specialists are permitted to effect proprietary transactions in investment company units and Trust issued receipts (securities commonly referred to as exchange-traded funds or ETFs) without Floor Official approval for the purpose of bringing the ETF price into parity with the underlying index value. These transactions, however, must be effected in a manner that is consistent with the maintenance of a fair and orderly market. B. Proposed Specialist Stabilization Rules NYSE proposes to retain the negative obligation in that specialist dealings must be reasonably necessary for the maintenance of a fair and orderly market and that transactions with the trend of the market be accompanied by appropriate re-entry on the opposite side of the market. NYSE proposes to amend its stabilization rules to reflect four types of specialist dealer transactions—‘‘Neutral,’’ ‘‘NonConditional,’’ ‘‘Conditional,’’ and ‘‘Prohibited.’’ sroberts on PROD1PC70 with NOTICES 1. Neutral Transactions 9 NYSE proposes to define Neutral Transactions as purchases or sales by which a specialist liquidates or decreases a position. NYSE proposes that Neutral Transactions must be effected in a reasonable and orderly manner in relation to the condition of the general market, the market in the particular stock, and the adequacy of the specialist’s position to the immediate 8 This rule provides that, during any period of volatile or unusual market conditions resulting in a significant price movement in the subject security, the specialist’s transaction in reentering the market should reflect, at a minimum, the specialist’s usual level of dealer participation. Further, any series of specialist destabilizing transactions during periods of volatile or unusual market conditions should be accompanied by the specialist’s re-entry in the market and effecting transactions which reflect a significant degree of dealer participation. See NYSE Rule 104.10(6)(i)(B). 9 Proposed NYSE Rule 104.10(5)(i)(a)(I). VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 and reasonably anticipated needs of the round-lot and odd-lot market. Neutral Transactions may be made without restriction as to price but must be reasonably necessary to render the specialist’s position adequate to the market’s needs. This is similar to what the current rule permits today,10 but eliminates the requirement for Floor Official approval in situations where the transaction is a sale on a direct minus tick or a purchase on a direct plus tick. The specialist’s obligation to maintain a fair and orderly market may require reentry on the opposite side of the market after effecting one or more Neutral Transactions and should be in accordance with the immediate and anticipated needs of the market. Reentry on the opposite side of the market is not required merely as a result of the specialist engaging in one or more Neutral Transactions, but may be necessary in order for the specialist to meet his or her affirmative obligation to maintain a fair and orderly market. Transactions 11 2. Non-Conditional Non-Conditional Transactions are defined as certain specialist bids or purchases and offers or sales that establish or increase the specialist’s position other than reaching across the market to trade with the Exchange quote. Like Neutral Transactions, NonConditional Transactions must be effected in a reasonable and orderly manner in relation to the condition of the general market, the market in the particular stock, and the adequacy of the specialist’s position to the immediate and reasonably anticipated needs of the round-lot and odd-lot market. Proposed NYSE Rule 104.10(5)(i)(a)(II)(b) sets forth seven types of Non-Conditional Transactions (items (i) through (vii)), which may be effected without restriction as to price or the need for Floor Official approval. The first two types of Non-Conditional Transactions (items (i) and (ii)) are allowed without restriction under the current rule and have not been changed.12 The following is a list of Non-Conditional Transactions: (i) Matching another market’s better bid or offer;13 (ii) Bringing the price of a security into parity with an underlying or related security or asset; 14 10 NYSE Rule 104.10(6)(i)(A). NYSE Rule 104.10(5)(i)(a)(II). 12 NYSE Rules 104.10(5)(iv) and 104.10(7). 13 See Securities Exchange Release No. 54362 (August 25, 2006), 71 FR 52201 (September 1, 2006) (SR–NYSE–2006–07). 14 See Securities Exchange Release No. 37016 (March 22, 1996), 61 FR 14185 (March 29, 1996) (SR–NYSE–96–04). 11 Proposed PO 00000 Frm 00103 Fmt 4703 Sfmt 4703 (iii) Adding size to an independently established bid or offer on the Exchange; (iv) Purchasing at the published bid on the Exchange; (v) Selling at the published offer on the Exchange; (vi) Purchasing or selling at a price between the Exchange published bid and published offer; or (vii) Purchasing below the published bid or selling above the published offer on the Exchange (e.g., during a ‘‘sweep’’). Re-entry on the opposite side of the market is not required as a result of the specialist engaging in one or more NonConditional Transactions, but may be required in order for the specialist to meet its affirmative obligation to maintain a fair and orderly market. Where such re-entry is necessary, it should be commensurate with the size of the specialist’s Non-Conditional Transactions and the immediate and anticipated needs of the market. 3. Specialist Trades To Increase Its Position by Trading With the Exchange Quote 15 Transactions in which the specialist is increasing or establishing a position in his or her registered securities by reaching across the market to trade with the Exchange bid or offer are governed by proposed NYSE Rule 104.10(5)(i)(b) for inactive securities and proposed NYSE Rule 104.10(6) for active securities. NYSE proposes to define Active Securities as: 16 (a) Securities comprising the S&P 500 Stock Index; (b) Securities trading on the Exchange during the first five trading days following their initial public offering; and (c) Securities that have been designated as ‘‘active’’ by a Floor Official.17 ‘‘Inactive securities’’ are securities that do not fall within the definition of ‘‘Active’’ securities. 15 Proposed NYSE Rule 104.10(6). NYSE Rule 104.10(6)(i). 17 A governing Floor Official may designate a security as ‘‘active’’ by determining, among other things, that the security in question has exhibited substantially greater than normal trading volume and is likely to continue to sustain such higher volume during the remainder of the trading session. The Floor Official’s determination that a security should be considered ‘‘active’’ lasts only for the trading session on the particular day it is determined. While the security may be designated ‘‘active’’ on subsequent days, such determinations must be made based on its trading characteristics that day. Floor Officials would also be required to notify the Market Surveillance Division of New York Stock Exchange Regulation (‘‘NYSER’’) whenever he or she designates a security as ‘‘active.’’ Both the specialist and Floor Official would be required to create and maintain such documentation regarding the security as the Exchange may require. 16 Proposed E:\FR\FM\08DEN1.SGM 08DEN1 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices sroberts on PROD1PC70 with NOTICES a. Conditional Transactions in Active Securities NYSE proposes a pilot program until June 30, 2007 (‘‘Pilot’’) that would allow Conditional Transactions, which are specialist trades in Active Securities that establish or increase a position by reaching across the market to trade with the Exchange’s published bid (in the case of a specialist’s sale) or offer (in the case of a specialist’s purchase) when such bid (offer) is priced below (above) the last differently-priced trade and the last differently-priced published bid (offer) on the Exchange. NYSE proposes to allow a specialist to execute Conditional Transactions without restriction as to price or Floor Official approval, provided that the specialist appropriately re-enters on the opposite side of the market in a size commensurate with the specialist’s Conditional Transaction. NYSE proposes to issue guidelines that specialists should follow, called ‘‘Price Participation Points’’ (‘‘PPPs’’), that would identify the price at or before which a specialist is expected to reenter the market after effecting one or more Conditional Transactions. The Exchange noted that PPPs are minimum guidelines only and compliance with them does not guarantee that a specialist is meeting its obligations.18 NYSE proposes that certain Conditional Transactions would require the specialist to immediately re-enter, or re-enter as the specialist’s next available quoting or trading action, regardless of the PPP. For example, immediate reentry may be required based on the price and/or volume of the specialist’s Conditional Transaction(s) in reference to the market in the security at the time of such trading. The fact that there may have been one or more independent trades following the specialist’s Conditional Transaction does not, by itself, eliminate the need for immediate re-entry, when otherwise appropriate. In addition, immediate re-entry is required after a Conditional Transaction: (a) Of 10,000 shares or more or a quantity of stock with a market value of $200,000 or more; and (b) which exceeds 50% of the published bid or offer size (as relevant).19 b. Inactive Securities Specialist transactions in Inactive Securities that reach across the market to trade with the existing bid or offer when the specialist is establishing or increasing a position would continue to be governed by the requirements of 18 See 19 See proposed NYSE Rule 104.10(6)(iv)(a). proposed NYSE Rule 104.10(6)(iv)(c)(I) and (II). VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 current NYSE rules.20 A specialist would not be permitted to establish or increase its position by reaching across the market to purchase the offer at a price that is above the last sale price on the Exchange or sell to the bid at a price below the last sale price on the Exchange, unless such specialist trade is reasonably necessary to render the specialist’s position adequate to the immediate and reasonably anticipated needs of the market and approved by a Floor Official. Further, specialists would not be permitted to purchase more than 50% of the stock offered at a price that is equal to the last sale price when the last sale price was higher than the last differently priced regular way sale, unless such trade is approved by a Floor Official. Specialists must reenter the market when reasonably necessary after effecting such trades. 4. Prohibited Transactions 21 NYSE proposes that, during the last ten minutes of trading, (1) A specialist with a long position in a security would be prohibited from making a purchase in such security that results in a new Exchange high for the day at the time of the specialist’s transaction, and (2) a specialist with a short position in a security would be prohibited from making a sale in such security, including securities subject to the Regulation SHO Pilot,22 that results in a new Exchange low for the day at the time of the specialist’s transaction. However, the specialist would be permitted to effect such a transaction in order to match another market’s better bid or offer or to bring the price of the security into parity with an underlying or related security or asset. C. Other Changes The Exchange proposes to delete current NYSE Rule 104.10(9). This rule states that if a specialist has sell orders on the limit order book (‘‘Book’’) at two or more different prices, the specialist should not, as a dealer, purchase all of the stock from the Book at the lowest limit price and then immediately purchase stock from the Book at a higher limit price. This rule currently requires the specialist to cross the entire amount of stock he or she is purchasing at one price. The same principle applies when a specialist sells to orders on the Book. The Exchange also proposes to make conforming changes such as re20 The current requirements under NYSE Rule 104.10(5)(i) and NYSE Rule 104.10(6)(i) are reflected in proposed NYSE Rule 104.10(5)(i)(b)(I). See also Amendment No. 1. 21 Proposed NYSE Rule 104.10(5)(i)(c). 22 17 CFR 240.202T. PO 00000 Frm 00104 Fmt 4703 Sfmt 4703 71223 numbering certain provisions and other non-substantive language changes. For example, current NYSE Rule 104.10(6)(i)(D) which governs the ability of the crowd to prevent the specialist, when liquidating or decreasing a position, from trading on parity with the crowd during a manual transaction has been re-numbered NYSE Rule 104.10(5)(i)(a)(I)(d). NYSE Rules 70 and 123 have been amended to reflect this provision’s new rule number. D. Description of Amendment No. 1 In Amendment No. 1, the Exchange proposes to clarify that the transactions discussed in proposed NYSE Rule 104.10(5)(i)(b)(I) regarding transactions by a specialist for the specialist’s account to establish or increase a position apply to transactions that reach across the market to trade with the Exchange bid or offer. In addition, in the original filing, the Exchange proposed to rescind NYSE Rule 104.10(7), which provides that the requirement to obtain Floor Official approval for transactions for a specialist’s own account contained in NYSE Rule 104.10 does not apply to transactions effected in ETFs when the specialist transactions are for the purpose of bringing the ETF into parity with the underlying index value. Amendment No. 1 proposes to retain NYSE Rule 104.10(7) and include that the provisions therein should not apply to streetTRACKS Gold Shares, as the term is defined in NYSE Rule 1300 or Currency Trust Shares, as the term is defined in NYSE Rule 1301A. In Amendment No. 1, the Exchange further requests that the Commission reinterpret the specialist’s negative obligation to eliminate the requirement that each trade by the specialist for the dealer account meet a test of reasonable necessity. The Exchange believes that such an interpretation is appropriate in view of the development of the national market system over the past seventy years since the interpretation was initially issued. According to the Exchange, the Commission has been granted specific authority by Congress to reinterpret the negative obligation. Specifically, in 1975, in connection with the 1975 amendments 23 to the Act, Congress eliminated the negative obligation clause from Section 11(b) of the Act and gave the Commission the flexibility to define dealer obligations for both exchange members and over-the-counter market makers. In making the changes, 23 Securities Acts Amendments of 1975 (‘‘1975 Amendments’’), Pub. L. No. 94–29, 89 Stat. 97 (June 4, 1975). E:\FR\FM\08DEN1.SGM 08DEN1 71224 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices sroberts on PROD1PC70 with NOTICES Congress noted that changes in the marketplace might warrant changes in the scope of the dealer obligation. 24 In Amendment No. 1, the Exchange stated that it believes that the conditions for change that were identified by Congress have largely come to pass and that, as a result, it is appropriate to redefine the scope of the specialist’s negative obligation. For example, the Exchange argued that the institutionalization of the market, increased competition, and increased application of computer and communication technology has significantly diminished the time-andplace advantages of specialists. As a result, markets have seen increases in the average daily trading volume and the movement off the Floor of the decision making that affects the direction and extent of movements in the specialty stocks. The Exchange stated that there has also been a dramatic increase in transparency with respect to the specialist’s Book through, among other things, Exchange initiatives like Exchange OPENBOOK.TM The Exchange stated that it believes that this increased transparency gives all market participants, both on and off the Floor, a greater ability to see and react to market changes. The Exchange stated that there has also been a significant increase in competition in Exchange-listed securities. For example, unlike in previous years, Exchange specialists must now compete with upstairs liquidity providers and with multiple over-the-counter dealers, crossing networks and Alternative Trading Systems. As a result of unlisted trading privileges (‘‘UTP’’) and dual listings, the Exchange stated that specialists also face competition from other national and regional exchanges. For all of these reasons, the Exchange stated that it believes that it is appropriate for the Commission to reinterpret the negative obligation away from an emphasis on trade-by-trade necessity, and toward a more general evaluation of the reasonable necessity of trading activity in specialty securities for the dealer account. The Exchange stated that NYSER has appropriate surveillance procedures in 24 S. Rep. No. 94–75, at 100 (1975) (‘‘It might well be that with active competition among market makers and the elimination of trading advantages specialists now enjoy, such a restriction on specialists’ dealings would become unnecessary. Because trading patterns and market making behavior in the context of a national market system cannot now be predicted, it appears appropriate to expand the Commission’s rulemaking authority in this area so that the Commission may define responsibilities and restrict activities of specialists in response to changing market conditions.’’). VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 place to surveil for compliance with the negative obligation by specialists. For example, NYSER would monitor, on a patterns and practices basis, specialist activity that appears to cause or exacerbate an excessive price movement in the market, as such transactions would appear to be in violation of a specialist’s negative obligation. Additionally, the Division of Market Surveillance of NYSER would monitor for all subsequent action taken by the specialist, or lack thereof, to cushion such price movement. As today, the Exchange would, in the context of price volatility alerts, monitor for excessive price movements that may involve a failure to comply with either the affirmative or negative obligation. The Exchange represented that, as it gains experience with its new market structure, it would enhance existing surveillances and/or create new surveillances where necessary and appropriate to monitor for compliance with the specialist negative obligation. III. Comments Commission received five comment letters from one commenter 25 and two letters from the Exchange responding to the commenter.26 The commenter opposed NYSE’s proposal. The commenter argued that the negative obligation and current stabilization rules support public order interaction and that the Exchange’s proposal would result in the displacement of public orders by specialists. The commenter argued that, as a result, NYSE’s proposal is inconsistent with Section 11A of the Act, which promotes the opportunity for investors’ orders to be executed without the participation of a dealer. A. Stabilization Rules The commenter argued that NYSE’s proposal to amend its Rule 104.10 to allow specialists to trade in a destabilizing manner was a ‘‘de facto abandonment of the specialist’s historic mandate to stabilize the market by trading counter to the price trend.’’ 27 The commenter stated that the specialist’s role is, in essence, to act as the ‘‘trader of last resort’’ and expressed concern that the proposed changes to the Exchange’s stabilization rules allowing specialists to trade for their own account in instances in which they 25 See supra note 4. supra note 5. 27 See Rutherfurd Letter II. The commenter described NYSE’s proposal as permitting ‘‘direct and unnecessary specialist intervention in determining market price direction,’’ which the commenter argued cannot serve the public interest, and would have an adverse impact on many public investor trading strategies. 26 See PO 00000 Frm 00105 Fmt 4703 Sfmt 4703 are currently not permitted would displace public orders that would otherwise be capable of execution.28 The commenter argued that specialists would be unconstrained by whether a particular trade is ‘‘necessary’’ or not and whether the trade had an impact on the market’s price direction.29 The commenter argued that NYSE’s proposal provides specialists with proprietary trading privileges that are unrelated to the specialist’s market making function.30 The commenter stated that active stocks, in particular, trade well in terms of depth and liquidity without unnecessary dealer intervention. He also noted that the stocks in which specialists are least needed are the stocks in which they would be allowed to most freely effect non-stabilizing transactions. The commenter further argued that the maintenance of the stabilization requirements for inactive stocks is meaningless because they rarely, if ever, trade. In addition, the commenter believed that the proposed PPPs would be ineffective in regulating specialists and, in fact, would allow a specialist to increase profits by trading on the opposite side of the market from its previous trade.31 In the commenter’s opinion, specialists would act as risk adverse intra-day ‘‘flip traders’’ who do not seek to hold positions. The Exchange disagreed with the commenter, and stated that it believed that its specialists would continue to assume risk by committing capital to cushion market volatility when other market participants are trading with the trend and destabilizing the price of the security.32 The Exchange believed that, in order for specialists to continue in this role, they must have the appropriate tools to compete. The Exchange argued that specialists are increasingly unable to compete in a tick-based rules environment given the significant changes in competitive forces, customer expectations, technology, and automation that have impacted the NYSE market in recent years and reduced the specialist’s ability to direct or influence trading or control the quote. Notwithstanding the changes in the market place, NYSE’s specialists will continue in the Hybrid Market to be required to commit capital and add liquidity in order to bridge gaps in supply and demand, reduce volatility, 28 Id. 29 Id. 30 See Rutherfurd Letter IV. Letter II. 32 SeeNYSE Letter I, supra note 5, at 9. 31 SeeRutherfurd E:\FR\FM\08DEN1.SGM 08DEN1 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices sroberts on PROD1PC70 with NOTICES and encourage stable prices.33 The Exchange believed that the current tickbased rules were ‘‘appropriate for and worked well in a market where substantially all trading was conducted manually, at a pace that enabled individuals to discern ‘tick’ changes easily and which tolerated the time it took to call a Floor Official into the Crowd to approve a specialist’s proposed destabilizing transaction.’’ 34 The Exchange argued, however, that the current rules hinder the specialists from operating in the Hybrid Market, where trading is substantially electronic and the speed and frequency of executions and quote changes preclude individuals from being able to accurately track ‘‘ticks’’ or stop trading to allow for Floor Official involvement.35 The Exchange, therefore, believes that keeping the current tick-based rule would be inconsistent with Section 11A(a)(i)(C)(ii) of the Act, which promotes fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets. The Exchange also disagreed with the commenter’s suggestion that specialists have a monopoly on algorithmic trading or have access to electronic trading that creates an ‘‘unlevel competitive playing field.’’ 36 The Exchange argued that its rules do not prevent market participants from employing algorithmic-based trading strategies in connection with round-lot trading and stated that, in fact, customers benefit from the use of eQuotes and d-Quotes via their floor brokers and can create or purchase their own algorithmic systems to generate orders that can be entered via NYSE SuperDot.37 The Exchange stated that the Hybrid Market provides all market participants with the ability to trade electronically and that all orders entered on the Exchange would be executed, consistent with their instructions, in accordance with Exchange rules. The Exchange represented that no class of customers would be advantaged or disadvantaged by these rules because all market participants are afforded an opportunity to interact with published trading interest.38 While the Exchange acknowledged that specialists occupy a unique position in relation to other market participants, the Exchange disagreed with the commenter that specialists continue to enjoy a time and place advantage.39 It noted that, for example, last sale prices and quotations are immediately available to all market participants and that the growth of internalization has allowed ‘‘upstairs’’ trading firms to have comparable informational advantages as the specialists but the firms are able to trade on their information instantaneously without restrictions.40 Also, NYSE argued that, while the specialists’ algorithms have a slight informational advantage by having knowledge of orders as they enter NYSE systems, such knowledge does not deny other market participants an opportunity to interact with incoming orders. NYSE further notes that specialists’ algorithmic ability to trade with incoming marketable orders is limited to providing price improvement or matching a better price posted by another market center. These trading opportunities are subject to competition by floor brokers who have a similar opportunity to interact with incoming orders via d-Quotes.41 NYSE also noted that marketable CAP–DI orders automatically convert and trade along with specialist principal transactions.42 Accordingly, the Exchange argued that specialists’ algorithms do not act as an impediment to competition among market participants. The Exchange, therefore, believes that the Stabilization Proposal and the amended interpretation of the negative obligations of specialists present an appropriately flexible approach that will allow specialists to continue to add value to the marketplace. Moreover, the Exchange argued that the current marketplace is dominated by professional traders—program traders, hedge funds, day traders, and institutions—employing algorithmic trading and smart order routers.43 Unlike in the past, NYSE specialists must now compete with upstairs liquidity providers, with multiple overthe-counter dealers, crossing networks, and ECNs, as well as with NYSE floor brokers empowered with new, more effective, electronic order types.44 These market participants have the ability to trade on alternative systems while actively participating in trading on the Exchange. The Exchange stated that, unlike the Exchange specialists, none of 33 Id. 34 Id. 39 Id. 35 Id. 40 Id. at 3–4. at 4. 36 Id. at 11 (referencing Rutherfurd Letter II); see also Rutherfurd Letter III. 37 See NYSE Letter I, supra note 5, at 11. 38 Id. VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 at 8. 41 Id. 42 Id. 43 Id. 44 Id. PO 00000 Frm 00106 Fmt 4703 Sfmt 4703 71225 these market participants have similar restrictions on their trading. B. Negative Obligation The commenter argued that the transaction-by-transaction approach to determining the reasonable necessity of a specialist’s proprietary trade is the only consistent interpretation of the negative obligation. According to the commenter, the negative obligation limits a specialist’s ability to trade to those situations when there is a disparity in supply and demand and the specialist is needed to ensure appropriate trade-to-trade price continuity. In these situations, the commenter argued that the specialist is not restricted by the negative obligation and, in fact, is required to trade pursuant to the affirmative obligation. The commenter argued that supply and demand assessments arise in each particular trade, and thus the trade-bytrade approach should be maintained in its current form.45 The commenter believed that NYSE’s proposal to reinterpret the negative obligation so that specialist trading is surveilled on a ‘‘patterns and practices,’’ rather than on a trade-by-trade basis, effectively results in a de facto rescission of the negative obligation.46 The commenter disagreed with the Exchange’s assertions that specialists’ trading privileges have been reduced, and that increased competition and automation support a new interpretation of the negative obligation. The commenter believed that specialists will enjoy a time and place advantage in the Hybrid Market ‘‘far in excess of any that the specialist may have enjoyed in the physical auction.’’ 47 For example, the commenter stated that the specialist alone has knowledge of floor broker hidden public orders and can trade algorithmically to take advantage of material, non-public market information. For this reason, the commenter believed that the negative obligation in its current form will still be relevant and should be maintained. The NYSE responded that the specialists do not have the time and place advantage they once possessed. The Exchange argued that the dissemination of the consolidated quote and trade information and NYSE limit orders via OpenBook provide all investors with market information.48 In 45 The commenter also argued that NYSE should propose to amend its Rule 104 and petition the Commission to amend Rule 11b–1 under the Act so that the rule text would clearly express NYSE’s proposal. 46 See Rutherfurd Letters I, II, III, IV, and V. 47 See Rutherfurd Letters II and V. 48 See NYSE Letter II, at 2. E:\FR\FM\08DEN1.SGM 08DEN1 71226 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices addition, NYSE argued that the expansion of Direct+ and technology available to floor brokers have diminished the size and significance of the Crowd, and allows orders to be entered and executed at the best bid (offer) without human intervention.49 Further, the Exchange noted that quoting in pennies had reduced concentration of volume and average trade size.50 Finally, NYSE stated that the national market system order routing requirements have resulted in orders being executed on markets other than the market on which they were entered.51 The commenter also challenged the Exchange’s arguments based on the legislative history of Section 11(b) of the Act.52 The commenter stated that NYSE ‘‘continues to be the dominant, primary market in its stocks by a huge measure’’ and believed that the Exchange’s competitive position is much stronger today than it was in 1975, when Congress and the Commission declined to act on specialists’ negative obligations.53 The NYSE disagreed with the commenter’s argument. NYSE stated that competition has increased and that competition has, consequently, effected its market share.54 NYSE argued that increased internalization, the existence of alternative trading venues, and the ability of floor brokers to compete directly with specialists has resulted in increased competition to the specialist.55 The commenter also expressed concern about how the negative obligations would be measured and enforced. Further, the commenter believed that, even in a fast-moving Hybrid Market, a specialist’s algorithm could easily be programmed to conform to the current trade-by-trade negative obligation requirements. The commenter stated that NYSE’s proposal to surveil compliance with the negative obligation on a patterns or practices basis is vague and questioned the effectiveness of looking at whether specialist trading causes or exacerbates excessive price movements. The commenter argued that a ‘‘specialist cannot know whether subsequent trades that may be part of a ‘pattern’ are 49 Id. at 3. 50 Id. sroberts on PROD1PC70 with NOTICES 51 Id. 52 See Rutherfurd Letter II (referring to NYSE’s excerpt of a Senate Report in SR–NYSE–2006–82: ‘‘It might well be that with active competition among market makers and the elimination of trading advantages specialists now enjoy, such a restriction on specialists’ dealings would become unnecessary.’’ S. Rep. No. 94–75, at 100 (1975)). 53 Id. See also Rutherfurd Letters III and V. 54 See NYSE Letter II, at 2 55 Id. at 3. VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 necessary because subsequent order flow will dictate pricing, market direction, and, on a case-by-case basis, whether specialist intervention is appropriate as to any particular trade.’’ 56 According to the commenter, the ‘‘problem with commingling ‘necessity’ and ‘pattern’ is that the broad pattern may arguably be okay if there is no unusual price movement, but many individual trades within the pattern may not be ‘necessary’ at all. * * * ’’ 57 In addition, the commenter believed that the ‘‘patterns and practices’’ surveillance standard was flawed in that each specialist would establish his or her own such standard, which the commenter believed could lead a specialist to trade more aggressively. The commenter also questioned NYSE’s plan to monitor price movements as part of its surveillance of the negative obligation, because such examinations had historically been performed to measure the specialist’s compliance with the affirmative obligation by looking at whether a specialist had failed to trade to counter the market trend. The Exchange believes that the tradeby-trade interpretation established seventy years ago no longer addresses the realities of the modern market. The Exchange emphasized that it is not proposing to eliminate the negative obligation or its reasonable necessity test. The Exchange noted that it is, instead, proposing to reinterpret the negative obligation’s reasonable necessity test to eliminate the requirement that each trade must meet the test of reasonable necessity. The Exchange disagreed with the commenter’s suggestion that a nontrade-by-trade approach is unworkable, and will ultimately lead to customer disadvantage because specialists would engage in ‘‘in and out profit taking that interferes with direct public interaction.’’ 58 The Exchange argued that such a pattern of trading would continue to violate the specialist’s negative obligation, and that its revised approach will provide an appropriate regulatory check on specialists.59 C. Public Notice The commenter argued that the proposed rule change, as amended by Amendment No. 1 regarding the reinterpretation of the negative obligation of specialists, should be republished and the public comment 56 See Rutherfurd Letter II. 57 Id. 58 See NYSE Letter I, supra note 5, at 10 (citing Rutherfurd Letter II). 59 Id. PO 00000 Frm 00107 Fmt 4703 Sfmt 4703 period should be reset.60 In addition, the commenter urged the Commission to consider the proposal at a public hearing.61 IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the proposed rule change as modified by Amendment No. 1, including whether the proposal is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File No. SR–NYSE–2006–76 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, Station Place, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NYSE–2006–76. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Room. Copies of such filing also will be available for inspection and copying at the principal office of NYSE. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–NYSE–2006–76 and should be submitted on or before December 29, 2006. 60 See 61 See E:\FR\FM\08DEN1.SGM Rutherfurd Letters I, II, III, IV, and V. Rutherfurd Letters I, II, and III. 08DEN1 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices V. Discussion and Commission Findings sroberts on PROD1PC70 with NOTICES After careful consideration, 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 62 and, in particular, the requirements of Section 6 of the Act.63 Specifically, the Commission finds that the proposed rule change is consistent with Section 6(b)(5) of the Act,64 which requires, among other things, that the rules of a national securities exchange be designed to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, and 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. Finally, the Commission believes that the proposal is consistent with the principles set forth in Section 11A of the Act and the requirements of Rule 11b–1 under the Act.65 Specialists’ dealer activities are governed, in part, by the negative and affirmative trading obligations. Rule 11b–1 under the Act requires exchanges that permit members to register as specialists to have rules governing specialists’ dealer transactions so that their proprietary trades conform to the negative and affirmative obligations. The negative obligation as set forth in Rule 11b–1 under the Act requires that a specialist’s dealings be restricted, so far as practicable, to those reasonably necessary to permit the specialist to maintain a fair and orderly market.66 The affirmative obligation as set forth in Rule 11b–1 under the Act requires a specialist to engage in a course of dealings for its own account to assist in the maintenance, so far as practicable, of a fair and orderly market.67 NYSE has adopted these obligations in its Rule 104.68 62 In approving this proposed rule change, as amended, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 63 15 U.S.C. 78f. 64 15 U.S.C. 78f(b)(5). 65 17 CFR 240.11b–1. 66 17 CFR 240.11b–1(a)(2)(iii). 67 17 CFR 240.11b–1(a)(2)(ii). 68 NYSE Rule 104(a) reflects NYSE’s adoption of the negative obligation and states that ‘‘no specialist shall effect on the Exchange purchases or sales of any security in which such specialist is registered, for any account in which he or his member organization * * * is directly or indirectly interested, unless such dealings are reasonably VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 When debating the adoption of the Act, Congress considered barring the ability of exchange members to trade for their own accounts.69 Instead, pursuant to Section 11(e) of the Act, Congress directed the Commission to make a study of the feasibility and advisability of the completely segregating the functions of brokers and dealers.70 In 1935, soon after the adoption of the Act, the Commission recommended that the national securities exchanges adopt sixteen rules to regulate trading on exchanges in order to eliminate some of the undesirable consequences of dealer activities.71 These rules were adopted by all the exchanges. The tenth rule (‘‘Tenth Rule’’) prohibited specialists from effecting purchases or sales for their registered securities unless such dealings were reasonably necessary to permit specialists to maintain a fair and orderly market.72 ‘‘This rule * * * represents an attempt to eliminate the dealer activities of specialists except insofar as such activities allegedly perform a useful service to the market. In view of the specialist’s fiduciary obligation to buyers and sellers whose orders he has accepted for execution; in view of his special knowledge and superior bargaining power in trading for his own account; in view of his peculiar opportunities and motives for attracting public interest to the stock in which he specializes; and in view of the undesirable effect which his trading may exert upon the market; it was deemed essential by the Commission that the dealer functions of the specialist be subjected to stringent control. The rule was intended to allow him only sufficient latitude in his personal trading to enable him to maintain a fair and orderly market in the securities in which he is registered.’’ 73 In 1937, the Commission issued an interpretation (‘‘Saperstein necessary to permit such specialist to maintain a fair and orderly market * * *’’ 69 Report of the Committee on Banking and Currency, Stock Exchange Practices, S. Rep. No. 1455 (1934), reprinted in 5 J.S. Ellenberger and Ellen P. Mahar, Legislative History of the Securities Act of 1933 and Securities Exchange Act of 1934 (2001), at 19–30. 70 Commission, Report on the Feasibility and Advisability of the Complete Segregation of the Functions of Dealer and Broker (June 20, 1936) (‘‘Segregation Study’’). 71 The text of the recommended rules can be found at Appendix O–1 of the Segregation Study. See also Segregation Study at 60–64 for a summary of the rules. 72 The Tenth Rule stated: ‘‘No specialist shall effect on the exchange purchases or sales of any security in which such specialist is registered, for any account in which he, or the firm of which he is a partner, or any partner of such firm, is directly or indirectly interested, unless such dealings are reasonably necessary to permit such specialist to maintain a fair and orderly market, or to act as an odd-lot dealer in such security.’’ See Segregation Study Appendix O–1 at 169. See also NYSE Rule 104(a). 73 Id. at 63. PO 00000 Frm 00108 Fmt 4703 Sfmt 4703 71227 Interpretation’’) to clarify various aspects of the Tenth Rule, which the exchanges believed to be unnecessary because of other, more general rules regarding specialists that the exchanges had already adopted.74 In the interpretation, the Commission emphasized that ‘‘a mere showing that a transaction by a specialist for his own account had no undesirable effect, or even no discernible effect, upon the market’’ was not enough to evidence compliance with the rule.75 The Saperstein Interpretation stated that the ‘‘rule leaves no doubt that it prohibits all transactions for the account of a specialist, excepting only such transactions as are properly a part of a course of dealings reasonably necessary to permit the specialist to maintain a fair and orderly market * * *’’ 76 The Saperstein Interpretation thereafter stated that each transaction by a specialist for his own account must meet the test of reasonable necessity.77 The interpretation made clear that a specialist would be required to comply with the rule on a transaction-bytransaction basis. The Saperstein Interpretation also provided the basis for some of the current stabilization rules. Specifically, in the Interpretation, the Commission noted that certain transactions effected by a specialist when increasing or establishing a position tend to have a detrimental effect on the market and therefore would be commonly unjustifiable. These transactions included: (1) A purchase above the last sale price; (2) the purchase of all or substantially all the stock offered on the book at the last sale price; (3) the supplying of all or substantially all the stock bid for on the book at the last sale price; and (4) transactions that clean up the market in a manner that is similar to cleaning up the book. The Saperstein Interpretation noted that these transactions may be justifiable ‘‘but only when they are an essential part of a course of dealings designed to promote the continuity and stability of the market and effected in an orderly manner.’’ 78 NYSE has proposed to amend its rules that restrict the ability of specialists to 74 Securities Exchange Act Release No. 1117, 1937 SEC LEXIS 357 (March 30, 1937). The Saperstein Interpretation took the form of an interpretation by David Saperstein, then-Director of the Commission’s Trading and Exchange Division, and was contained in a letter sent to the Presidents of the various exchanges having a specialist system, including NYSE and a predecessor to the American Stock Exchange. 75 Saperstein Interpretation at 3–4. 76 Id. at 4. 77 Id. 78 Id. at 5. E:\FR\FM\08DEN1.SGM 08DEN1 sroberts on PROD1PC70 with NOTICES 71228 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices trade with the trend of the market. NYSE has also asked the Commission to reinterpret the negative obligation to eliminate the requirement that each trade be measured against the reasonable necessity test. NYSE believes that specialists are an integral part of its market structure and that they perform important functions in the marketplace. NYSE believes that specialists will continue to contribute vitally to the Hybrid Market by committing capital and adding liquidity in order to bridge gaps in supply and demand, which can help to keep the market fair and orderly and reduce volatility. However, NYSE argues that with the anticipated increase in the volume of orders and speed of market activity as a result of the Hybrid Market and the implementation of Regulation NMS, its current rules restricting the ability of specialists to trade for their own account based upon the tick in relation to the last sale on the Exchange, as set forth in NYSE Rules 104.10(5) and (6), are both unworkable and less relevant in determining whether a specialist’s trading is consistent with the negative obligation. Instead, NYSE believes these rules may in fact hinder specialists’ ability to maintain fair and orderly markets in the Hybrid environment. In addition, NYSE argues that the time and place and informational advantages traditionally enjoyed by specialists have been diminished. Prior to the Hybrid Market, the majority of orders that were executed on the Exchange were handled by the specialist. Specialists would have unique knowledge at the point of sale as to the extent of interest available in the market for execution. Under the Hybrid Market, all investors have access to the depth of the NYSE Book and will be able to access NYSE liquidity without the involvement of a specialist. Floor brokers and their customers also will be able to interact with incoming orders directly without the involvement of the specialist. This increased transparency and access gives all market participants, both on and off the floor, a greater ability to see and react to market changes. The Commission believes that these combined factors significantly change the market in which the NYSE specialist operates and justifies a new approach to regulating specialists’ dealer trades so that they will be able to effectively perform their obligation to maintain a fair and orderly market. The Commission notes that specialists remain constrained by the negative obligation and that their proprietary trading must be limited to that reasonably necessary to maintain a fair VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 and orderly market. Therefore, for the reasons discussed below, the Commission believes that NYSE’s proposal to amend its stabilization rules is consistent with the Act. In addition, the Commission has decided to reinterpret the negative obligation to remove the obligation to measure each individual specialist trade against the test of reasonable necessity. A. Negative Obligation In Amendment No. 1, the Exchange requested that the Commission reinterpret the reasonable necessity test found in the negative obligation to eliminate the trade-by-trade analysis that measures whether a specialist’s proprietary trade is consistent with the negative obligation. As noted above, the negative obligation as set forth in Rule 11b–1 under the Act requires that a specialist’s dealings be restricted, so far as practicable, to those reasonably necessary to permit the specialist to maintain a fair and orderly market.79 The commenter argued that the tradeby-trade requirement of the Saperstein Interpretation was the only consistent reading of reasonable necessity test. In addition, the commenter believed that, in the Hybrid Market, specialists will not experience a reduction in their advantages, but rather would enjoy advantages far in excess of those available to them in the floor-based auction environment.80 NYSE disagrees with the commenter’s assertion and argues that specialists do not have the informational advantages they once possessed. Specifically, NYSE argues that market information is ‘‘ubiquitous, readily available to all market participants as a result of consolidated quote and trade streams’’ and OpenBook.81 NYSE also argued that ‘‘the expansion of NYSE Direct+ and technology available to floor brokers has diminished the size and significance of the Crowd and enables orders entered into the Exchange system to execute at the best bid and offer without the need for human intervention.’’ 82 The Commission agrees with NYSE that the national market system has 79 17 CFR 240.11b–1(a)(2)(iii). Commission notes that the commenter’s assertion that specialists have the exclusive ability to trade with incoming marketable orders is incorrect. Floor brokers are permitted to execute against incoming marketable orders via d-Quotes. See NYSE Rule 70.25(b)(i). In addition, the commenter asserted that specialists have access to floor broker agency interest data. This statement is likewise inaccurate. Specialists’ algorithms will not have access to such data. See NYSE Rule 104(c)(ii). Further, a floor broker may exclude its interest from aggregate floor broker interest that is disclosed to the specialist on the floor. See Rule 70.20(g). 81 See NYSE Letter II, supra note 5. 82 Id. 80 The PO 00000 Frm 00109 Fmt 4703 Sfmt 4703 changed greatly in the nearly seventy years since the Saperstein Interpretation was issued. The Commission believes that the trade-by-trade standard that was established seventy years ago is unworkable in the current market environment. The high speed and volume of trading in today’s market make impracticable a trade-by-trade determination by the specialist of whether a particular trade is reasonably necessary. Further, the Commission believes that the informational advantages that specialists once enjoyed have been diminished. The Commission believes that eliminating the trade-by-trade standard with respect to the negative obligation should enhance the specialist’s ability to fulfill its obligation to maintain a fair and orderly market. The Commission believes that increased automation and competition—both within the Hybrid Market and in the markets generally— are significant factors, among others, that affect the ability of specialists to make a trade-by-trade analysis regarding their negative obligations. The Commission finds that permitting specialists to consider the reasonable necessity of their transactions under the negative obligation without a transaction-by-transaction test, is appropriate and consistent with the Act.83 The Commission emphasizes that it is not eliminating the negative obligation. Therefore, specialists must continue to assess their need to trade and limit their proprietary trades to those reasonably necessary to allow the specialist to maintain a fair and orderly market. The commenter expressed concern that eliminating the trade-by-trade test could lead to more aggressive trading by specialists. The Commission notes that the new interpretation does not relieve specialists of their obligations under federal securities laws or NYSE Rules. A specialist’s ability to effect proprietary transactions remains limited under the Act and NYSE Rules and a specialist must still determine whether their transactions are reasonably necessary. The Commission notes that the Exchange is obligated to surveil its specialists to ensure their compliance with the Act and the Exchange’s Rules, and the Exchange has represented that it will conduct surveillance of specialist 83 The commenter believed that this ‘‘reinterpretation’’ of the Saperstein Interpretation should be done through a change to the text of NYSE Rules. The Commission believes this to be unnecessary, as the original Saperstein Interpretation, was communicated through a letter from then-Director Saperstein to the presidents of the various exchanges. E:\FR\FM\08DEN1.SGM 08DEN1 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices trading for compliance with the negative obligation. B. Stabilization Rules NYSE proposes to amend its rules that specifically restrict certain specialist transactions that are effected with the trend of the market. As noted above, these rules supplement the negative obligation. 1. Neutral Transactions NYSE proposes to allow a specialist to liquidate or reduce a position regardless of the tick and without the need to receive Floor Official approval. Currently, NYSE rules are less restrictive regarding liquidating trades because these transactions do not create as great a potential conflict of interest for specialists. For example, if a specialist wanted to inappropriately influence the trend of the market in a security in which the specialist held a position, that specialist would have an incentive to increase the value of his or her position in the security by inflating the price. When liquidating a position, the specialist would not have a comparable incentive to cause the price to move downward. Importantly, however, specialists’ liquidating trades remain subject to the negative obligation and, therefore, specialists remain constrained by reasonable necessity when engaging in liquidating transactions. Therefore, the Commission finds that it is consistent with the Act for NYSE to eliminate the need for specialists to obtain Floor Official approval when liquidating or reducing a position. sroberts on PROD1PC70 with NOTICES 2. Non-Conditional Transactions NYSE proposed to allow a specialist to increase or establish a position in transactions other than transactions that reach across the market to trade with the Exchange bid or offer, without the need for Floor Official approval and regardless of the tick. The Commission believes that these Non-Conditional Transactions do not create a significant potential conflict of interest for specialists. Non-Conditional Transactions reflect instances where an independent source establishes the price of the transaction, thereby addressing concerns that a specialist may be ‘‘leading the market.’’ In addition, the proposed rule would allow specialists to buy at the published bid or sell at the published offer without Floor Official approval. While in this circumstance the specialist may establish the bid/offer, the trade itself is initiated by other market participants and not the specialist. VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 NYSE argues that requiring Floor Official approval is impractical in the Hybrid Market, where trading is substantially electronic and the speed and frequency of executions and quote changes preclude specialists from being able to accurately track ticks or stop trading to allow for Floor Official involvement. The Commission also believes that the proposal to remove specific restrictions on Non-Conditional Transactions could enhance the specialist’s ability to maintain fair and orderly markets. Finally, the Commission notes that Non-Conditional Transactions remain subject to the negative obligation. Accordingly, the Commission believes the proposed rule change regarding Non-Conditional Transactions is consistent with the Act. 3. Prohibited Transactions NYSE has proposed to prohibit certain transactions during the last ten minutes of the trading day. The Commission finds that the proposed rules for Prohibited Transactions are consistent with the Act because they restrict trades that may inappropriately influence the price of a security to advantage a specialist’s proprietary position. The Commission also believes exempting specialist transactions that match another market’s better bid or offer or that bring the price of the security into parity with an underlying or related security asset is appropriate because in these situations, an independent party, not the specialist, has set the price. 4. Conditional Transactions in Active Securities NYSE proposes to allow specialists to trade with the NYSE quote without the need for Floor Official approval and regardless of the tick when increasing or establishing a position in certain Active Securities.84 As proposed, NYSE specialists will remain subject to the negative obligation and will be required to appropriately reenter the market after a Conditional Trade is executed. NYSE will issue guidelines known as PPPs to provide specialists with a price at which they should reenter. For certain Conditional Trades, specialist reentry 84 Transactions that increase or establish a specialist’s position in securities that do not satisfy the definition of Active Security would remain subject to the current NYSE rule, which requires that a specialist receive Floor Official approval before executing a transaction on a destabilizing tick. See proposed NYSE Rule 104.10(5)(i)(b). NYSE has proposed some clarifying changes to the rule text of this provision and the Commission finds that these changes better reflect the operation of this rule and therefore are consistent with the Act. PO 00000 Frm 00110 Fmt 4703 Sfmt 4703 71229 must immediately follow the Conditional Trade. The Commission believes that the provisions governing Conditional Transactions in Active Securities may reflect an appropriate balance between the needs of specialists and other market participants in today’s fast moving markets. The Commission recognizes the potential conflicts of interest presented when a specialist engages in aggressive trading activity such as reaching across the market to trade with the NYSE Quote while increasing its position. The concern is lessened with Active Securities, however, because the specialist likely will be less able to unilaterally cause a price movement. Accordingly, the Commission is approving this proposed provision on a pilot basis until June 30, 2007. Before the Commission decides whether to extend the operation of this rule or to approve this rule on a permanent basis, NYSE must provide data and analysis on the impact of this rule change. Specifically, during the Pilot, NYSE must provide to the Commission on a regular, ongoing basis, statistics relating to market quality and specialist trading activity under the Pilot. These statistics should include general market quality measures, in addition to specific measures aggregated up from a trade-bytrade analysis of market activity and specialist activity during periods immediately following a specialist’s Conditional Trade. After the initiation of the Pilot, NYSE must continue to work with Commission staff to ensure that these statistics are sufficiently informative to allow NYSE and the Commission to evaluate (i) the degree to which the trading activity of specialists under the Pilot affects execution quality for orders arriving on the same side of the market immediately after Conditional Trades, (ii) whether specialist Conditional Trades tend to be immediately followed by market price movements in the same direction as the specialist Conditional Trades, and (iii) the extent to which specialists provide liquidity on the opposite side of the market immediately after a Conditional Trade. These statistics should reflect all relevant aspects of the specialist trading and quoting activity immediately following Conditional Trades, including the frequency and speed of re-entry, the re-entry price relative to the take-out price, and the size of the re-entry quote relative to the size taken. The Commission recognizes that the national market system is changing in considerable ways. Technological advancements and market forces, as well as regulatory changes such as the E:\FR\FM\08DEN1.SGM 08DEN1 71230 Federal Register / Vol. 71, No. 236 / Friday, December 8, 2006 / Notices Commission’s Regulation NMS, have spurred trading centers to become even more automated, with trading volume and intermarket competition expected to continue to increase. Although it is difficult to forecast at this time the precise effect of such changes on the Exchange generally and specialists in particular, the Commission believes that the Exchange has made a case for modifying the rules relating to Conditional Transactions in Active Securities in anticipation of such changes. At the same time, the Commission recognizes that the proposed rule change represents a significant shift in the roles and obligations of specialists at the Exchange. Therefore, the Commission has required that, for Conditional Transactions, the Exchange implement this proposed rule change only for Active Securities and only as a Pilot. sroberts on PROD1PC70 with NOTICES 5. Other Changes The Commission finds that the proposal to delete current NYSE Rule 104.10(9) is appropriate because it is no longer applicable given the proposed changes to the stabilization rules as described above. In addition, the Commission also believes that the deletion of section (9) is consistent with the proposed re-definition of a Sweep Transaction 85 and notes that NYSE Rule 104.10(6)(c)(III) makes clear that each specialist trade at a separate price in a Sweep is viewed as a transaction with the published bid or offer for the purposes of the transactions that require immediate re-entry pursuant to proposed NYSE Rule 104.10(6)(iv)(c). Further, the Commission believes that retaining NYSE Rule 104.10(7) and including streetTRACKS Gold Shares (as defined in NYSE Rule 1300) and Currency Trust Shares (as defined in NYSE Rule 1301A) are appropriate because these are derivative products in which there is limited risk for the specialist to assert price control. C. Accelerated Approval of Amendment No. 1 The Commission finds good cause to approve Amendment No. 1 to the proposed rule change prior to the thirtieth day after Amendment No. 1 is published for comment in the Federal Register pursuant to Section 19(b)(2) of the Act.86 The commenter requested that the Commission publish the Exchange’s proposal as amended in Amendment No. 1 for public comment. The Commission has authority under 85 See Securities Exchange Act Release No. 54820 (November 27, 2006). 86 15 U.S.C 78s(b)(2). VerDate Aug<31>2005 19:05 Dec 07, 2006 Jkt 211001 Section 19(b)(2) of the Act to approve the proposed rule change prior to the thirtieth day after it is published for comment.87 The Commission notes that the Exchange’s request that the Commission issue a new interpretation of the negative obligation described in Amendment No. 1 was published for a 21-day comment period in an earlier proposed rule change.88 In that order, the Commission specifically requested comment on NYSE’s request to reinterpret the negative obligation. The Commission received comment letters from the commenter himself in response to that request, which were fully considered by the Commission. Therefore, the Commission believes that the public has had appropriate notice of the Exchange’s request to re-interpret the negative obligation of specialists. The remaining modifications in Amendment No. 1 were clarifications and/or technical corrections to the originally proposed rule change. For these reasons, the Commission believes that good cause exists to accelerate approval of the proposed rule change as amended by Amendment No. 1. VI. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act,89 that the proposed rule change (File No. SR– NYSE–2006–76), as modified by Amendment No. 1, be, and hereby is, approved, on an accelerated basis and the Pilot is approved on a temporary basis until June 30, 2007. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.90 Florence E. Harmon, Deputy Secretary. [FR Doc. E6–20886 Filed 12–7–06; 8:45 am] BILLING CODE 8011–01–P DEPARTMENT OF STATE [Public Notice 5635] Bureau of Near Eastern Affairs; Notice of New Information Collection Under Emergency Review: Iran Democracy Program Grants Vetting; Form DS– 4100, OMB Control Number 1405–xxxx Department of State, Bureau of Near Eastern Affairs. AGENCY: 87 Id. 88 See Securities Exchange Act Release No. 54578 (October 5, 2006), 71 FR 60216 (October 12, 2006). See also Securities Exchange Act Release No. 54685 (November 1, 2006), 71 FR 65559 (November 8, 2006). 89 15 U.S.C. 78s(b)(2). 90 17 CFR 200.30–3(a)(12). PO 00000 Frm 00111 Fmt 4703 Sfmt 4703 Notice of request for Emergency OMB approval. ACTION: SUMMARY: The Department of State has submitted the following new information collection request to the Office of Management and Budget (OMB) for review and approval in accordance with the emergency review procedures of the Paperwork Reduction Act of 1995. Type of Request: Emergency Review. Originating Office: Bureau of Near Eastern Affairs, Middle East Partnership Initiative. Title of Information Collection: Iran Democracy Program Grants Vetting. Frequency: On occasion. Form Number: DS–4100. Respondents: Potential Grantees for Iran Democracy Program. Estimated Number of Respondents: 200. Average Hours per Response: 1 hour per response. Total Estimated Burden: 200 hours. The proposed information collection is published to obtain comments from the public and affected agencies. Emergency review and approval of this collection has been requested from OMB by December 8, 2006. If granted, the emergency approval is only valid for 180 days. Comments should be directed to Katherine Astrich, State Department Desk Officer, Office of Information and Regulatory Affairs, Office of Management and Budget (OMB), Washington, DC 20530, who may be reached on 202–395–4718. During the first 60 days of this same period a regular review of this information collection is also being undertaken. Comments are encouraged and will be accepted until 60 days from the date that this notice is published in the Federal Register. The agency requests written comments and suggestions from the public and affected agencies concerning the proposed collection of information. Your comments are being solicited to permit the agency to: • Evaluate whether the proposed collection of information is necessary for the proper performance of the functions of the agency, including whether the information will have practical utility. • Evaluate the accuracy of the agency’s estimate of the burden of the proposed collection, including the validity of the methodology and assumptions used. • Enhance the quality, utility, and clarity of the information to be collected. • Minimize the reporting burden on those who are to respond, including E:\FR\FM\08DEN1.SGM 08DEN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 71, Number 236 (Friday, December 8, 2006)]
[Notices]
[Pages 71221-71230]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-20886]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54860; File No. SR NYSE-2006-76]


Self-Regulatory Organizations; New York Stock Exchange LLC; 
Notice of Filing and Order Granting Accelerated Approval to Proposed 
Rule Change, as Amended, Relating to Exchange Rule 104.10 (``Dealings 
by Specialists'')

December 1, 2006.

I. Introduction

    On September 22, 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 amend specialist stabilization requirements set 
forth in NYSE Rule 104.10 (``Dealings by Specialists''). The proposed 
rule change was published for comment in the Federal Register on 
September 28, 2006.\3\ The Commission received five comment letters \4\ 
from one commenter and two comment response letters from NYSE.\5\ On 
October 25, 2006, NYSE filed Amendment No. 1 to the proposed rule 
change.\6\ This notice and order approves the proposed rule change, as 
modified by Amendment No. 1, on an accelerated basis.\7\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 54504 (September 26, 
2006), 71 FR 57011 (``Stabilization Proposal'').
    \4\ See letters from George Rutherfurd to the Commission, dated 
October 11, 2006 (``Rutherfurd Letter I''); October 20, 2006 
(``Rutherfurd Letter II''); October 26, 2006 (``Rutherfurd Letter 
III''); November 2, 2006 (``Rutherfurd Letter IV''); and November 
14, 2006 (``Rutherfurd Letter V'').
    \5\ See letters from Mary Yeager, Assistant Secretary, NYSE, to 
Nancy M. Morris, Secretary, Commission, dated November 6, 2006 
(``NYSE Letter I'') and November 29, 2006 (``NYSE Letter II'').
    \6\ For a description of Amendment No. 1, see Section II.D., 
infra.
    \7\ The proposed rule change, as amended by Amendment No. 1, was 
approved on a temporary, pilot basis in File No. SR-NYSE-2006-82. 
See Securities Exchange Release No. 54578 (October 5, 2006), 71 FR 
60216 (October 12, 2006) (``Phase 3 Pilot'').
---------------------------------------------------------------------------

II. Description of the Proposal

    NYSE Rule 104 governs specialist dealings and includes, among other 
things, restrictions upon specialists' ability to trade as a dealer in 
the stocks in which he or she is registered. Under NYSE Rule 104(a), 
specialists are not permitted to effect transactions on the Exchange 
for their proprietary accounts in any security in which the specialist 
is registered, ``unless such dealings are reasonably necessary to 
permit such specialist to maintain a fair and orderly market * * *'' 
This restriction is known as the ``negative obligation.'' In 
particular, NYSE Rules 104.10(5) and (6) expand upon the negative 
obligation with regard to specific types of proprietary transactions. 
These sections further define the instances when a specialist is 
restricted in his or her ability to trade in relation to the direction 
of the market.

A. Current Specialist Stabilization Rules

    Specifically, current NYSE Rule 104.10(5)(i) provides that 
specialist proprietary transactions are to be effected in a reasonable 
and orderly manner in relation to the general market, the market in a 
particular stock, and the adequacy of the specialist's position to the 
immediate and reasonably anticipated needs of the market. The rule 
further provides that, unless it is to render the specialist's position 
in a stock adequate for current or reasonably anticipated needs of the 
market, a specialist should not effect a non-stabilizing transaction 
(i.e., a transaction with the trend of price movement) for the 
specialist's account when acquiring or increasing a position. In this 
regard, the rule restricts specialists from purchasing stock at a price 
above the last sale (in the same trading session) and purchasing more 
than 50% of the stock offered on a ``zero plus tick,'' i.e., at the 
same price as the last sale, when such last sale price was higher than 
the previous, differently priced sale in the stock on the Exchange. 
Specialists are, however, permitted to effect these types of 
transactions with Floor Official approval or in less active markets 
where such transactions are an essential part of a proper course of 
dealings and where the amount of stock involved and the price change, 
if any, are normal in relation to the market.
    NYSE Rule 104.10(6) sets forth the specialist's stabilization 
requirements when liquidating or reducing a position. This rule 
provides that such trades should be effected in a reasonable and 
orderly manner in relation to the condition of the general market, the 
market in the particular security, and the adequacy of the specialist's 
position to meet the immediate and anticipated needs of the market in 
the security. Specialists are permitted to liquidate or reduce a 
position by selling stock on a ``direct minus tick,'' i.e., selling 
stock at a price lower than the price of the last sale on the Exchange, 
or by purchasing stock on a ``direct plus tick,'' i.e., at a price 
higher than the price of the last

[[Page 71222]]

sale on the Exchange, if such transaction is reasonably necessary and 
the specialist has obtained Floor Official approval. After such direct 
tick liquidating transactions and after proprietary liquidating sales 
on ``zero minus ticks'' and proprietary liquidating purchases on ``zero 
plus ticks,'' specialists are required to re-enter the market on the 
opposite side in an appropriate amount, where the imbalance of supply 
and demand indicates that immediately succeeding transactions may 
result in lower (following specialist's sale) or higher (following 
specialist's purchase) prices.\8\
---------------------------------------------------------------------------

    \8\ This rule provides that, during any period of volatile or 
unusual market conditions resulting in a significant price movement 
in the subject security, the specialist's transaction in reentering 
the market should reflect, at a minimum, the specialist's usual 
level of dealer participation. Further, any series of specialist 
destabilizing transactions during periods of volatile or unusual 
market conditions should be accompanied by the specialist's re-entry 
in the market and effecting transactions which reflect a significant 
degree of dealer participation. See NYSE Rule 104.10(6)(i)(B).
---------------------------------------------------------------------------

    Pursuant to NYSE Rule 104.10(b)(7), specialists are permitted to 
effect proprietary transactions in investment company units and Trust 
issued receipts (securities commonly referred to as exchange-traded 
funds or ETFs) without Floor Official approval for the purpose of 
bringing the ETF price into parity with the underlying index value. 
These transactions, however, must be effected in a manner that is 
consistent with the maintenance of a fair and orderly market.

B. Proposed Specialist Stabilization Rules

    NYSE proposes to retain the negative obligation in that specialist 
dealings must be reasonably necessary for the maintenance of a fair and 
orderly market and that transactions with the trend of the market be 
accompanied by appropriate re-entry on the opposite side of the market. 
NYSE proposes to amend its stabilization rules to reflect four types of 
specialist dealer transactions--``Neutral,'' ``Non-Conditional,'' 
``Conditional,'' and ``Prohibited.''
1. Neutral Transactions \9\
---------------------------------------------------------------------------

    \9\ Proposed NYSE Rule 104.10(5)(i)(a)(I).
---------------------------------------------------------------------------

    NYSE proposes to define Neutral Transactions as purchases or sales 
by which a specialist liquidates or decreases a position. NYSE proposes 
that Neutral Transactions must be effected in a reasonable and orderly 
manner in relation to the condition of the general market, the market 
in the particular stock, and the adequacy of the specialist's position 
to the immediate and reasonably anticipated needs of the round-lot and 
odd-lot market. Neutral Transactions may be made without restriction as 
to price but must be reasonably necessary to render the specialist's 
position adequate to the market's needs. This is similar to what the 
current rule permits today,\10\ but eliminates the requirement for 
Floor Official approval in situations where the transaction is a sale 
on a direct minus tick or a purchase on a direct plus tick. The 
specialist's obligation to maintain a fair and orderly market may 
require re-entry on the opposite side of the market after effecting one 
or more Neutral Transactions and should be in accordance with the 
immediate and anticipated needs of the market. Re-entry on the opposite 
side of the market is not required merely as a result of the specialist 
engaging in one or more Neutral Transactions, but may be necessary in 
order for the specialist to meet his or her affirmative obligation to 
maintain a fair and orderly market.
---------------------------------------------------------------------------

    \10\ NYSE Rule 104.10(6)(i)(A).
---------------------------------------------------------------------------

2. Non-Conditional Transactions \11\
---------------------------------------------------------------------------

    \11\ Proposed NYSE Rule 104.10(5)(i)(a)(II).
---------------------------------------------------------------------------

    Non-Conditional Transactions are defined as certain specialist bids 
or purchases and offers or sales that establish or increase the 
specialist's position other than reaching across the market to trade 
with the Exchange quote. Like Neutral Transactions, Non-Conditional 
Transactions must be effected in a reasonable and orderly manner in 
relation to the condition of the general market, the market in the 
particular stock, and the adequacy of the specialist's position to the 
immediate and reasonably anticipated needs of the round-lot and odd-lot 
market. Proposed NYSE Rule 104.10(5)(i)(a)(II)(b) sets forth seven 
types of Non-Conditional Transactions (items (i) through (vii)), which 
may be effected without restriction as to price or the need for Floor 
Official approval. The first two types of Non-Conditional Transactions 
(items (i) and (ii)) are allowed without restriction under the current 
rule and have not been changed.\12\ The following is a list of Non-
Conditional Transactions:
---------------------------------------------------------------------------

    \12\ NYSE Rules 104.10(5)(iv) and 104.10(7).
---------------------------------------------------------------------------

    (i) Matching another market's better bid or offer;\13\
---------------------------------------------------------------------------

    \13\ See Securities Exchange Release No. 54362 (August 25, 
2006), 71 FR 52201 (September 1, 2006) (SR-NYSE-2006-07).
---------------------------------------------------------------------------

    (ii) Bringing the price of a security into parity with an 
underlying or related security or asset; \14\
---------------------------------------------------------------------------

    \14\ See Securities Exchange Release No. 37016 (March 22, 1996), 
61 FR 14185 (March 29, 1996) (SR-NYSE-96-04).
---------------------------------------------------------------------------

    (iii) Adding size to an independently established bid or offer on 
the Exchange;
    (iv) Purchasing at the published bid on the Exchange;
    (v) Selling at the published offer on the Exchange;
    (vi) Purchasing or selling at a price between the Exchange 
published bid and published offer; or
    (vii) Purchasing below the published bid or selling above the 
published offer on the Exchange (e.g., during a ``sweep'').
    Re-entry on the opposite side of the market is not required as a 
result of the specialist engaging in one or more Non-Conditional 
Transactions, but may be required in order for the specialist to meet 
its affirmative obligation to maintain a fair and orderly market. Where 
such re-entry is necessary, it should be commensurate with the size of 
the specialist's Non-Conditional Transactions and the immediate and 
anticipated needs of the market.
3. Specialist Trades To Increase Its Position by Trading With the 
Exchange Quote \15\
---------------------------------------------------------------------------

    \15\ Proposed NYSE Rule 104.10(6).
---------------------------------------------------------------------------

    Transactions in which the specialist is increasing or establishing 
a position in his or her registered securities by reaching across the 
market to trade with the Exchange bid or offer are governed by proposed 
NYSE Rule 104.10(5)(i)(b) for inactive securities and proposed NYSE 
Rule 104.10(6) for active securities. NYSE proposes to define Active 
Securities as: \16\
---------------------------------------------------------------------------

    \16\ Proposed NYSE Rule 104.10(6)(i).
---------------------------------------------------------------------------

    (a) Securities comprising the S&P 500[supreg] Stock Index;
    (b) Securities trading on the Exchange during the first five 
trading days following their initial public offering; and
    (c) Securities that have been designated as ``active'' by a Floor 
Official.\17\
---------------------------------------------------------------------------

    \17\ A governing Floor Official may designate a security as 
``active'' by determining, among other things, that the security in 
question has exhibited substantially greater than normal trading 
volume and is likely to continue to sustain such higher volume 
during the remainder of the trading session. The Floor Official's 
determination that a security should be considered ``active'' lasts 
only for the trading session on the particular day it is determined. 
While the security may be designated ``active'' on subsequent days, 
such determinations must be made based on its trading 
characteristics that day. Floor Officials would also be required to 
notify the Market Surveillance Division of New York Stock Exchange 
Regulation (``NYSER'') whenever he or she designates a security as 
``active.'' Both the specialist and Floor Official would be required 
to create and maintain such documentation regarding the security as 
the Exchange may require.
---------------------------------------------------------------------------

    ``Inactive securities'' are securities that do not fall within the 
definition of ``Active'' securities.

[[Page 71223]]

a. Conditional Transactions in Active Securities
    NYSE proposes a pilot program until June 30, 2007 (``Pilot'') that 
would allow Conditional Transactions, which are specialist trades in 
Active Securities that establish or increase a position by reaching 
across the market to trade with the Exchange's published bid (in the 
case of a specialist's sale) or offer (in the case of a specialist's 
purchase) when such bid (offer) is priced below (above) the last 
differently-priced trade and the last differently-priced published bid 
(offer) on the Exchange.
    NYSE proposes to allow a specialist to execute Conditional 
Transactions without restriction as to price or Floor Official 
approval, provided that the specialist appropriately re-enters on the 
opposite side of the market in a size commensurate with the 
specialist's Conditional Transaction. NYSE proposes to issue guidelines 
that specialists should follow, called ``Price Participation Points'' 
(``PPPs''), that would identify the price at or before which a 
specialist is expected to re-enter the market after effecting one or 
more Conditional Transactions. The Exchange noted that PPPs are minimum 
guidelines only and compliance with them does not guarantee that a 
specialist is meeting its obligations.\18\
---------------------------------------------------------------------------

    \18\ See proposed NYSE Rule 104.10(6)(iv)(a).
---------------------------------------------------------------------------

    NYSE proposes that certain Conditional Transactions would require 
the specialist to immediately re-enter, or re-enter as the specialist's 
next available quoting or trading action, regardless of the PPP. For 
example, immediate re-entry may be required based on the price and/or 
volume of the specialist's Conditional Transaction(s) in reference to 
the market in the security at the time of such trading. The fact that 
there may have been one or more independent trades following the 
specialist's Conditional Transaction does not, by itself, eliminate the 
need for immediate re-entry, when otherwise appropriate. In addition, 
immediate re-entry is required after a Conditional Transaction: (a) Of 
10,000 shares or more or a quantity of stock with a market value of 
$200,000 or more; and (b) which exceeds 50% of the published bid or 
offer size (as relevant).\19\
---------------------------------------------------------------------------

    \19\ See proposed NYSE Rule 104.10(6)(iv)(c)(I) and (II).
---------------------------------------------------------------------------

b. Inactive Securities
    Specialist transactions in Inactive Securities that reach across 
the market to trade with the existing bid or offer when the specialist 
is establishing or increasing a position would continue to be governed 
by the requirements of current NYSE rules.\20\ A specialist would not 
be permitted to establish or increase its position by reaching across 
the market to purchase the offer at a price that is above the last sale 
price on the Exchange or sell to the bid at a price below the last sale 
price on the Exchange, unless such specialist trade is reasonably 
necessary to render the specialist's position adequate to the immediate 
and reasonably anticipated needs of the market and approved by a Floor 
Official. Further, specialists would not be permitted to purchase more 
than 50% of the stock offered at a price that is equal to the last sale 
price when the last sale price was higher than the last differently 
priced regular way sale, unless such trade is approved by a Floor 
Official. Specialists must reenter the market when reasonably necessary 
after effecting such trades.
---------------------------------------------------------------------------

    \20\ The current requirements under NYSE Rule 104.10(5)(i) and 
NYSE Rule 104.10(6)(i) are reflected in proposed NYSE Rule 
104.10(5)(i)(b)(I). See also Amendment No. 1.
---------------------------------------------------------------------------

4. Prohibited Transactions \21\
---------------------------------------------------------------------------

    \21\ Proposed NYSE Rule 104.10(5)(i)(c).
---------------------------------------------------------------------------

    NYSE proposes that, during the last ten minutes of trading, (1) A 
specialist with a long position in a security would be prohibited from 
making a purchase in such security that results in a new Exchange high 
for the day at the time of the specialist's transaction, and (2) a 
specialist with a short position in a security would be prohibited from 
making a sale in such security, including securities subject to the 
Regulation SHO Pilot,\22\ that results in a new Exchange low for the 
day at the time of the specialist's transaction. However, the 
specialist would be permitted to effect such a transaction in order to 
match another market's better bid or offer or to bring the price of the 
security into parity with an underlying or related security or asset.
---------------------------------------------------------------------------

    \22\ 17 CFR 240.202T.
---------------------------------------------------------------------------

C. Other Changes

    The Exchange proposes to delete current NYSE Rule 104.10(9). This 
rule states that if a specialist has sell orders on the limit order 
book (``Book'') at two or more different prices, the specialist should 
not, as a dealer, purchase all of the stock from the Book at the lowest 
limit price and then immediately purchase stock from the Book at a 
higher limit price. This rule currently requires the specialist to 
cross the entire amount of stock he or she is purchasing at one price. 
The same principle applies when a specialist sells to orders on the 
Book.
    The Exchange also proposes to make conforming changes such as re-
numbering certain provisions and other non-substantive language 
changes. For example, current NYSE Rule 104.10(6)(i)(D) which governs 
the ability of the crowd to prevent the specialist, when liquidating or 
decreasing a position, from trading on parity with the crowd during a 
manual transaction has been re-numbered NYSE Rule 
104.10(5)(i)(a)(I)(d). NYSE Rules 70 and 123 have been amended to 
reflect this provision's new rule number.

D. Description of Amendment No. 1

    In Amendment No. 1, the Exchange proposes to clarify that the 
transactions discussed in proposed NYSE Rule 104.10(5)(i)(b)(I) 
regarding transactions by a specialist for the specialist's account to 
establish or increase a position apply to transactions that reach 
across the market to trade with the Exchange bid or offer.
    In addition, in the original filing, the Exchange proposed to 
rescind NYSE Rule 104.10(7), which provides that the requirement to 
obtain Floor Official approval for transactions for a specialist's own 
account contained in NYSE Rule 104.10 does not apply to transactions 
effected in ETFs when the specialist transactions are for the purpose 
of bringing the ETF into parity with the underlying index value. 
Amendment No. 1 proposes to retain NYSE Rule 104.10(7) and include that 
the provisions therein should not apply to streetTRACKS[supreg] Gold 
Shares, as the term is defined in NYSE Rule 1300 or Currency Trust 
Shares, as the term is defined in NYSE Rule 1301A.
    In Amendment No. 1, the Exchange further requests that the 
Commission re-interpret the specialist's negative obligation to 
eliminate the requirement that each trade by the specialist for the 
dealer account meet a test of reasonable necessity. The Exchange 
believes that such an interpretation is appropriate in view of the 
development of the national market system over the past seventy years 
since the interpretation was initially issued.
    According to the Exchange, the Commission has been granted specific 
authority by Congress to reinterpret the negative obligation. 
Specifically, in 1975, in connection with the 1975 amendments \23\ to 
the Act, Congress eliminated the negative obligation clause from 
Section 11(b) of the Act and gave the Commission the flexibility to 
define dealer obligations for both exchange members and over-the-
counter market makers. In making the changes,

[[Page 71224]]

Congress noted that changes in the marketplace might warrant changes in 
the scope of the dealer obligation. \24\
---------------------------------------------------------------------------

    \23\ Securities Acts Amendments of 1975 (``1975 Amendments''), 
Pub. L. No. 94-29, 89 Stat. 97 (June 4, 1975).
    \24\ S. Rep. No. 94-75, at 100 (1975) (``It might well be that 
with active competition among market makers and the elimination of 
trading advantages specialists now enjoy, such a restriction on 
specialists' dealings would become unnecessary. Because trading 
patterns and market making behavior in the context of a national 
market system cannot now be predicted, it appears appropriate to 
expand the Commission's rulemaking authority in this area so that 
the Commission may define responsibilities and restrict activities 
of specialists in response to changing market conditions.'').
---------------------------------------------------------------------------

    In Amendment No. 1, the Exchange stated that it believes that the 
conditions for change that were identified by Congress have largely 
come to pass and that, as a result, it is appropriate to redefine the 
scope of the specialist's negative obligation. For example, the 
Exchange argued that the institutionalization of the market, increased 
competition, and increased application of computer and communication 
technology has significantly diminished the time-and-place advantages 
of specialists. As a result, markets have seen increases in the average 
daily trading volume and the movement off the Floor of the decision 
making that affects the direction and extent of movements in the 
specialty stocks. The Exchange stated that there has also been a 
dramatic increase in transparency with respect to the specialist's Book 
through, among other things, Exchange initiatives like Exchange 
OPENBOOK.^TM The Exchange stated that it believes that this 
increased transparency gives all market participants, both on and off 
the Floor, a greater ability to see and react to market changes.
    The Exchange stated that there has also been a significant increase 
in competition in Exchange-listed securities. For example, unlike in 
previous years, Exchange specialists must now compete with upstairs 
liquidity providers and with multiple over-the-counter dealers, 
crossing networks and Alternative Trading Systems. As a result of 
unlisted trading privileges (``UTP'') and dual listings, the Exchange 
stated that specialists also face competition from other national and 
regional exchanges. For all of these reasons, the Exchange stated that 
it believes that it is appropriate for the Commission to reinterpret 
the negative obligation away from an emphasis on trade-by-trade 
necessity, and toward a more general evaluation of the reasonable 
necessity of trading activity in specialty securities for the dealer 
account.
    The Exchange stated that NYSER has appropriate surveillance 
procedures in place to surveil for compliance with the negative 
obligation by specialists. For example, NYSER would monitor, on a 
patterns and practices basis, specialist activity that appears to cause 
or exacerbate an excessive price movement in the market, as such 
transactions would appear to be in violation of a specialist's negative 
obligation. Additionally, the Division of Market Surveillance of NYSER 
would monitor for all subsequent action taken by the specialist, or 
lack thereof, to cushion such price movement. As today, the Exchange 
would, in the context of price volatility alerts, monitor for excessive 
price movements that may involve a failure to comply with either the 
affirmative or negative obligation. The Exchange represented that, as 
it gains experience with its new market structure, it would enhance 
existing surveillances and/or create new surveillances where necessary 
and appropriate to monitor for compliance with the specialist negative 
obligation.

III. Comments

     Commission received five comment letters from one commenter \25\ 
and two letters from the Exchange responding to the commenter.\26\ The 
commenter opposed NYSE's proposal. The commenter argued that the 
negative obligation and current stabilization rules support public 
order interaction and that the Exchange's proposal would result in the 
displacement of public orders by specialists. The commenter argued 
that, as a result, NYSE's proposal is inconsistent with Section 11A of 
the Act, which promotes the opportunity for investors' orders to be 
executed without the participation of a dealer.
---------------------------------------------------------------------------

    \25\ See supra note 4.
    \26\ See supra note 5.
---------------------------------------------------------------------------

A. Stabilization Rules

    The commenter argued that NYSE's proposal to amend its Rule 104.10 
to allow specialists to trade in a destabilizing manner was a ``de 
facto abandonment of the specialist's historic mandate to stabilize the 
market by trading counter to the price trend.'' \27\
---------------------------------------------------------------------------

    \27\ See Rutherfurd Letter II. The commenter described NYSE's 
proposal as permitting ``direct and unnecessary specialist 
intervention in determining market price direction,'' which the 
commenter argued cannot serve the public interest, and would have an 
adverse impact on many public investor trading strategies.
---------------------------------------------------------------------------

    The commenter stated that the specialist's role is, in essence, to 
act as the ``trader of last resort'' and expressed concern that the 
proposed changes to the Exchange's stabilization rules allowing 
specialists to trade for their own account in instances in which they 
are currently not permitted would displace public orders that would 
otherwise be capable of execution.\28\ The commenter argued that 
specialists would be unconstrained by whether a particular trade is 
``necessary'' or not and whether the trade had an impact on the 
market's price direction.\29\ The commenter argued that NYSE's proposal 
provides specialists with proprietary trading privileges that are 
unrelated to the specialist's market making function.\30\
---------------------------------------------------------------------------

    \28\ Id.
    \29\ Id.
    \30\ See Rutherfurd Letter IV.
---------------------------------------------------------------------------

    The commenter stated that active stocks, in particular, trade well 
in terms of depth and liquidity without unnecessary dealer 
intervention. He also noted that the stocks in which specialists are 
least needed are the stocks in which they would be allowed to most 
freely effect non-stabilizing transactions. The commenter further 
argued that the maintenance of the stabilization requirements for 
inactive stocks is meaningless because they rarely, if ever, trade.
    In addition, the commenter believed that the proposed PPPs would be 
ineffective in regulating specialists and, in fact, would allow a 
specialist to increase profits by trading on the opposite side of the 
market from its previous trade.\31\ In the commenter's opinion, 
specialists would act as risk adverse intra-day ``flip traders'' who do 
not seek to hold positions. The Exchange disagreed with the commenter, 
and stated that it believed that its specialists would continue to 
assume risk by committing capital to cushion market volatility when 
other market participants are trading with the trend and destabilizing 
the price of the security.\32\ The Exchange believed that, in order for 
specialists to continue in this role, they must have the appropriate 
tools to compete.
---------------------------------------------------------------------------

    \31\ SeeRutherfurd Letter II.
    \32\ SeeNYSE Letter I, supra note 5, at 9.
---------------------------------------------------------------------------

    The Exchange argued that specialists are increasingly unable to 
compete in a tick-based rules environment given the significant changes 
in competitive forces, customer expectations, technology, and 
automation that have impacted the NYSE market in recent years and 
reduced the specialist's ability to direct or influence trading or 
control the quote. Notwithstanding the changes in the market place, 
NYSE's specialists will continue in the Hybrid Market to be required to 
commit capital and add liquidity in order to bridge gaps in supply and 
demand, reduce volatility,

[[Page 71225]]

and encourage stable prices.\33\ The Exchange believed that the current 
tick-based rules were ``appropriate for and worked well in a market 
where substantially all trading was conducted manually, at a pace that 
enabled individuals to discern `tick' changes easily and which 
tolerated the time it took to call a Floor Official into the Crowd to 
approve a specialist's proposed destabilizing transaction.'' \34\ The 
Exchange argued, however, that the current rules hinder the specialists 
from operating in the Hybrid Market, where trading is substantially 
electronic and the speed and frequency of executions and quote changes 
preclude individuals from being able to accurately track ``ticks'' or 
stop trading to allow for Floor Official involvement.\35\ The Exchange, 
therefore, believes that keeping the current tick-based rule would be 
inconsistent with Section 11A(a)(i)(C)(ii) of the Act, which promotes 
fair competition among brokers and dealers, among exchange markets, and 
between exchange markets and markets other than exchange markets.
---------------------------------------------------------------------------

    \33\ Id.
    \34\ Id. at 3-4.
    \35\ Id. at 4.
---------------------------------------------------------------------------

    The Exchange also disagreed with the commenter's suggestion that 
specialists have a monopoly on algorithmic trading or have access to 
electronic trading that creates an ``unlevel competitive playing 
field.'' \36\ The Exchange argued that its rules do not prevent market 
participants from employing algorithmic-based trading strategies in 
connection with round-lot trading and stated that, in fact, customers 
benefit from the use of e-Quotes and d-Quotes via their floor brokers 
and can create or purchase their own algorithmic systems to generate 
orders that can be entered via NYSE SuperDot[supreg].\37\ The Exchange 
stated that the Hybrid Market provides all market participants with the 
ability to trade electronically and that all orders entered on the 
Exchange would be executed, consistent with their instructions, in 
accordance with Exchange rules. The Exchange represented that no class 
of customers would be advantaged or disadvantaged by these rules 
because all market participants are afforded an opportunity to interact 
with published trading interest.\38\
---------------------------------------------------------------------------

    \36\ Id. at 11 (referencing Rutherfurd Letter II); see also 
Rutherfurd Letter III.
    \37\ See NYSE Letter I, supra note 5, at 11.
    \38\ Id.
---------------------------------------------------------------------------

    While the Exchange acknowledged that specialists occupy a unique 
position in relation to other market participants, the Exchange 
disagreed with the commenter that specialists continue to enjoy a time 
and place advantage.\39\ It noted that, for example, last sale prices 
and quotations are immediately available to all market participants and 
that the growth of internalization has allowed ``upstairs'' trading 
firms to have comparable informational advantages as the specialists 
but the firms are able to trade on their information instantaneously 
without restrictions.\40\ Also, NYSE argued that, while the 
specialists' algorithms have a slight informational advantage by having 
knowledge of orders as they enter NYSE systems, such knowledge does not 
deny other market participants an opportunity to interact with incoming 
orders. NYSE further notes that specialists' algorithmic ability to 
trade with incoming marketable orders is limited to providing price 
improvement or matching a better price posted by another market center. 
These trading opportunities are subject to competition by floor brokers 
who have a similar opportunity to interact with incoming orders via d-
Quotes.\41\ NYSE also noted that marketable CAP-DI orders automatically 
convert and trade along with specialist principal transactions.\42\ 
Accordingly, the Exchange argued that specialists' algorithms do not 
act as an impediment to competition among market participants. The 
Exchange, therefore, believes that the Stabilization Proposal and the 
amended interpretation of the negative obligations of specialists 
present an appropriately flexible approach that will allow specialists 
to continue to add value to the marketplace.
---------------------------------------------------------------------------

    \39\ Id. at 8.
    \40\ Id.
    \41\ Id.
    \42\ Id.
---------------------------------------------------------------------------

    Moreover, the Exchange argued that the current marketplace is 
dominated by professional traders--program traders, hedge funds, day 
traders, and institutions--employing algorithmic trading and smart 
order routers.\43\ Unlike in the past, NYSE specialists must now 
compete with upstairs liquidity providers, with multiple over-the-
counter dealers, crossing networks, and ECNs, as well as with NYSE 
floor brokers empowered with new, more effective, electronic order 
types.\44\ These market participants have the ability to trade on 
alternative systems while actively participating in trading on the 
Exchange. The Exchange stated that, unlike the Exchange specialists, 
none of these market participants have similar restrictions on their 
trading.
---------------------------------------------------------------------------

    \43\ Id.
    \44\ Id.
---------------------------------------------------------------------------

B. Negative Obligation

    The commenter argued that the transaction-by-transaction approach 
to determining the reasonable necessity of a specialist's proprietary 
trade is the only consistent interpretation of the negative obligation. 
According to the commenter, the negative obligation limits a 
specialist's ability to trade to those situations when there is a 
disparity in supply and demand and the specialist is needed to ensure 
appropriate trade-to-trade price continuity. In these situations, the 
commenter argued that the specialist is not restricted by the negative 
obligation and, in fact, is required to trade pursuant to the 
affirmative obligation. The commenter argued that supply and demand 
assessments arise in each particular trade, and thus the trade-by-trade 
approach should be maintained in its current form.\45\ The commenter 
believed that NYSE's proposal to reinterpret the negative obligation so 
that specialist trading is surveilled on a ``patterns and practices,'' 
rather than on a trade-by-trade basis, effectively results in a de 
facto rescission of the negative obligation.\46\ The commenter 
disagreed with the Exchange's assertions that specialists' trading 
privileges have been reduced, and that increased competition and 
automation support a new interpretation of the negative obligation. The 
commenter believed that specialists will enjoy a time and place 
advantage in the Hybrid Market ``far in excess of any that the 
specialist may have enjoyed in the physical auction.'' \47\ For 
example, the commenter stated that the specialist alone has knowledge 
of floor broker hidden public orders and can trade algorithmically to 
take advantage of material, non-public market information. For this 
reason, the commenter believed that the negative obligation in its 
current form will still be relevant and should be maintained. The NYSE 
responded that the specialists do not have the time and place advantage 
they once possessed. The Exchange argued that the dissemination of the 
consolidated quote and trade information and NYSE limit orders via 
OpenBook provide all investors with market information.\48\ In

[[Page 71226]]

addition, NYSE argued that the expansion of Direct+[supreg] and 
technology available to floor brokers have diminished the size and 
significance of the Crowd, and allows orders to be entered and executed 
at the best bid (offer) without human intervention.\49\ Further, the 
Exchange noted that quoting in pennies had reduced concentration of 
volume and average trade size.\50\ Finally, NYSE stated that the 
national market system order routing requirements have resulted in 
orders being executed on markets other than the market on which they 
were entered.\51\
---------------------------------------------------------------------------

    \45\ The commenter also argued that NYSE should propose to amend 
its Rule 104 and petition the Commission to amend Rule 11b-1 under 
the Act so that the rule text would clearly express NYSE's proposal.
    \46\ See Rutherfurd Letters I, II, III, IV, and V.
    \47\ See Rutherfurd Letters II and V.
    \48\ See NYSE Letter II, at 2.
    \49\ Id. at 3.
    \50\ Id.
    \51\ Id.
---------------------------------------------------------------------------

    The commenter also challenged the Exchange's arguments based on the 
legislative history of Section 11(b) of the Act.\52\ The commenter 
stated that NYSE ``continues to be the dominant, primary market in its 
stocks by a huge measure'' and believed that the Exchange's competitive 
position is much stronger today than it was in 1975, when Congress and 
the Commission declined to act on specialists' negative 
obligations.\53\ The NYSE disagreed with the commenter's argument. NYSE 
stated that competition has increased and that competition has, 
consequently, effected its market share.\54\ NYSE argued that increased 
internalization, the existence of alternative trading venues, and the 
ability of floor brokers to compete directly with specialists has 
resulted in increased competition to the specialist.\55\
---------------------------------------------------------------------------

    \52\ See Rutherfurd Letter II (referring to NYSE's excerpt of a 
Senate Report in SR-NYSE-2006-82: ``It might well be that with 
active competition among market makers and the elimination of 
trading advantages specialists now enjoy, such a restriction on 
specialists' dealings would become unnecessary.'' S. Rep. No. 94-75, 
at 100 (1975)).
    \53\ Id. See also Rutherfurd Letters III and V.
    \54\ See NYSE Letter II, at 2
    \55\ Id. at 3.
---------------------------------------------------------------------------

    The commenter also expressed concern about how the negative 
obligations would be measured and enforced. Further, the commenter 
believed that, even in a fast-moving Hybrid Market, a specialist's 
algorithm could easily be programmed to conform to the current trade-
by-trade negative obligation requirements. The commenter stated that 
NYSE's proposal to surveil compliance with the negative obligation on a 
patterns or practices basis is vague and questioned the effectiveness 
of looking at whether specialist trading causes or exacerbates 
excessive price movements. The commenter argued that a ``specialist 
cannot know whether subsequent trades that may be part of a `pattern' 
are necessary because subsequent order flow will dictate pricing, 
market direction, and, on a case-by-case basis, whether specialist 
intervention is appropriate as to any particular trade.'' \56\ 
According to the commenter, the ``problem with commingling `necessity' 
and `pattern' is that the broad pattern may arguably be okay if there 
is no unusual price movement, but many individual trades within the 
pattern may not be `necessary' at all. * * * '' \57\ In addition, the 
commenter believed that the ``patterns and practices'' surveillance 
standard was flawed in that each specialist would establish his or her 
own such standard, which the commenter believed could lead a specialist 
to trade more aggressively. The commenter also questioned NYSE's plan 
to monitor price movements as part of its surveillance of the negative 
obligation, because such examinations had historically been performed 
to measure the specialist's compliance with the affirmative obligation 
by looking at whether a specialist had failed to trade to counter the 
market trend.
---------------------------------------------------------------------------

    \56\ See Rutherfurd Letter II.
    \57\ Id.
---------------------------------------------------------------------------

    The Exchange believes that the trade-by-trade interpretation 
established seventy years ago no longer addresses the realities of the 
modern market. The Exchange emphasized that it is not proposing to 
eliminate the negative obligation or its reasonable necessity test. The 
Exchange noted that it is, instead, proposing to reinterpret the 
negative obligation's reasonable necessity test to eliminate the 
requirement that each trade must meet the test of reasonable necessity.
    The Exchange disagreed with the commenter's suggestion that a non-
trade-by-trade approach is unworkable, and will ultimately lead to 
customer disadvantage because specialists would engage in ``in and out 
profit taking that interferes with direct public interaction.'' \58\ 
The Exchange argued that such a pattern of trading would continue to 
violate the specialist's negative obligation, and that its revised 
approach will provide an appropriate regulatory check on 
specialists.\59\
---------------------------------------------------------------------------

    \58\ See NYSE Letter I, supra note 5, at 10 (citing Rutherfurd 
Letter II).
    \59\ Id.
---------------------------------------------------------------------------

C. Public Notice

    The commenter argued that the proposed rule change, as amended by 
Amendment No. 1 regarding the reinterpretation of the negative 
obligation of specialists, should be republished and the public comment 
period should be reset.\60\ In addition, the commenter urged the 
Commission to consider the proposal at a public hearing.\61\
---------------------------------------------------------------------------

    \60\ See Rutherfurd Letters I, II, III, IV, and V.
    \61\ See Rutherfurd Letters I, II, and III.
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the proposed rule change as modified by Amendment 
No. 1, including whether the proposal is consistent with the Act. 
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File No. SR-NYSE-2006-76 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-NYSE-2006-76. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (https://www.sec.gov/rules/
sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing also will be available for inspection and copying at the 
principal office of NYSE. All comments received will be posted without 
change; the Commission does not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly. All submissions should refer to File Number 
SR-NYSE-2006-76 and should be submitted on or before December 29, 2006.

[[Page 71227]]

V. Discussion and Commission Findings

    After careful consideration, 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 \62\ and, in particular, the requirements of 
Section 6 of the Act.\63\ Specifically, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\64\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, and 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. Finally, the Commission 
believes that the proposal is consistent with the principles set forth 
in Section 11A of the Act and the requirements of Rule 11b-1 under the 
Act.\65\
---------------------------------------------------------------------------

    \62\ In approving this proposed rule change, as amended, the 
Commission has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \63\ 15 U.S.C. 78f.
    \64\ 15 U.S.C. 78f(b)(5).
    \65\ 17 CFR 240.11b-1.
---------------------------------------------------------------------------

    Specialists' dealer activities are governed, in part, by the 
negative and affirmative trading obligations. Rule 11b-1 under the Act 
requires exchanges that permit members to register as specialists to 
have rules governing specialists' dealer transactions so that their 
proprietary trades conform to the negative and affirmative obligations. 
The negative obligation as set forth in Rule 11b-1 under the Act 
requires that a specialist's dealings be restricted, so far as 
practicable, to those reasonably necessary to permit the specialist to 
maintain a fair and orderly market.\66\ The affirmative obligation as 
set forth in Rule 11b-1 under the Act requires a specialist to engage 
in a course of dealings for its own account to assist in the 
maintenance, so far as practicable, of a fair and orderly market.\67\ 
NYSE has adopted these obligations in its Rule 104.\68\
---------------------------------------------------------------------------

    \66\ 17 CFR 240.11b-1(a)(2)(iii).
    \67\ 17 CFR 240.11b-1(a)(2)(ii).
    \68\ NYSE Rule 104(a) reflects NYSE's adoption of the negative 
obligation and states that ``no specialist shall effect on the 
Exchange purchases or sales of any security in which such specialist 
is registered, for any account in which he or his member 
organization * * * is directly or indirectly interested, unless such 
dealings are reasonably necessary to permit such specialist to 
maintain a fair and orderly market * * *''
---------------------------------------------------------------------------

    When debating the adoption of the Act, Congress considered barring 
the ability of exchange members to trade for their own accounts.\69\ 
Instead, pursuant to Section 11(e) of the Act, Congress directed the 
Commission to make a study of the feasibility and advisability of the 
completely segregating the functions of brokers and dealers.\70\ In 
1935, soon after the adoption of the Act, the Commission recommended 
that the national securities exchanges adopt sixteen rules to regulate 
trading on exchanges in order to eliminate some of the undesirable 
consequences of dealer activities.\71\ These rules were adopted by all 
the exchanges. The tenth rule (``Tenth Rule'') prohibited specialists 
from effecting purchases or sales for their registered securities 
unless such dealings were reasonably necessary to permit specialists to 
maintain a fair and orderly market.\72\
---------------------------------------------------------------------------

    \69\ Report of the Committee on Banking and Currency, Stock 
Exchange Practices, S. Rep. No. 1455 (1934), reprinted in 5 J.S. 
Ellenberger and Ellen P. Mahar, Legislative History of the 
Securities Act of 1933 and Securities Exchange Act of 1934 (2001), 
at 19-30.
    \70\ Commission, Report on the Feasibility and Advisability of 
the Complete Segregation of the Functions of Dealer and Broker (June 
20, 1936) (``Segregation Study'').
    \71\ The text of the recommended rules can be found at Appendix 
O-1 of the Segregation Study. See also Segregation Study at 60-64 
for a summary of the rules.
    \72\ The Tenth Rule stated: ``No specialist shall effect on the 
exchange purchases or sales of any security in which such specialist 
is registered, for any account in which he, or the firm of which he 
is a partner, or any partner of such firm, is directly or indirectly 
interested, unless such dealings are reasonably necessary to permit 
such specialist to maintain a fair and orderly market, or to act as 
an odd-lot dealer in such security.'' See Segregation Study Appendix 
O-1 at 169. See also NYSE Rule 104(a).
---------------------------------------------------------------------------

    ``This rule * * * represents an attempt to eliminate the dealer 
activities of specialists except insofar as such activities 
allegedly perform a useful service to the market. In view of the 
specialist's fiduciary obligation to buyers and sellers whose orders 
he has accepted for execution; in view of his special knowledge and 
superior bargaining power in trading for his own account; in view of 
his peculiar opportunities and motives for attracting public 
interest to the stock in which he specializes; and in view of the 
undesirable effect which his trading may exert upon the market; it 
was deemed essential by the Commission that the dealer functions of 
the specialist be subjected to stringent control. The rule was 
intended to allow him only sufficient latitude in his personal 
trading to enable him to maintain a fair and orderly market in the 
securities in which he is registered.'' \73\
---------------------------------------------------------------------------

    \73\ Id. at 63.

    In 1937, the Commission issued an interpretation (``Saperstein 
Interpretation'') to clarify various aspects of the Tenth Rule, which 
the exchanges believed to be unnecessary because of other, more general 
rules regarding specialists that the exchanges had already adopted.\74\ 
In the interpretation, the Commission emphasized that ``a mere showing 
that a transaction by a specialist for his own account had no 
undesirable effect, or even no discernible effect, upon the market'' 
was not enough to evidence compliance with the rule.\75\ The Saperstein 
Interpretation stated that the ``rule leaves no doubt that it prohibits 
all transactions for the account of a specialist, excepting only such 
transactions as are properly a part of a course of dealings reasonably 
necessary to permit the specialist to maintain a fair and orderly 
market * * *'' \76\ The Saperstein Interpretation thereafter stated 
that each transaction by a specialist for his own account must meet the 
test of reasonable necessity.\77\ The interpretation made clear that a 
specialist would be required to comply with the rule on a transaction-
by-transaction basis.
---------------------------------------------------------------------------

    \74\ Securities Exchange Act Release No. 1117, 1937 SEC LEXIS 
357 (March 30, 1937). The Saperstein Interpretation took the form of 
an interpretation by David Saperstein, then-Director of the 
Commission's Trading and Exchange Division, and was contained in a 
letter sent to the Presidents of the various exchanges having a 
specialist system, including NYSE and a predecessor to the American 
Stock Exchange.
    \75\ Saperstein Interpretation at 3-4.
    \76\ Id. at 4.
    \77\ Id.
---------------------------------------------------------------------------

    The Saperstein Interpretation also provided the basis for some of 
the current stabilization rules. Specifically, in the Interpretation, 
the Commission noted that certain transactions effected by a specialist 
when increasing or establishing a position tend to have a detrimental 
effect on the market and therefore would be commonly unjustifiable. 
These transactions included: (1) A purchase above the last sale price; 
(2) the purchase of all or substantially all the stock offered on the 
book at the last sale price; (3) the supplying of all or substantially 
all the stock bid for on the book at the last sale price; and (4) 
transactions that clean up the market in a manner that is similar to 
cleaning up the book. The Saperstein Interpretation noted that these 
transactions may be justifiable ``but only when they are an essential 
part of a course of dealings designed to promote the continuity and 
stability of the market and effected in an orderly manner.'' \78\
---------------------------------------------------------------------------

    \78\ Id. at 5.
---------------------------------------------------------------------------

    NYSE has proposed to amend its rules that restrict the ability of 
specialists to

[[Page 71228]]

trade with the trend of the market. NYSE has also asked the Commission 
to reinterpret the negative obligation to eliminate the requirement 
that each trade be measured against the reasonable necessity test. NYSE 
believes that specialists are an integral part of its market structure 
and that they perform important functions in the marketplace. NYSE 
believes that specialists will continue to contribute vitally to the 
Hybrid Market by committing capital and adding liquidity in order to 
bridge gaps in supply and demand, which can help to keep the market 
fair and orderly and reduce volatility. However, NYSE argues that with 
the anticipated increase in the volume of orders and speed of market 
activity as a result of the Hybrid Market and the implementation of 
Regulation NMS, its current rules restricting the ability of 
specialists to trade for their own account based upon the tick in 
relation to the last sale on the Exchange, as set forth in NYSE Rules 
104.10(5) and (6), are both unworkable and less relevant in determining 
whether a specialist's trading is consistent with the negative 
obligation. Instead, NYSE believes these rules may in fact hinder 
specialists' ability to maintain fair and orderly markets in the Hybrid 
environment.
    In addition, NYSE argues that the time and place and informational 
advantages traditionally enjoyed by specialists have been diminished. 
Prior to the Hybrid Market, the majority of orders that were executed 
on the Exchange were handled by the specialist. Specialists would have 
unique knowledge at the point of sale as to the extent of interest 
available in the market for execution. Under the Hybrid Market, all 
investors have access to the depth of the NYSE Book and will be able to 
access NYSE liquidity without the involvement of a specialist. Floor 
brokers and their customers also will be able to interact with incoming 
orders directly without the involvement of the specialist. This 
increased transparency and access gives all market participants, both 
on and off the floor, a greater ability to see and react to market 
changes.
    The Commission believes that these combined factors significantly 
change the market in which the NYSE specialist operates and justifies a 
new approach to regulating specialists' dealer trades so that they will 
be able to effectively perform their obligation to maintain a fair and 
orderly market. The Commission notes that specialists remain 
constrained by the negative obligation and that their proprietary 
trading must be limited to that reasonably necessary to maintain a fair 
and orderly market. Therefore, for the reasons discussed below, the 
Commission believes that NYSE's proposal to amend its stabilization 
rules is consistent with the Act. In addition, the Commission has 
decided to reinterpret the negative obligation to remove the obligation 
to measure each individual specialist trade against the test of 
reasonable necessity.

A. Negative Obligation

    In Amendment No. 1, the Exchange requested that the Commission 
reinterpret the reasonable necessity test found in the negative 
obligation to eliminate the trade-by-trade analysis that measures 
whether a specialist's proprietary trade is consistent with the 
negative obligation. As noted above, the negative obligation as set 
forth in Rule 11b-1 under the Act requires that a specialist's dealings 
be restricted, so far as practicable, to those reasonably necessary to 
permit the specialist to maintain a fair and orderly market.\79\
---------------------------------------------------------------------------

    \79\ 17 CFR 240.11b-1(a)(2)(iii).
---------------------------------------------------------------------------

    The commenter argued that the trade-by-trade requirement of the 
Saperstein Interpretation was the only consistent reading of reasonable 
necessity test. In addition, the commenter believed that, in the Hybrid 
Market, specialists will not experience a reduction in their 
advantages, but rather would enjoy advantages far in excess of those 
available to them in the floor-based auction environment.\80\ NYSE 
disagrees with the commenter's assertion and argues that specialists do 
not have the informational advantages they once possessed. 
Specifically, NYSE argues that market information is ``ubiquitous, 
readily available to all market participants as a result of 
consolidated quote and trade streams'' and OpenBook.\81\ NYSE also 
argued that ``the expansion of NYSE Direct+[supreg] and technology 
available to floor brokers has diminished the size and significance of 
the Crowd and enables orders entered into the Exchange system to 
execute at the best bid and offer without the need for human 
intervention.'' \82\
---------------------------------------------------------------------------

    \80\ The Commission notes that the commenter's assertion that 
specialists have the exclusive ability to trade with incoming 
marketable orders is incorrect. Floor brokers are permitted to 
execute against incoming marketable orders via d-Quotes. See NYSE 
Rule 70.25(b)(i). In addition, the commenter asserted that 
specialists have access to floor broker agency interest data. This 
statement is likewise inaccurate. Specialists' algorithms will not 
have access to such data. See NYSE Rule 104(c)(ii). Further, a floor 
broker may exclude its interest from aggregate floor broker interest 
that is disclosed to the specialist on the floor. See Rule 70.20(g).
    \81\ See NYSE Letter II, supra note 5.
    \82\ Id.
---------------------------------------------------------------------------

    The Commission agrees with NYSE that the national market system has 
changed greatly in the nearly seventy years since the Saperstein 
Interpretation was issued. The Commission believes that the trade-by-
trade standard that was established seventy years ago is unworkable in 
the current market environment. The high speed and volume of trading in 
today's market make impracticable a trade-by-trade determination by the 
specialist of whether a particular trade is reasonably necessary. 
Further, the Commission believes that the informational advantages that 
specialists once enjoyed have been diminished.
    The Commission believes that eliminating the trade-by-trade 
standard with respect to the negative obligation should enhance the 
specialist's ability to fulfill its obligation to maintain a fair and 
orderly market. The Commission believes that increased automation and 
competition--both within the Hybrid Market and in the markets 
generally--are significant factors, among others, that affect the 
ability of specialists to make a trade-by-trade analysis regarding 
their negative obligations. The Commission finds that permitting 
specialists to consider the reasonable necessity of their transactions 
under the negative obligation without a transaction-by-transaction 
test, is appropriate and consistent with the Act.\83\ The Commission 
emphasizes that it is not eliminating the negative obligation. 
Therefore, specialists must continue to assess their need to trade and 
limit their proprietary trades to those reasonably necessary to allow 
the specialist to maintain a fair and orderly market.
---------------------------------------------------------------------------

    \83\ The commenter believed that this ``reinterpretation'' of 
the Saperstein Interpretation should be done through a change to the 
text of NYSE Rules. The Commission believes this to be unnecessary, 
as the original Saperstein Interpretation, was communicated through 
a letter from then-Director Saperstein to the presidents of the 
various exchanges.
------------------------------------------------------

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.