Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing of Proposed Rule Change Relating to NYSE Rule 104.10 (“Dealings by Specialists”), 54499-54504 [E7-18828]

Download as PDF Federal Register / Vol. 72, No. 185 / Tuesday, September 25, 2007 / Notices yshivers on PROD1PC62 with NOTICES processed in NSCC’s Continuous Net Settlement (‘‘CNS’’) system. When NSCC revised and updated CNS in 2004 (referred to as the ‘‘CNS Rewrite’’), it provided the capability on any settlement day to take in and process transactions due for settlement that day provided the trades are recorded or compared prior to an established cut-off time in the morning.3 This capability is currently provided for as-of equity transactions but has not yet been expanded to as-of fixed income transactions.4 Rather, settlement of as-of fixed income corporate debt, municipal, and unit investment trust (‘‘UIT’’) trades (corporate debt, municipal, and UIT trades are collectively referred to as ‘‘CMU’’ trades) compared on or after their designated settlement date currently occurs on the business day following the day they are compared. Given that settlement risks associated with CMU trades would be reduced if they settled on an accelerated basis in the same manner that as-of equity trades are settled, NSCC is enhancing its fixed income processing to permit same day settlement of as-of fixed income transactions.5 To accomplish this, NSCC is amending Procedure II (Trade Comparison and Recording Service) so that CNS-eligible as-of CMU trades matched on or after their originally designated settlement date will be processed in CNS on the day they are submitted for comparison so long as they compare prior to the cut-off time established for same day settlement, which currently is 11:30 a.m.6 As-of trades not eligible for CNS processing will settle on a trade-for-trade basis. Trades that match after the designated cut-off time will continue to be assigned a settlement date of the next business day. In addition, because these trades are effectively guaranteed upon comparison, risk associated with the trades will be mitigated through the existing component of the Clearing Fund formula, as set forth in Procedure XV (Clearing Fund Formula and Other Matters), that is designed to mitigate the risk to NSCC associated with trades that are processed on a settlement cycle shorter than three days. Under this 3 Securities Exchange Act Release No. 50026 (July15, 2004), 69 FR 43650 [File No. SR–NSCC– 2004–01]. 4 NSCC’s systems did not have the capacity forsame day settling trades for fixed income transactions in 2004. 5 The settlement of cash and next day CMU tradeswhich are compared by NSCC will continue to be the responsibility of the parties to the trades. 6 In addition, references in Procedure VII (CNSAccounting Operation) that currently note that debt securities are not eligible for such accelerated settlement will be removed. VerDate Aug<31>2005 15:20 Sep 24, 2007 Jkt 211001 54499 component, activity specified for a shortened settlement cycle is isolated, and a charge is calculated.7 SECURITIES AND EXCHANGE COMMISSION III. Discussion [Release No. 34–56455; File No. SR–NYSE– 2007–83] Section 19(b) of the Act directs the Commission to approve a proposed rule change of a self-regulatory organization if it finds that such proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to such organization. Section 17A(b)(3)(F) of the Act requires that the rules of a clearing agency be designed to promote the prompt and accurate clearance and settlement of securities transactions.8 The Commission believes that NSCC’s rule change is consistent with this Section because it should facilitate the prompt and accurate clearance and settlement of securities by increasing automated trade processing and by expanding the types of trades eligible for CNS netting and NSCC settlement. IV. Conclusion On the basis of the foregoing, the Commission finds that the proposed rule change is consistent with the requirements of the Act and in particular Section 17A of the Act and the rules and regulations thereunder. In approving the proposed rule change, the Commission considered the proposal’s impact on efficiency, competition, and capital formation. It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (File No. SR– NSCC–2007–11) be and hereby is approved. For the Commission by the Division of Market Regulation, pursuant to delegated authority.9 Florence E. Harmon, Deputy Secretary. [FR Doc. E7–18825 Filed 9–24–07; 8:45 am] BILLING CODE 8010–01–P 7 The component calculates a charge based on theaverage of a member’s charges for the specified activity on the three days with the highest charges calculated for the specified activity over the most recent twenty day period. Securities Exchange Act Release No. 54816 (November 27, 2006), 71 FR 69604 [File No. SR–NSCC–2006–09]. 8 15 U.S.C. 78q–1(b)(3)(F). 9 17 CFR 200.30–3(a)(12). PO 00000 Frm 00083 Fmt 4703 Sfmt 4703 Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing of Proposed Rule Change Relating to NYSE Rule 104.10 (‘‘Dealings by Specialists’’) September 18, 2007. Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on September 14, 2007 the New York Stock Exchange LLC (‘‘NYSE’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘Commission’’ or ‘‘SEC’’) the proposed rule change as described in Items I, II, and III below, which Items have been substantially prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange is proposing to amend NYSE Rule 104.10 to: (i) Extend the duration of the pilot program applicable to Conditional Transactions as defined in Rule 104.10(6)(iv) to March 31, 2008; (ii) remove the ‘‘active securities’’ limitation on Conditional Transactions that establish or increase a specialist’s position and reach across the market to transact with the NYSE’s published quote; and (iii) make certain conforming changes to Rule 104.10(5). The text of the proposed rule change is available at NYSE, the Commission’s Public Reference Room, and http:// www.nyse.com. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the NYSE included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The NYSE has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. 1 15 2 17 E:\FR\FM\25SEN1.SGM U.S.C 78s(b)(1). CFR 240.19b–4. 25SEN1 54500 Federal Register / Vol. 72, No. 185 / Tuesday, September 25, 2007 / Notices A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change yshivers on PROD1PC62 with NOTICES 1. Purpose (1) Rule Filing History. On October 5, 2006, to coincide with the Exchange’s implementation of Phase III of the NYSE HYBRID MARKETSM, the NYSE began operating on a pilot basis, among other rules, changes to Rule 104.10 (‘‘Stabilization Rule’’).3 The Stabilization Rule governs specialists’ dealings in assigned stocks including restrictions on specialists’ ability to trade as a dealer in their assigned stocks. As will be described in greater detail below, the Stabilization Proposal provided additional opportunities for specialists to trade on a proprietary basis. On December 1, 2006, the Commission approved the Stabilization Proposal but required that subsection 104.10(6) of the Rule continue to operate as a pilot (‘‘Conditional Transactions’’) through June 30, 2007.4 (2) Summary of the Stabilization Proposal. Rule 104 governs specialist dealings in the market. Specialists’ transactions for their own accounts are subject to specific expectations of performance. These include a specialist’s affirmative and negative obligations. Pursuant to these obligations specialists have a duty to ensure that his or her principal transactions are designed to contribute to the maintenance of price continuity with reasonable depth. The affirmative obligation requires a registered specialist to maintain 3 See Securities Exchange Act Release No. 54578 (October 5, 2006), 71 FR 60216 (October 12, 2006) (SR–NYSE–2006–82). On October 6, 2006, NYSE specialist firms LaBranche & Co. and Kellogg Specialist Group commenced operating pursuant to the Stabilization Rule in two NYSE-listed securities, American Express Company (AXP) and Equity Office Property Trust (EOP), respectively. The operation of the Pilot implemented pursuant to SR–NYSE–2006–82 was later modified on October 13, 2006 to, among other things, clarify that Rule 104.10(6) was included in the operation of the Pilot. See Securities Exchange Act Release No. 54610 (October 16, 2006), 71 FR 62142 (October 23, 2006) (SR–NYSE–2006–84). The proposed amendments to the Stabilization Rule (collectively referred to herein as ‘‘Stabilization Proposal’’) were filed on September 22, 2006 in SR–NYSE–2006–76. On October 25, 2006, the Exchange amended SR–NYSE–2006–76 to clarify certain provisions of the proposal, which was ultimately approved by the Commission on December 1, 2006. See Securities Exchange Act Release No. 54860 (December 1, 2006), 71 FR 71221 (December 8, 2006) (SR–NYSE–2006–76). 4 See Securities Exchange Act Release No. 54860, supra note 3. On June 28, 2007 the Exchange filed with the Commission to extend the operation of the Stabilization Pilot until September 30, 2007. See Securities Exchange Act Release No. 55995 (June 29, 2007), 72 FR 37288 (July 9, 2007) (SR–NYSE– 2007–58). VerDate Aug<31>2005 15:20 Sep 24, 2007 Jkt 211001 adequate minimum capital based on his or her registered securities and use said capital to engage in a course of dealings for his or her own account to assist in the maintenance, so far as practicable, of a fair and orderly market.5 Thus, pursuant to the affirmative obligations, registered dealers on primary exchanges are required to commit the dealer’s capital in their registered securities in order to maintain a fair and orderly market. The negative obligation, which is part of Exchange Rule 104 requires that specialists allow public orders to be executed against each other without undue dealer intervention and that specialists not deal in a manner that is inconsistent with the overall objective of maintaining a fair and orderly market. Specifically, Rule 104(a) provides: 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, his member organization or any other member, allied member, or approved person, (unless an exemption with respect to such approved person is in effect pursuant to Rule 98) in such organization or officer or employee thereof 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. Thus, prior to the Stabilization Proposal, NYSE Rule 104.10(5) required that specialist proprietary transactions be effected in a reasonable and orderly manner in relation to the general market, the market in their assigned stocks, and the adequacy of the specialist’s position to the immediate and reasonably anticipated needs of the market. For example, a specialist was not permitted to effect a transaction that would acquire or increase a position unless it was necessary to render the specialist’s position adequate for the immediate or anticipated needs of the market. Specialists were precluded from purchasing stock at a price above the last sale (in the same trading session) or from 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 was higher than the previous, differently priced sale of stock on the Exchange). Rule 104.10(6) applied similar standards when a specialist was liquidating or reducing a position. A specialist could, however, effect these types of transactions with the approval of a floor official. The Stabilization Proposal retained the basic standard that a specialist’s dealings must be reasonably necessary 5 See PO 00000 17 CFR 240.11b–1. Frm 00084 Fmt 4703 Sfmt 4703 for the maintenance of a fair and orderly market, and that transactions that are with the trend of the market may have to be accompanied by appropriate reentry on the opposite side of the market. In place of the then existing last transaction or ‘‘tick’’ test, the Exchange proposed to identify four types of transactions: ‘‘Neutral,’’ ‘‘NonConditional’’ ‘‘Conditional’’ and ‘‘Prohibited.’’ Neutral Transactions are purchases or sales that liquidate or decrease a specialist’s position. These transactions must be effected in a fair and orderly manner to render the specialist position adequate to the market’s needs, consistent with the specialist’s negative obligations, but are not subject to price restrictions or to floor official approval. The obligation to maintain a fair and orderly market may require the specialist to enter the market on the opposite side, which could be the case if market conditions required the specialist to meet his affirmative obligations. The NYSE’s rationale for this change was based in part on the recognition that position-reducing transactions are beneficial to the market because the specialists are adding liquidity to the market. Non-Conditional Transactions are seven enumerated types of trades which increase or establish a position other than transactions that reach across the market.6 Specialists are permitted to effect these transactions without regard to price and without floor official approval. The NYSE believes that these transactions, because they reflect instances where an independent source establishes the price, are unlikely to create a conflict of interest or to ‘‘lead the market.’’ Even though these transactions may establish the bid or offer, they are initiated by other market participants and not by the specialist. The NYSE also believes that, in the Hybrid Market where trading is substantially electronic, the speed and frequency of executions and quote changes preclude the specialist from being able to track accurately price ticks or to allow for floor official involvement. Re-entry on the opposite side of the market may be required for 6 NYSE Rule 104.10(5)(i)(a)(II)(b) states that the transactions without regard to price may be made in order to: (i) Match another market’s better bid or offer price; (ii) bring the price of a security into parity with an underlying or related security or asset; (iii) add size to an independently established bid or offer on the exchange; (iv) purchase at the published bid price on the Exchange; (v) sell at the published offer price on the Exchange (vi) purchase or sell at a price between the Exchange published bid and published offer; and (vii) purchase below the published bid or sell below the published offer on the Exchange. E:\FR\FM\25SEN1.SGM 25SEN1 Federal Register / Vol. 72, No. 185 / Tuesday, September 25, 2007 / Notices yshivers on PROD1PC62 with NOTICES the specialist to meet its affirmative obligations or to maintain a fair and orderly market. Prohibited Transactions are certain transactions during the last 10 minutes of trading and are designed to prevent the specialist from setting the closing price. Conditional Transactions are specialists’ transactions in an active security that establishes or increases a position and reaches across the market to trade as the contra-side to the Exchange published bid or offer. Conditional transactions may only be executed in an ‘‘active security.’’ Active securities include those securities that are part of the S&P 500 Stock Index(c), securities trading on the Exchange during the first 5 trading days following their initial public offering, and securities declared to be active securities by a floor official.7 Conditional Transactions may have additional re-entry obligations pursuant to the rule. Specifically, pursuant to NYSE Rule 104.10(6)(iii) ‘‘Appropriate’’ re-entry means ‘‘re-entry on the opposite side of the market at or before the price participation point or the ‘‘PPP’’).8 Depending on the type of Conditional Transaction a specialist’s obligation to re-enter may be immediate or subject to the same re-entry conditions of NonConditional Transactions.9 In any event, 7 Pursuant to current NYSE Rule 104.10(6)(c), a Floor Official may designate a security active when such security has exhibited substantially greater than normal trading volume and is, in the Floor Official’s judgment likely to continue to sustain such higher volume during the remainder of the current trading session. 8 NYSE Rule 104.10(6)(iv)(a) provides that the PPP identifies the price at or before which a specialist is expected to re-enter the market after effecting a Conditional Transaction. PPPs are only minimum guidelines and compliance with them does not guarantee that a specialist is meeting its obligations. The Exchange issued guidance regarding PPPs in January 2007. See NYSE Member Education Bulletin 2007–1. 9 NYSE Rule 104.10(6)(iv)(c) requires immediate re-entry following Conditional Transactions that is: (I) A purchase that (1) reaches across the market to trade with an Exchange published offer that is above the last differently priced trade on the Exchange and above the last differently priced published offer on the Exchange, (2) is 10,000 shares or more or has a market value of $200,000 or more, and (3) exceeds 50% of the published offer size. (II) A sale that (1) reaches across the market to trade with an Exchange published bid that is below the last differently priced trade on the Exchange and below the last differently priced published bid on the Exchange, (2) is 10,000 shares or more or has a market value of $200,000 or more, and (3) exceeds 50% of the published bid size. Pursuant to current NYSE Rule 104.10(6)(v) Conditional Transactions that involve: (a) A specialist’s purchase from the Exchange published offer that is priced above the last differently-priced trade on the Exchange or above the last differently-priced published offer on the Exchange; and VerDate Aug<31>2005 15:20 Sep 24, 2007 Jkt 211001 Conditional Transactions remain subject to a specialist’s overall negative obligation as discussed above. Specialist transactions in securities not within the definition of ‘‘active’’ securities continue to be governed by the ‘‘tick test’’ and floor official approval requirements described above that are now set forth in Rule 104.10(5)(i)(B)(I). In the Stabilization Proposal, the Exchange asserted that it believed the types of transactions described above were suitable for all securities. While the Commission acknowledged the considerable changes in the national market system, it stated that it believed that the Stabilization Proposal represented a significant change in the roles and obligations of specialist at the Exchange and thus required that the NYSE to implement the proposed Conditional Transactions only for active securities as a pilot.10 The Commission further stated that, before it decided whether to extend the operation of the rule or to approve the rule on a permanent basis, it would require the NYSE to provide data and analysis on the impact of the rule change.11 (3) The Exchange’s Analysis of the Conditional Transaction Pilot. The Exchange has closely monitored its market quality as it made changes to its operations, including the implementation of the Hybrid Market and the pilot that allowed specialists to effect Conditional Transactions. The Exchange has performed a review 12 of the market quality for the period July 1, 2006 to September 30, 2006, compared to the market quality for the period from April 1, 2007 through June 30, 2007 and the NYSE states that its review shows that overall there has been a narrowing (b) A specialist’s sale to the Exchange published bid that is priced below the last differently-priced trade on the Exchange or below the last differentlypriced published bid on the Exchange are subject to the re-entry requirements for Non-Conditional Transactions pursuant to NYSE Rule 104.10(5)(i)(a)(II)(c). Rule 104.10(5)(i)(a)(II)(c) provides: Re-entry Obligation Following Non-Conditional Transactions—The specialist’s obligation to maintain a fair and orderly market may require reentry on the opposite side of the market trend after effecting one or more Non-Conditional Transactions. Such re-entry transactions should be commensurate with the size of the Non-Conditional Transactions and the immediate and anticipated needs of the market. 10 See Securities Exchange Act Release No. 54860, supra note 3, at 71230. 11 Id. 12 See Appendix 3A, which is available on the NYSE Web site at the following link: http:// www.nyse.com/Frameset.html?displayPage=http:// apps.nyse.com/commdata/pub19b4.nsf/ rulefilings?openview. Appendix 3A is also available on the Commission Web site at http://www.sec.gov/rules/sro/ nyse.shtml. PO 00000 Frm 00085 Fmt 4703 Sfmt 4703 54501 of the effective spread for marketable orders and a lowering of volatility. The percentage of trades executed automatically substantially increased. Other indicators remained generally the same except for the percentage of times that the NYSE set the National Best Bid or Offer. In addition, the Exchange reviewed data related to the specialists’ re-entry requirement. Specifically, the Exchange reviewed the specialist’s re-entry quote and execution activity on the opposite side of the market at 30-second and oneminute intervals for the month of April 2007. The Exchange states that the data showed that specialists effected Conditional Transactions sparingly and that, in those instances where specialists effected Conditional Transactions, the data showed that specialist overall complied with their obligations to re-enter liquidity on the opposite side of the market. The Exchange further compared the 84 securities that are listed on the NYSE and are included in the S&P 500 index (‘‘S&P 500’’) operating in the Conditional Transaction Pilot that that had the lowest consolidated volume for the months of March and April 2007. The 84 securities were divided into two deciles containing 42 securities per decile. The Exchange created a matched sample for these two deciles by finding other NYSE-listed securities not included in the S&P 500 (‘‘non-S&P 500’’) that had comparable consolidated volumes, Volume Weighted Average Price (‘‘VWAP’’) and market capital.13 The Exchange believes that its review showed that there was no discernible difference between the change in market quality in the lowest two deciles of the S&P 500 securities operating pursuant to the Conditional Transaction Pilot as compared to similar securities in the non-S&P 500 securities. The Exchange noted a difference in the market quality statistics for the S&P 500 securities as compared to the non-S&P 500 matched sample. However, upon further review, the Exchange noted that the differences were present both before and after the Conditional Transaction Pilot, which suggests that a factor other than the Conditional Transaction Pilot was the cause of the noted difference. The Exchange believes that the most probable cause of the noted difference was the inclusion in the S&P 500. The 13 See Appendices 3B and 3C, which are available on the NYSE Web site at the following link: http:// www.nyse.com/Frameset.html?displayPage=http:// apps.nyse.com/commdata/pub19b4.nsf/ rulefilings?openview. Appendices 3B and 3C are also available on the Commission Web site at http://www.sec.gov/rules/ sro/nyse.shtml. E:\FR\FM\25SEN1.SGM 25SEN1 yshivers on PROD1PC62 with NOTICES 54502 Federal Register / Vol. 72, No. 185 / Tuesday, September 25, 2007 / Notices stocks in the S&P 500 appear to have inherently different market quality characteristics from those not in the S&P 500. The changes in market quality were similar for both groups. The Exchange therefore believes that the Conditional Transaction Pilot was not the cause of the market quality differences in the samples. Therefore, the Exchange believes that the data supports the conclusion that the Conditional Transaction Pilot has not had a detrimental effect on market quality. Thus, in analyzing the data related to the Conditional Transaction Pilot, the Exchange believes that it is clear that specialists have acted appropriately in regard to Conditional Transactions and have re-entered the market as required, with no discernable adverse impact on liquidity or market quality. The Exchange therefore believes that Conditional Transaction Pilot should be modified to include all stocks traded on the NYSE. (4) Inclusion of All NYSE Traded Securities in the Conditional Transaction Pilot. The NYSE now seeks approval to extend the term of the Conditional Transaction Pilot to March 31, 2008 and to make it applicable to all securities traded on the NYSE. As explained more fully below, the Exchange believes that it is appropriate to provide specialists the same ability to effect Conditional Transactions in all securities traded on the Exchange. (5) Importance of the Specialist Role to the NYSE’s Hybrid Market Model. The Exchange states that the specialist is critical to the NYSE’s Hybrid Market model. Advances in technology have virtually obviated the specialists’ time and place advantage. The rate of trading participation by specialists in specialist stocks has been significantly reduced. Therefore, the Exchange believes that the basis for concern over specialist conflicts of interest (and the consequent ability to trade to the detriment of the public) is also diminished. The NYSE believes that these factors and specialist re-entry obligations support the expansion of specialists trading opportunities in all of the securities traded on the NYSE. The amendments to NYSE Rule 104.10(5) and (6) in this filing should be seen as part of the NYSE’s goal of providing the market with the ability to seek the best price by submitting orders to a traditional floor-based auction process or by obtaining virtually instantaneous execution in an electronic platform. The NYSE believes that specialists play a critical role in achieving this goal, but it is in many ways a different role from the VerDate Aug<31>2005 15:20 Sep 24, 2007 Jkt 211001 ‘‘traditional’’ function of specialists prior to implementation of the NYSE’s current market structure. The Exchange states that, most importantly, it has attempted to balance concerns over the potential conflict of interest between specialists’ agency function in the auction process and the specialists’ ability (and need) to trade for their own account as a dealer. The Exchange believes that specialists provide an extraordinary benefit to the NYSE market by using their capital to cushion market volatility. Specialists’ capital commitment provides depth, and lowers volatility and overall execution costs for investors. Furthermore, specialists add liquidity to the market when there is little or no liquidity, bridging the gap between supply and demand by purchasing when no one else is buying and by overall maintaining a fair and orderly market. In order for specialists to continue providing that benefit, they must be allowed greater flexibility in trading for their dealer accounts to be competitive with other market participants in times of market stability so that they may be adequately positioned to step in during times of market instability. The Exchange believes that the ability of the specialists to effect Conditional Transactions allows specialists, to a greater degree, to manage the inventory of the dealer account to provide more liquidity against the market trend and thus moderate volatility. Moreover, the NYSE believes human judgment is particularly valuable in less liquid securities because the service provided by specialists is even more critical during the opening and closing of trading in such securities, particularly in times of uncertainty such as when an earnings surprise, news, or an outside event leads to market volatility and/or instability. In these cases, the specialists’ trading judgment, exercised in carrying out their affirmative obligations, results in reduced volatility and more stable prices. But while the Hybrid Market is intended to combine the benefits of specialist and floor broker expertise with the speed, certainty and anonymity of electronic executions, implementation of this system has created a significantly different trading environment for specialists. Historically, the NYSE specialist’s unique dual role as broker and dealer afforded him or her an informational advantage over other market participants because, in that role, the specialists served as the main conduit of the order flow information in his or her PO 00000 Frm 00086 Fmt 4703 Sfmt 4703 subject security. As a result of this information advantage, specialists trading for their own account were constrained by affirmative and negative obligations. Today, the Exchange believes that there is a virtual elimination of the informational advantage of the specialist. Certain order types that previously required specialist intervention for execution are now handled systemically and automatically. For example, in December 2006 the Exchange changed its stop order handling process to make stop orders no longer visible to the part of the Display Book that the specialist ‘‘sees.’’ 14 Currently, when a transaction on the Exchange results in the election of a stop order that had been received prior to such transaction, the elected stop order is sent as a market order to the Display Book and the specialist’s system employing algorithms where it is handled in the same way as any other market order. The specialist therefore has no information regarding the status of stop orders. Moreover, the quantity and quality of information that is available solely to the specialist has decreased. In the auction market, the specialist had information about all orders on the Display Book and also received information from the Crowd. Floor Brokers, Registered Competitive Market Makers (‘‘RCMMs’’) and Competitive Traders (‘‘CTs’’) all interacted verbally with the specialists and each other in the Crowd at the trading post for each security. Through this interaction and the proximity of the other market participants, the specialist was in possession of information not readily available to all other market participants. In his or her position, the specialist had information directly from the Crowd and the Display Book. Additionally, the specialist was able to glean incidental information based on his or her observation of the communication between other market participants. Currently, the Hybrid Market provides Floor brokers with electronic trading tools that have resulted in less personal and verbal interaction between Floor brokers and specialists.15 A Floor broker is now able to electronically represent his or her customer’s interest through the use of e-quotes and d-quotes. 14 See Securities Exchange Act Release No. 54820 (November 27, 2006), 71 FR 70824 (December 6, 2006) (SR–NYSE–2006–65) (clarifying certain definitions and the systematic processing of certain orders in the Hybrid Market). 15 Currently, approximately 90% of the transactions executed on the Exchange are done through electronic executions. E:\FR\FM\25SEN1.SGM 25SEN1 Federal Register / Vol. 72, No. 185 / Tuesday, September 25, 2007 / Notices yshivers on PROD1PC62 with NOTICES Moreover, the electronic representation need not take place directly in front of the post and panel where the security is traded as the Exchange definition of Crowd has expanded the physical area encompassed in a Crowd. Today, a Crowd is one of three trading zones which is one of the three trading rooms operating as part of the NYSE Floor. The verbal information the specialist was once able to obtain from Floor broker’s expressed interest is greatly reduced. Moreover, the Exchange believes that the observations of Crowd to Crowd transactions offer little if any information to the specialists. A specialist at a trading post is unable to know with any degree of certainty the security being traded by Floor brokers electronically bidding and offering in front of him or her. The Exchange believes that the reduced ability of a specialist to glean market information because a specialist’s intervention is no longer required to receive an execution, the specialist’s inability to see stop orders and the dramatic increase in transparency with respect to the Display Book through, among other things, Exchange initiatives like Exchange OPENBOOKTM make it clear that the specialist no longer possesses an information advantage over other market participants. In fact, it may be argued that the specialist has less information than some market participants with the increased internalization of orders. Often prior, to orders being sent to an exchange for execution, the broker-dealer will ‘‘shop’’ the order. In some instances, the brokerdealer will execute all or part the customer order against its principal account with any residual being sent to an exchange for execution. Internalization of order flow limits price discovery and does not result in transparency. As such, the specialist can be said, in certain instances, to be at an informational disadvantage to other market participants. The Exchange states that in approving the Stabilization Proposal, the Commission agreed with the Exchange that trade-by-trade negative compliance obligations previously embodied in the so-called Saperstein Interpretation16 established seventy years ago no longer address the realities of the modern market. The Commission’s approval order stated: 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 trade-by-trade analysis regarding their negative obligations. The Commission finds that permitting specialists to consider the reasonable necessity of their transactions under negative obligations without a transaction-by-transaction test, is appropriate and consistent with the Act. The Commission emphasizes that it is not eliminating the negative obligation (footnote omitted). Therefore, specialists must continue to assess their need to trade and limit their proprietary trades to those reasonably necessary to allow the specialists to maintain a fair and orderly market.17 The Commission believes that eliminating the trade-by-trade standard with respect to the negative obligation should enhance the specialists’ ability to fulfill its obligation to The re-interpretation of the Saperstein letter thus moved away from defining stabilization in terms of the last sale to focus on market conditions, the type of trade in question and the specialists’ existing position. The Exchange’s proposal to allow specialists to effect Conditional Transactions in all securities is a request to further address the realities of the current market. The Exchange states that it does not in any way reduce the obligations imposed on them pursuant to NYSE Rule 104 to re-enter a transaction on the opposite side of the market and their negative obligation. The Exchange believes that these critically distinguishing obligations imposed on NYSE specialists, coupled with the empirical evidence that, when given the opportunity to effect Conditional Transactions in less liquid securities there is no discernable diminishment of market quality, justifies the extension of the specialist ability to effect Conditional Transactions in all securities. For the reasons stated above, the Exchange believes that extending the ability of the specialist to effect Conditional Transactions to all securities will allow specialists to more effectively meet their affirmative and negative obligations by giving them the tools to better manage the inventory of the dealer account. (6) Exchange Continued Data Provision to the Commission. The Exchange represents that it will continue to provide the Division of Market Regulation and the Office of Economic Analysis with statistics related to market quality, specialist trading activity and sample statistics. The sample statistics include the daily Consolidated Tape volume in shares, daily number of trades, daily high-low 16 Securities Exchange Act Release No. 1117, 1937 SEC LEXIS 357 (March 30, 1937). 17 See Securities Exchange Act Release No. 54860, supra note 3. VerDate Aug<31>2005 15:20 Sep 24, 2007 Jkt 211001 PO 00000 Frm 00087 Fmt 4703 Sfmt 4703 54503 volatility in basis points, and daily close price in dollars. The Exchange will also calculate the specialist profit on round-trip Hit Bid and Take Offer (‘‘HB/TO’’) executions. This will be accomplished by measuring the specialist profit on HB/TO activity by taking the round-trip trading profits for all HB/TO trades where the specialist executes an offsetting trade within 30 seconds. In cases where the volume of the offsetting execution is less than the size of the HB/TO execution, the calculation will only include profits realized within the 30second window. The Exchange will further calculate the quote-based specialist re-entry ratio. Each re-entry price level will be categorized and reported separately. For example, if the specialist buys from the offer at $50.00 and then re-enters at $50.01, then this is categorized as a one cent re-entry. Similarly, if the specialist buys from the offer at $50.00 and then re-enters at $50.02, then this is categorized as a two cent re-entry. The categories will be in cent intervals at 0, 1, 2, 3, 4, and 5 or more cents. The time window for these calculations will also be in 30 seconds. In addition, the Exchange will provide the Commission with data related to the average realized spread on specialist HB/TO executions. These calculations will be done using the same formula as Rule 605 of Regulation NMS under the Act.18 Specifically, the average realized spread should be a share-weighted average of realized spreads. For specialist buys, it is double the amount of difference between the execution price and the midpoint of the consolidated best bid and offer five minutes after the time of HB/TO execution. For specialist sells, it is double the amount of difference between the midpoint of the consolidated best bid and offer five minutes after the time of HB/TO execution and the execution price. All of the aforementioned information will be provided to the Commission on a monthly basis. The Exchange represents that it will also maintain average measures for each stock-day during a particular month in order to provide such information to the Commission upon request. (7) Surveillance. As noted in the NYSE’s original Stabilization Rule filing, NYSE Regulation (‘‘NYSER’’) believes that it has appropriate surveillance procedures in place to surveil for compliance with the negative obligations of specialists. NYSER monitors, using a pattern and 18 17 E:\FR\FM\25SEN1.SGM CFR 242.605. 25SEN1 54504 Federal Register / Vol. 72, No. 185 / Tuesday, September 25, 2007 / Notices yshivers on PROD1PC62 with NOTICES practice and/or outlier approach, specialist activity that appears to cause or exacerbate excessive price movement in the market (since such transactions would appear to be in violation of a specialist’s negative obligation). In this connection, NYSER surveils for specialist compliance with the PPP reentry requirements and, based on its preliminary reviews of surveillance data, has not identified significant compliance issues to date. The Division of Market Surveillance of NYSER also monitors specialist trading to cushion such price movements. (8) Conclusion. The Exchange seeks to be able to modify and change its business model in order to continue to improve market quality. If the Exchange is to do this then it must be allowed to provide the specialists that operate on the Exchange with the flexibility to compete. The Exchange believes that this flexibility can be achieved by extending the specialists ability to effect Conditional Transactions in all securities. The Exchange believes that its current stabilization rules do not afford specialists trading on the NYSE the necessary flexibility to manage the dealer account inventory. The Exchange believes that these rules are antiquated and inconsistent with the electronic trading environment that has virtually eliminated the specialists’ agency role and information advantage. The Exchange believes that the proposed amendments regarding specialists’ ability to effect Conditional Transactions will allow specialists on the Exchange to efficiently and systematically trade and quote in their securities and thus be in a position to fluidly manage their risk. Providing the specialists with the required flexibility to compete will add value to the Exchange market by encouraging them to continue to commit capital, thus benefiting the marketplace by increasing liquidity at prices outside the best bid and offer, bridging temporary gaps in supply and demand, and dampening volatility. Given all the above, the NYSE believes that allowing specialists to effect Conditional Transactions in all securities on pilot basis until March 31, 2008 is appropriate at this time. 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. The proposed rule change also is designed to support the principles of Section 11A(a)(1) 20 under the Act in that it seeks to assure economically efficient execution of securities transactions. 2. Statutory Basis The Exchange believes that the basis under the Act for this proposed rule change is the requirement under Section 6(b)(5) 19 of the Act that an Exchange have rules that are designed to promote just and equitable principles of trade, to Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: 19 15 U.S.C. 78f(b)(5). VerDate Aug<31>2005 15:20 Sep 24, 2007 B. Self-Regulatory Organization’s Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others The Exchange states that the proposed rule change was developed in response to concerns expressed by certain member organizations. During the drafting of the rule filing and proposed rule, those member organizations reviewed an initial draft and provided the Exchange with written comments relating to specialists’ obligations and actions during periods of instability. The Exchange states that it has incorporated these comments into the final rule proposal, but the Exchange has neither solicited nor received written comments on the final proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) As the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the NYSE consents, the Commission will: (A) By order approve such proposed rule change, or (B) Institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments 20 15 Jkt 211001 PO 00000 U.S.C. 78k–1(a)(1). Frm 00088 Fmt 4703 Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–NYSE–2007–83 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F. Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NYSE–2007–83. 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 (http://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, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. 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–2007–83 and should be submitted on or before October 16, 2007. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.21 Florence E. Harmon, Deputy Secretary. [FR Doc. E7–18828 Filed 9–24–07; 8:45 am] BILLING CODE 8010–01–P 21 17 Sfmt 4703 E:\FR\FM\25SEN1.SGM CFR 200.30–3(a)(12). 25SEN1

Agencies

[Federal Register Volume 72, Number 185 (Tuesday, September 25, 2007)]
[Notices]
[Pages 54499-54504]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-18828]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56455; File No. SR-NYSE-2007-83]


Self-Regulatory Organizations; New York Stock Exchange LLC; 
Notice of Filing of Proposed Rule Change Relating to NYSE Rule 104.10 
(``Dealings by Specialists'')

September 18, 2007.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 14, 2007 the New York Stock Exchange LLC (``NYSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') the proposed rule change as described in 
Items I, II, and III below, which Items have been substantially 
prepared by the Exchange. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend NYSE Rule 104.10 to: (i) Extend 
the duration of the pilot program applicable to Conditional 
Transactions as defined in Rule 104.10(6)(iv) to March 31, 2008; (ii) 
remove the ``active securities'' limitation on Conditional Transactions 
that establish or increase a specialist's position and reach across the 
market to transact with the NYSE's published quote; and (iii) make 
certain conforming changes to Rule 104.10(5). The text of the proposed 
rule change is available at NYSE, the Commission's Public Reference 
Room, and http://www.nyse.com.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NYSE included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The NYSE has prepared summaries, set forth in sections 
A, B, and C below, of the most significant aspects of such statements.

[[Page 54500]]

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    (1) Rule Filing History.
    On October 5, 2006, to coincide with the Exchange's implementation 
of Phase III of the NYSE HYBRID MARKET\SM\, the NYSE began operating on 
a pilot basis, among other rules, changes to Rule 104.10 
(``Stabilization Rule'').\3\ The Stabilization Rule governs 
specialists' dealings in assigned stocks including restrictions on 
specialists' ability to trade as a dealer in their assigned stocks. As 
will be described in greater detail below, the Stabilization Proposal 
provided additional opportunities for specialists to trade on a 
proprietary basis. On December 1, 2006, the Commission approved the 
Stabilization Proposal but required that subsection 104.10(6) of the 
Rule continue to operate as a pilot (``Conditional Transactions'') 
through June 30, 2007.\4\
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    \3\ See Securities Exchange Act Release No. 54578 (October 5, 
2006), 71 FR 60216 (October 12, 2006) (SR-NYSE-2006-82). On October 
6, 2006, NYSE specialist firms LaBranche & Co. and Kellogg 
Specialist Group commenced operating pursuant to the Stabilization 
Rule in two NYSE-listed securities, American Express Company (AXP) 
and Equity Office Property Trust (EOP), respectively.
    The operation of the Pilot implemented pursuant to SR-NYSE-2006-
82 was later modified on October 13, 2006 to, among other things, 
clarify that Rule 104.10(6) was included in the operation of the 
Pilot. See Securities Exchange Act Release No. 54610 (October 16, 
2006), 71 FR 62142 (October 23, 2006) (SR-NYSE-2006-84).
    The proposed amendments to the Stabilization Rule (collectively 
referred to herein as ``Stabilization Proposal'') were filed on 
September 22, 2006 in SR-NYSE-2006-76. On October 25, 2006, the 
Exchange amended SR-NYSE-2006-76 to clarify certain provisions of 
the proposal, which was ultimately approved by the Commission on 
December 1, 2006. See Securities Exchange Act Release No. 54860 
(December 1, 2006), 71 FR 71221 (December 8, 2006) (SR-NYSE-2006-
76).
    \4\ See Securities Exchange Act Release No. 54860, supra note 3. 
On June 28, 2007 the Exchange filed with the Commission to extend 
the operation of the Stabilization Pilot until September 30, 2007. 
See Securities Exchange Act Release No. 55995 (June 29, 2007), 72 FR 
37288 (July 9, 2007) (SR-NYSE-2007-58).
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    (2) Summary of the Stabilization Proposal.
    Rule 104 governs specialist dealings in the market. Specialists' 
transactions for their own accounts are subject to specific 
expectations of performance. These include a specialist's affirmative 
and negative obligations. Pursuant to these obligations specialists 
have a duty to ensure that his or her principal transactions are 
designed to contribute to the maintenance of price continuity with 
reasonable depth.
    The affirmative obligation requires a registered specialist to 
maintain adequate minimum capital based on his or her registered 
securities and use said capital to engage in a course of dealings for 
his or her own account to assist in the maintenance, so far as 
practicable, of a fair and orderly market.\5\ Thus, pursuant to the 
affirmative obligations, registered dealers on primary exchanges are 
required to commit the dealer's capital in their registered securities 
in order to maintain a fair and orderly market.
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    \5\ See 17 CFR 240.11b-1.
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    The negative obligation, which is part of Exchange Rule 104 
requires that specialists allow public orders to be executed against 
each other without undue dealer intervention and that specialists not 
deal in a manner that is inconsistent with the overall objective of 
maintaining a fair and orderly market. Specifically, Rule 104(a) 
provides:

    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, his member organization or any other member, allied 
member, or approved person, (unless an exemption with respect to 
such approved person is in effect pursuant to Rule 98) in such 
organization or officer or employee thereof 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.

    Thus, prior to the Stabilization Proposal, NYSE Rule 104.10(5) 
required that specialist proprietary transactions be effected in a 
reasonable and orderly manner in relation to the general market, the 
market in their assigned stocks, and the adequacy of the specialist's 
position to the immediate and reasonably anticipated needs of the 
market. For example, a specialist was not permitted to effect a 
transaction that would acquire or increase a position unless it was 
necessary to render the specialist's position adequate for the 
immediate or anticipated needs of the market. Specialists were 
precluded from purchasing stock at a price above the last sale (in the 
same trading session) or from 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 was higher than the previous, differently 
priced sale of stock on the Exchange). Rule 104.10(6) applied similar 
standards when a specialist was liquidating or reducing a position. A 
specialist could, however, effect these types of transactions with the 
approval of a floor official.
    The Stabilization Proposal retained the basic standard that a 
specialist's dealings must be reasonably necessary for the maintenance 
of a fair and orderly market, and that transactions that are with the 
trend of the market may have to be accompanied by appropriate re-entry 
on the opposite side of the market. In place of the then existing last 
transaction or ``tick'' test, the Exchange proposed to identify four 
types of transactions: ``Neutral,'' ``Non-Conditional'' ``Conditional'' 
and ``Prohibited.''
    Neutral Transactions are purchases or sales that liquidate or 
decrease a specialist's position. These transactions must be effected 
in a fair and orderly manner to render the specialist position adequate 
to the market's needs, consistent with the specialist's negative 
obligations, but are not subject to price restrictions or to floor 
official approval. The obligation to maintain a fair and orderly market 
may require the specialist to enter the market on the opposite side, 
which could be the case if market conditions required the specialist to 
meet his affirmative obligations. The NYSE's rationale for this change 
was based in part on the recognition that position-reducing 
transactions are beneficial to the market because the specialists are 
adding liquidity to the market.
    Non-Conditional Transactions are seven enumerated types of trades 
which increase or establish a position other than transactions that 
reach across the market.\6\ Specialists are permitted to effect these 
transactions without regard to price and without floor official 
approval. The NYSE believes that these transactions, because they 
reflect instances where an independent source establishes the price, 
are unlikely to create a conflict of interest or to ``lead the 
market.'' Even though these transactions may establish the bid or 
offer, they are initiated by other market participants and not by the 
specialist. The NYSE also believes that, in the Hybrid Market where 
trading is substantially electronic, the speed and frequency of 
executions and quote changes preclude the specialist from being able to 
track accurately price ticks or to allow for floor official 
involvement. Re-entry on the opposite side of the market may be 
required for

[[Page 54501]]

the specialist to meet its affirmative obligations or to maintain a 
fair and orderly market.
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    \6\ NYSE Rule 104.10(5)(i)(a)(II)(b) states that the 
transactions without regard to price may be made in order to: (i) 
Match another market's better bid or offer price; (ii) bring the 
price of a security into parity with an underlying or related 
security or asset; (iii) add size to an independently established 
bid or offer on the exchange; (iv) purchase at the published bid 
price on the Exchange; (v) sell at the published offer price on the 
Exchange (vi) purchase or sell at a price between the Exchange 
published bid and published offer; and (vii) purchase below the 
published bid or sell below the published offer on the Exchange.
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    Prohibited Transactions are certain transactions during the last 10 
minutes of trading and are designed to prevent the specialist from 
setting the closing price.
    Conditional Transactions are specialists' transactions in an active 
security that establishes or increases a position and reaches across 
the market to trade as the contra-side to the Exchange published bid or 
offer. Conditional transactions may only be executed in an ``active 
security.'' Active securities include those securities that are part of 
the S&P 500 Stock Index\(c)\, securities trading on the Exchange during 
the first 5 trading days following their initial public offering, and 
securities declared to be active securities by a floor official.\7\
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    \7\ Pursuant to current NYSE Rule 104.10(6)(c), a Floor Official 
may designate a security active when such security has exhibited 
substantially greater than normal trading volume and is, in the 
Floor Official's judgment likely to continue to sustain such higher 
volume during the remainder of the current trading session.
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    Conditional Transactions may have additional re-entry obligations 
pursuant to the rule. Specifically, pursuant to NYSE Rule 
104.10(6)(iii) ``Appropriate'' re-entry means ``re-entry on the 
opposite side of the market at or before the price participation point 
or the ``PPP'').\8\ Depending on the type of Conditional Transaction a 
specialist's obligation to re-enter may be immediate or subject to the 
same re-entry conditions of Non-Conditional Transactions.\9\ In any 
event, Conditional Transactions remain subject to a specialist's 
overall negative obligation as discussed above.
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    \8\ NYSE Rule 104.10(6)(iv)(a) provides that the PPP identifies 
the price at or before which a specialist is expected to re-enter 
the market after effecting a Conditional Transaction. PPPs are only 
minimum guidelines and compliance with them does not guarantee that 
a specialist is meeting its obligations. The Exchange issued 
guidance regarding PPPs in January 2007. See NYSE Member Education 
Bulletin 2007-1.
    \9\ NYSE Rule 104.10(6)(iv)(c) requires immediate re-entry 
following Conditional Transactions that is:
    (I) A purchase that (1) reaches across the market to trade with 
an Exchange published offer that is above the last differently 
priced trade on the Exchange and above the last differently priced 
published offer on the Exchange, (2) is 10,000 shares or more or has 
a market value of $200,000 or more, and (3) exceeds 50% of the 
published offer size.
    (II) A sale that (1) reaches across the market to trade with an 
Exchange published bid that is below the last differently priced 
trade on the Exchange and below the last differently priced 
published bid on the Exchange, (2) is 10,000 shares or more or has a 
market value of $200,000 or more, and (3) exceeds 50% of the 
published bid size.
    Pursuant to current NYSE Rule 104.10(6)(v) Conditional 
Transactions that involve:
    (a) A specialist's purchase from the Exchange published offer 
that is priced above the last differently-priced trade on the 
Exchange or above the last differently-priced published offer on the 
Exchange; and
    (b) A specialist's sale to the Exchange published bid that is 
priced below the last differently-priced trade on the Exchange or 
below the last differently-priced published bid on the Exchange are 
subject to the re-entry requirements for Non-Conditional 
Transactions pursuant to NYSE Rule 104.10(5)(i)(a)(II)(c).
    Rule 104.10(5)(i)(a)(II)(c) provides:
    Re-entry Obligation Following Non-Conditional Transactions--The 
specialist's obligation to maintain a fair and orderly market may 
require re-entry on the opposite side of the market trend after 
effecting one or more Non-Conditional Transactions. Such re-entry 
transactions should be commensurate with the size of the Non-
Conditional Transactions and the immediate and anticipated needs of 
the market.
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    Specialist transactions in securities not within the definition of 
``active'' securities continue to be governed by the ``tick test'' and 
floor official approval requirements described above that are now set 
forth in Rule 104.10(5)(i)(B)(I).
    In the Stabilization Proposal, the Exchange asserted that it 
believed the types of transactions described above were suitable for 
all securities. While the Commission acknowledged the considerable 
changes in the national market system, it stated that it believed that 
the Stabilization Proposal represented a significant change in the 
roles and obligations of specialist at the Exchange and thus required 
that the NYSE to implement the proposed Conditional Transactions only 
for active securities as a pilot.\10\ The Commission further stated 
that, before it decided whether to extend the operation of the rule or 
to approve the rule on a permanent basis, it would require the NYSE to 
provide data and analysis on the impact of the rule change.\11\
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    \10\ See Securities Exchange Act Release No. 54860, supra note 
3, at 71230.
    \11\ Id.
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    (3) The Exchange's Analysis of the Conditional Transaction Pilot.
    The Exchange has closely monitored its market quality as it made 
changes to its operations, including the implementation of the Hybrid 
Market and the pilot that allowed specialists to effect Conditional 
Transactions. The Exchange has performed a review \12\ of the market 
quality for the period July 1, 2006 to September 30, 2006, compared to 
the market quality for the period from April 1, 2007 through June 30, 
2007 and the NYSE states that its review shows that overall there has 
been a narrowing of the effective spread for marketable orders and a 
lowering of volatility. The percentage of trades executed automatically 
substantially increased. Other indicators remained generally the same 
except for the percentage of times that the NYSE set the National Best 
Bid or Offer.
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    \12\ See Appendix 3A, which is available on the NYSE Web site at 
the following link: http://www.nyse.com/
Frameset.html?displayPage=http://apps.nyse.com/commdata/pub19b4.nsf/
rulefilings?openview.
    Appendix 3A is also available on the Commission Web site at 
http://www.sec.gov/rules/sro/nyse.shtml.
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    In addition, the Exchange reviewed data related to the specialists' 
re-entry requirement. Specifically, the Exchange reviewed the 
specialist's re-entry quote and execution activity on the opposite side 
of the market at 30-second and one-minute intervals for the month of 
April 2007. The Exchange states that the data showed that specialists 
effected Conditional Transactions sparingly and that, in those 
instances where specialists effected Conditional Transactions, the data 
showed that specialist overall complied with their obligations to re-
enter liquidity on the opposite side of the market.
    The Exchange further compared the 84 securities that are listed on 
the NYSE and are included in the S&P 500 index (``S&P 500'') operating 
in the Conditional Transaction Pilot that that had the lowest 
consolidated volume for the months of March and April 2007. The 84 
securities were divided into two deciles containing 42 securities per 
decile. The Exchange created a matched sample for these two deciles by 
finding other NYSE-listed securities not included in the S&P 500 
(``non-S&P 500'') that had comparable consolidated volumes, Volume 
Weighted Average Price (``VWAP'') and market capital.\13\ The Exchange 
believes that its review showed that there was no discernible 
difference between the change in market quality in the lowest two 
deciles of the S&P 500 securities operating pursuant to the Conditional 
Transaction Pilot as compared to similar securities in the non-S&P 500 
securities. The Exchange noted a difference in the market quality 
statistics for the S&P 500 securities as compared to the non-S&P 500 
matched sample. However, upon further review, the Exchange noted that 
the differences were present both before and after the Conditional 
Transaction Pilot, which suggests that a factor other than the 
Conditional Transaction Pilot was the cause of the noted difference. 
The Exchange believes that the most probable cause of the noted 
difference was the inclusion in the S&P 500. The

[[Page 54502]]

stocks in the S&P 500 appear to have inherently different market 
quality characteristics from those not in the S&P 500. The changes in 
market quality were similar for both groups. The Exchange therefore 
believes that the Conditional Transaction Pilot was not the cause of 
the market quality differences in the samples. Therefore, the Exchange 
believes that the data supports the conclusion that the Conditional 
Transaction Pilot has not had a detrimental effect on market quality.
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    \13\ See Appendices 3B and 3C, which are available on the NYSE 
Web site at the following link: http://www.nyse.com/
Frameset.html?displayPage=http://apps.nyse.com/commdata/pub19b4.nsf/
rulefilings?openview.
    Appendices 3B and 3C are also available on the Commission Web 
site at http://www.sec.gov/rules/sro/nyse.shtml.
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    Thus, in analyzing the data related to the Conditional Transaction 
Pilot, the Exchange believes that it is clear that specialists have 
acted appropriately in regard to Conditional Transactions and have re-
entered the market as required, with no discernable adverse impact on 
liquidity or market quality. The Exchange therefore believes that 
Conditional Transaction Pilot should be modified to include all stocks 
traded on the NYSE.
    (4) Inclusion of All NYSE Traded Securities in the Conditional 
Transaction Pilot.
    The NYSE now seeks approval to extend the term of the Conditional 
Transaction Pilot to March 31, 2008 and to make it applicable to all 
securities traded on the NYSE. As explained more fully below, the 
Exchange believes that it is appropriate to provide specialists the 
same ability to effect Conditional Transactions in all securities 
traded on the Exchange.
    (5) Importance of the Specialist Role to the NYSE's Hybrid Market 
Model.
    The Exchange states that the specialist is critical to the NYSE's 
Hybrid Market model. Advances in technology have virtually obviated the 
specialists' time and place advantage. The rate of trading 
participation by specialists in specialist stocks has been 
significantly reduced. Therefore, the Exchange believes that the basis 
for concern over specialist conflicts of interest (and the consequent 
ability to trade to the detriment of the public) is also diminished. 
The NYSE believes that these factors and specialist re-entry 
obligations support the expansion of specialists trading opportunities 
in all of the securities traded on the NYSE.
    The amendments to NYSE Rule 104.10(5) and (6) in this filing should 
be seen as part of the NYSE's goal of providing the market with the 
ability to seek the best price by submitting orders to a traditional 
floor-based auction process or by obtaining virtually instantaneous 
execution in an electronic platform. The NYSE believes that specialists 
play a critical role in achieving this goal, but it is in many ways a 
different role from the ``traditional'' function of specialists prior 
to implementation of the NYSE's current market structure. The Exchange 
states that, most importantly, it has attempted to balance concerns 
over the potential conflict of interest between specialists' agency 
function in the auction process and the specialists' ability (and need) 
to trade for their own account as a dealer.
    The Exchange believes that specialists provide an extraordinary 
benefit to the NYSE market by using their capital to cushion market 
volatility. Specialists' capital commitment provides depth, and lowers 
volatility and overall execution costs for investors. Furthermore, 
specialists add liquidity to the market when there is little or no 
liquidity, bridging the gap between supply and demand by purchasing 
when no one else is buying and by overall maintaining a fair and 
orderly market. In order for specialists to continue providing that 
benefit, they must be allowed greater flexibility in trading for their 
dealer accounts to be competitive with other market participants in 
times of market stability so that they may be adequately positioned to 
step in during times of market instability. The Exchange believes that 
the ability of the specialists to effect Conditional Transactions 
allows specialists, to a greater degree, to manage the inventory of the 
dealer account to provide more liquidity against the market trend and 
thus moderate volatility.
    Moreover, the NYSE believes human judgment is particularly valuable 
in less liquid securities because the service provided by specialists 
is even more critical during the opening and closing of trading in such 
securities, particularly in times of uncertainty such as when an 
earnings surprise, news, or an outside event leads to market volatility 
and/or instability. In these cases, the specialists' trading judgment, 
exercised in carrying out their affirmative obligations, results in 
reduced volatility and more stable prices.
    But while the Hybrid Market is intended to combine the benefits of 
specialist and floor broker expertise with the speed, certainty and 
anonymity of electronic executions, implementation of this system has 
created a significantly different trading environment for specialists. 
Historically, the NYSE specialist's unique dual role as broker and 
dealer afforded him or her an informational advantage over other market 
participants because, in that role, the specialists served as the main 
conduit of the order flow information in his or her subject security. 
As a result of this information advantage, specialists trading for 
their own account were constrained by affirmative and negative 
obligations.
    Today, the Exchange believes that there is a virtual elimination of 
the informational advantage of the specialist. Certain order types that 
previously required specialist intervention for execution are now 
handled systemically and automatically. For example, in December 2006 
the Exchange changed its stop order handling process to make stop 
orders no longer visible to the part of the Display Book that the 
specialist ``sees.'' \14\ Currently, when a transaction on the Exchange 
results in the election of a stop order that had been received prior to 
such transaction, the elected stop order is sent as a market order to 
the Display Book and the specialist's system employing algorithms where 
it is handled in the same way as any other market order. The specialist 
therefore has no information regarding the status of stop orders.
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    \14\ See Securities Exchange Act Release No. 54820 (November 27, 
2006), 71 FR 70824 (December 6, 2006) (SR-NYSE-2006-65) (clarifying 
certain definitions and the systematic processing of certain orders 
in the Hybrid Market).
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    Moreover, the quantity and quality of information that is available 
solely to the specialist has decreased. In the auction market, the 
specialist had information about all orders on the Display Book and 
also received information from the Crowd. Floor Brokers, Registered 
Competitive Market Makers (``RCMMs'') and Competitive Traders (``CTs'') 
all interacted verbally with the specialists and each other in the 
Crowd at the trading post for each security. Through this interaction 
and the proximity of the other market participants, the specialist was 
in possession of information not readily available to all other market 
participants. In his or her position, the specialist had information 
directly from the Crowd and the Display Book. Additionally, the 
specialist was able to glean incidental information based on his or her 
observation of the communication between other market participants.
    Currently, the Hybrid Market provides Floor brokers with electronic 
trading tools that have resulted in less personal and verbal 
interaction between Floor brokers and specialists.\15\ A Floor broker 
is now able to electronically represent his or her customer's interest 
through the use of e-quotes and d-quotes.

[[Page 54503]]

Moreover, the electronic representation need not take place directly in 
front of the post and panel where the security is traded as the 
Exchange definition of Crowd has expanded the physical area encompassed 
in a Crowd. Today, a Crowd is one of three trading zones which is one 
of the three trading rooms operating as part of the NYSE Floor. The 
verbal information the specialist was once able to obtain from Floor 
broker's expressed interest is greatly reduced. Moreover, the Exchange 
believes that the observations of Crowd to Crowd transactions offer 
little if any information to the specialists. A specialist at a trading 
post is unable to know with any degree of certainty the security being 
traded by Floor brokers electronically bidding and offering in front of 
him or her.
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    \15\ Currently, approximately 90% of the transactions executed 
on the Exchange are done through electronic executions.
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    The Exchange believes that the reduced ability of a specialist to 
glean market information because a specialist's intervention is no 
longer required to receive an execution, the specialist's inability to 
see stop orders and the dramatic increase in transparency with respect 
to the Display Book through, among other things, Exchange initiatives 
like Exchange OPENBOOK\TM\ make it clear that the specialist no longer 
possesses an information advantage over other market participants. In 
fact, it may be argued that the specialist has less information than 
some market participants with the increased internalization of orders. 
Often prior, to orders being sent to an exchange for execution, the 
broker-dealer will ``shop'' the order. In some instances, the broker-
dealer will execute all or part the customer order against its 
principal account with any residual being sent to an exchange for 
execution. Internalization of order flow limits price discovery and 
does not result in transparency. As such, the specialist can be said, 
in certain instances, to be at an informational disadvantage to other 
market participants.
    The Exchange states that in approving the Stabilization Proposal, 
the Commission agreed with the Exchange that trade-by-trade negative 
compliance obligations previously embodied in the so-called Saperstein 
Interpretation\16\ established seventy years ago no longer address the 
realities of the modern market. The Commission's approval order stated:
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    \16\ Securities Exchange Act Release No. 1117, 1937 SEC LEXIS 
357 (March 30, 1937).

    The Commission believes that eliminating the trade-by-trade 
standard with respect to the negative obligation should enhance the 
specialists' 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 trade-by-trade analysis 
regarding their negative obligations. The Commission finds that 
permitting specialists to consider the reasonable necessity of their 
transactions under negative obligations without a transaction-by-
transaction test, is appropriate and consistent with the Act. The 
Commission emphasizes that it is not eliminating the negative 
obligation (footnote omitted). Therefore, specialists must continue 
to assess their need to trade and limit their proprietary trades to 
those reasonably necessary to allow the specialists to maintain a 
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fair and orderly market.\17\

    \17\ See Securities Exchange Act Release No. 54860, supra note 
3.
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The re-interpretation of the Saperstein letter thus moved away from 
defining stabilization in terms of the last sale to focus on market 
conditions, the type of trade in question and the specialists' existing 
position.
    The Exchange's proposal to allow specialists to effect Conditional 
Transactions in all securities is a request to further address the 
realities of the current market. The Exchange states that it does not 
in any way reduce the obligations imposed on them pursuant to NYSE Rule 
104 to re-enter a transaction on the opposite side of the market and 
their negative obligation. The Exchange believes that these critically 
distinguishing obligations imposed on NYSE specialists, coupled with 
the empirical evidence that, when given the opportunity to effect 
Conditional Transactions in less liquid securities there is no 
discernable diminishment of market quality, justifies the extension of 
the specialist ability to effect Conditional Transactions in all 
securities.
    For the reasons stated above, the Exchange believes that extending 
the ability of the specialist to effect Conditional Transactions to all 
securities will allow specialists to more effectively meet their 
affirmative and negative obligations by giving them the tools to better 
manage the inventory of the dealer account.
    (6) Exchange Continued Data Provision to the Commission.
    The Exchange represents that it will continue to provide the 
Division of Market Regulation and the Office of Economic Analysis with 
statistics related to market quality, specialist trading activity and 
sample statistics. The sample statistics include the daily Consolidated 
Tape volume in shares, daily number of trades, daily high-low 
volatility in basis points, and daily close price in dollars.
    The Exchange will also calculate the specialist profit on round-
trip Hit Bid and Take Offer (``HB/TO'') executions. This will be 
accomplished by measuring the specialist profit on HB/TO activity by 
taking the round-trip trading profits for all HB/TO trades where the 
specialist executes an offsetting trade within 30 seconds. In cases 
where the volume of the offsetting execution is less than the size of 
the HB/TO execution, the calculation will only include profits realized 
within the 30-second window.
    The Exchange will further calculate the quote-based specialist re-
entry ratio. Each re-entry price level will be categorized and reported 
separately. For example, if the specialist buys from the offer at 
$50.00 and then re-enters at $50.01, then this is categorized as a one 
cent re-entry. Similarly, if the specialist buys from the offer at 
$50.00 and then re-enters at $50.02, then this is categorized as a two 
cent re-entry. The categories will be in cent intervals at 0, 1, 2, 3, 
4, and 5 or more cents. The time window for these calculations will 
also be in 30 seconds.
    In addition, the Exchange will provide the Commission with data 
related to the average realized spread on specialist HB/TO executions. 
These calculations will be done using the same formula as Rule 605 of 
Regulation NMS under the Act.\18\ Specifically, the average realized 
spread should be a share-weighted average of realized spreads. For 
specialist buys, it is double the amount of difference between the 
execution price and the midpoint of the consolidated best bid and offer 
five minutes after the time of HB/TO execution. For specialist sells, 
it is double the amount of difference between the midpoint of the 
consolidated best bid and offer five minutes after the time of HB/TO 
execution and the execution price.
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    \18\ 17 CFR 242.605.
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    All of the aforementioned information will be provided to the 
Commission on a monthly basis. The Exchange represents that it will 
also maintain average measures for each stock-day during a particular 
month in order to provide such information to the Commission upon 
request.
    (7) Surveillance.
    As noted in the NYSE's original Stabilization Rule filing, NYSE 
Regulation (``NYSER'') believes that it has appropriate surveillance 
procedures in place to surveil for compliance with the negative 
obligations of specialists. NYSER monitors, using a pattern and

[[Page 54504]]

practice and/or outlier approach, specialist activity that appears to 
cause or exacerbate excessive price movement in the market (since such 
transactions would appear to be in violation of a specialist's negative 
obligation). In this connection, NYSER surveils for specialist 
compliance with the PPP re-entry requirements and, based on its 
preliminary reviews of surveillance data, has not identified 
significant compliance issues to date. The Division of Market 
Surveillance of NYSER also monitors specialist trading to cushion such 
price movements.
    (8) Conclusion.
    The Exchange seeks to be able to modify and change its business 
model in order to continue to improve market quality. If the Exchange 
is to do this then it must be allowed to provide the specialists that 
operate on the Exchange with the flexibility to compete. The Exchange 
believes that this flexibility can be achieved by extending the 
specialists ability to effect Conditional Transactions in all 
securities.
    The Exchange believes that its current stabilization rules do not 
afford specialists trading on the NYSE the necessary flexibility to 
manage the dealer account inventory. The Exchange believes that these 
rules are antiquated and inconsistent with the electronic trading 
environment that has virtually eliminated the specialists' agency role 
and information advantage. The Exchange believes that the proposed 
amendments regarding specialists' ability to effect Conditional 
Transactions will allow specialists on the Exchange to efficiently and 
systematically trade and quote in their securities and thus be in a 
position to fluidly manage their risk. Providing the specialists with 
the required flexibility to compete will add value to the Exchange 
market by encouraging them to continue to commit capital, thus 
benefiting the marketplace by increasing liquidity at prices outside 
the best bid and offer, bridging temporary gaps in supply and demand, 
and dampening volatility.
    Given all the above, the NYSE believes that allowing specialists to 
effect Conditional Transactions in all securities on pilot basis until 
March 31, 2008 is appropriate at this time.
2. Statutory Basis
    The Exchange believes that the basis under the Act for this 
proposed rule change is the requirement under Section 6(b)(5) \19\ of 
the Act that an Exchange have rules that are designed to promote just 
and equitable principles of trade, 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. The 
proposed rule change also is designed to support the principles of 
Section 11A(a)(1) \20\ under the Act in that it seeks to assure 
economically efficient execution of securities transactions.
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    \19\ 15 U.S.C. 78f(b)(5).
    \20\ 15 U.S.C. 78k-1(a)(1).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange states that the proposed rule change was developed in 
response to concerns expressed by certain member organizations. During 
the drafting of the rule filing and proposed rule, those member 
organizations reviewed an initial draft and provided the Exchange with 
written comments relating to specialists' obligations and actions 
during periods of instability. The Exchange states that it has 
incorporated these comments into the final rule proposal, but the 
Exchange has neither solicited nor received written comments on the 
final proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) As the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the NYSE consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-NYSE-2007-83 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NYSE-2007-83. 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 (http://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, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. 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-2007-83 and should be 
submitted on or before October 16, 2007.
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    \21\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-18828 Filed 9-24-07; 8:45 am]
BILLING CODE 8010-01-P