Order Modifying the Exemption for Qualified Contingent Trades from Rule 611(a) of Regulation NMS Under the Securities Exchange Act of 1934, 19271-19274 [E8-7446]
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Federal Register / Vol. 73, No. 69 / Wednesday, April 9, 2008 / Notices
preferred stock are generally based on yield,
which in turn is based on prevailing interest
rates in the debt markets, as well as
perceived credit quality of the issuer and any
special features of the particular preferred
stock.17
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The SIFMA Exemption Request states
that, because the Commission did not
apply the Quote Rule to debt securities,
and preferred stock trades like debt
securities, the Commission exempted
preferred stock from the Quote Rule. In
addition, the SIFMA Exemption Request
notes that the Commission also
excepted ‘‘non-participatory preferred
stocks’’ from the definition of NMS
stock for the purposes of Regulation
ATS.18 As a result, the order display
and execution access provisions of
Regulation ATS 19 do not apply to nonparticipatory preferred securities.
III. Discussion
The Commission has decided to
exempt non-convertible preferred
securities from Rule 611(a). Nonconvertible preferred securities have
characteristics analogous to fixed
income instruments. Given these
characteristics, non-convertible
preferred securities typically are priced
based on yield and trade more like fixed
income instruments than like common
stocks. Due to these similarities to fixed
income instruments, non-convertible
preferred securities often are handled by
the fixed income desks of broker-dealers
rather than equity desks. As a general
matter, fixed income instruments are
not NMS stocks and not subject to Rule
611. Therefore, the systems of fixed
income desks of broker-dealers are not
designed to comply with Rule 611. In
addition, if broker-dealers were to shift
trading of non-convertible preferred
securities to their equity desks, which
have systems designed to comply with
Rule 611, investors would be less able
to benefit from the experience of brokerdealer personnel with expertise in
trading in debt and debt-like securities.
In sum, the exemption will promote
efficiency because the benefits of
applying Rule 611(a) to non-convertible
preferred securities would not justify
the additional costs of compliance,
including broker-dealer costs to program
systems to comply with Rule 611.
The Commission notes that it has
previously recognized the similarities
between non-convertible preferred
securities and fixed income
instruments, and, in doing so, has
treated non-convertible preferred
securities differently than common
stock. In 1997, the Commission
exempted non-convertible preferred
securities from certain requirements in
the Quote Rule due to the similarity of
its trading patterns with debt
securities.20 In addition, the
Commission excepted ‘‘nonparticipatory preferred stocks’’ from the
definition of NMS stock in Regulation
ATS.21 The Commission believes that its
decision to exempt non-convertible
preferred securities from Rule 611(a) is
consistent with its prior actions.
The Commission also believes that the
exemption for non-convertible preferred
securities is consistent with the
protection of investors in such
securities. The exemption applies solely
to Rule 611(a). Transactions in nonconvertible preferred securities will
remain subject to all other applicable
regulatory requirements.
For the foregoing reasons, the
Commission finds that granting the
foregoing exemption is necessary and
appropriate in the public interest, and is
consistent with the protection of
investors.
IV. Conclusion
It is hereby ordered, pursuant to Rule
611(d) of Regulation NMS, that nonconvertible preferred securities are
exempted from Rule 611(a) of
Regulation NMS.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.22
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8–7445 Filed 4–8–08; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–57620]
Order Modifying the Exemption for
Qualified Contingent Trades from Rule
611(a) of Regulation NMS Under the
Securities Exchange Act of 1934
April 4, 2008.
I. Introduction
Pursuant to Rule 611(d)1 of
Regulation NMS 2 under the Securities
Exchange Act of 1934 (‘‘Exchange Act’’),
the Securities and Exchange
Commission (‘‘Commission’’), by order,
may exempt from the provisions of Rule
611 of Regulation NMS (‘‘Rule 611’’ or
20 See
Blanc Letter.
CFR 242.300(d) and (g).
22 17 CFR 200.30–3(a)(82).
1 17 CFR 242.611(d).
2 17 CFR 242.600 et seq.
21 17
17 Id.
18 SIFMA
19 17
Exemption Request at 4.
CFR 242.301(b)(3).
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19271
‘‘Rule’’), either unconditionally or on
specified terms and conditions, any
person, security, transaction, quotation,
or order, or any class or classes of
persons, securities, quotations, or
orders, if the Commission determines
that such exemption is necessary or
appropriate in the public interest, and is
consistent with the protection of
investors.3 On August 31, 2006, the
Commission granted an exemption for
qualified contingent trades from Rule
611(a) (‘‘QCT Exemption’’).4 As
discussed below, the Commission is
modifying the QCT Exemption to
remove the minimum size limitation
that was included in the exemption as
originally granted.
II. Background
The Commission adopted Regulation
NMS in June 2005.5 Rule 611 addresses
intermarket trade-throughs of quotations
in NMS stocks.6 The Rule applies only
to quotations that are immediately
accessible through automatic execution.
On August 31, 2006, the Commission
granted the QCT Exemption for any
trade-throughs caused by the execution
of an order involving one or more NMS
stocks (each an ‘‘Exempted NMS Stock
Transaction) that are components of a
qualified contingent trade.7 In the QCT
Exemptive Order, the Commission
defined a ‘‘qualified contingent trade’’
as a transaction consisting of two or
more component orders, executed as
agent or principal, where:
(1) At least one component order is in
an NMS stock;
(2) all components are effected with a
product or price contingency that either
has been agreed to by the respective
counterparties or arranged for by a
broker-dealer as principal or agent;
(3) the execution of one component is
contingent upon the execution of all
other components at or near the same
time;
(4) the specific relationship between
the component orders (e.g., the spread
between the prices of the component
orders) is determined at the time the
contingent order is placed;
3 See also 15 U.S.C. 78mm(a)(1) (providing
general authority for Commission to grant
exemptions from provisions of Exchange Act and
rules thereunder).
4 Securities Exchange Act Release No. 54389
(August 31, 2006), 71 FR 52829 (September 7, 2006)
(‘‘QCT Exemptive Order’’).
5 Securities Exchange Act Release No. 51808
(June 9, 2005), 70 FR 37496 (June 29, 2005)
(‘‘Regulation NMS Adopting Release’’).
6 An ‘‘NMS stock’’ means any security or class of
securities, other than an option, for which
transaction reports are collected, processed, and
made available pursuant to an effective transaction
reporting plan. See 17 CFR 242.600(b)(46) and (47).
7 QCT Exemptive Order, 71 FR at 52831.
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(5) the component orders bear a
derivative relationship to one another,
represent different classes of shares of
the same issuer, or involve the securities
of participants in mergers or with
intentions to merge that have been
announced or since cancelled;8
(6) the Exempted NMS Stock
Transaction is fully hedged (without
regard to any prior existing position) as
a result of the other components of the
contingent trade;9 and
(7) the Exempted NMS Stock
Transaction that is part of a contingent
trade involves at least 10,000 shares or
has a market value of at least $200,000
(‘‘Size Condition’’).10
The Chicago Board Options Exchange,
Inc. (‘‘CBOE’’) has requested that the
Commission modify the QCT Exemption
by removing the Size Condition.11
According to the CBOE Exemption
Request, market participants find
contingent trades to be an efficient
means to effect coupled executions in
an option and the underlying stock
based on the pricing spread between the
two instruments. CBOE notes that a
large percentage of these contingent
trade orders end up unexecuted due to
a variety of factors. CBOE states that one
of the factors impeding the execution of
contingent trades is the Size Condition.
Contingent trades involving a stock size
under 10,000 shares (or $200,000)
cannot be executed if the stock leg
would trade through an automated
trading center’s protected quote.12
CBOE notes that, due to the need to
price the trade based on the spread
between the option and stock leg more
so than on current market quotations for
the stock, a contingent trade of a modest
size may still have the stock leg priced
outside of a protected quotation. In
CBOE’s experience, the Size Condition
is a factor that will continue to make it
more difficult to complete smaller-sized
8 Transactions involving securities of participants
in mergers or with intentions to merge that have
been announced would meet this aspect of the
exemption. Transactions involving cancelled
mergers, however, would constitute qualified
contingent trades only to the extent they involve the
unwinding of a pre-existing position in the merger
participants’ shares. Statistical arbitrage
transactions, absent some other derivative or merger
arbitrage relationship between component orders,
would not satisfy this element of the definition of
a qualified contingent trade.
9 A trading center may demonstrate that an
Exempted NMS Stock Transaction is fully hedged
under the circumstances based on the use of
reasonable risk-valuation methodologies.
10 See 17 CFR 242.600(b)(9) (defining ‘‘block size’’
with respect to an order as at least 10,000 shares
or $200,000 in market value).
11 Letter to Nancy M. Morris, Secretary,
Commission, from Edward J. Joyce, President and
Chief Operating Officer, CBOE, dated November 28,
2007 (‘‘CBOE Exemption Request’’).
12 See CBOE Exemption Request at 3.
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contingent trades. CBOE believes that
this impediment has a greater impact on
individual investors who want to effect
a buy-write transaction of modest size
than on institutional investors, who
tend to trade in much larger share
amounts.13
CBOE states that, if the Size Condition
is removed, the other conditions—
conditions (1) though (6) above—in the
QCT Exemption would continue to
ensure that eligible contingent trades are
not used in an abusive manner to avoid
compliance with Rule 611. CBOE
believes that the Commission primarily
focused on these conditions when it
found that the exemption was narrowly
drawn to encompass only those trades
most in need of relief to remain part of
a viable trading strategy and where
execution of the NMS stock component
at a trade-through price is reasonably
necessary to effect the contingent trade.
CBOE notes that the Commission
believed that conditions (1) through (6)
of the exemption require a close
connection between any Exempted NMS
Stock Transaction and the other
components of a qualified contingent
trade, and that this close connection
should both significantly limit the
number of Exempted NMS Stock
Transactions and help assure that the
exemption applies only to those trades
most in need of flexibility to be
executed efficiently. Finally, CBOE
believes that a key rationale behind the
Qualified Contingent Trade Exemption
is that contingent trades are not priced
based on current market quotations, but
rather the pricing relationship between
two related instruments. CBOE believes
that the rationale holds as true for a
small contingent trade that meets all the
requirements of the exemption as it does
for a large trade. In this regard, CBOE
notes that the Commission recently
approved a proposed rule change of the
options exchanges to amend the
definition in the Intermarket Linkage
Plan of ‘‘complex trade’’, which is
exempt from trade through liability, to
include stock-option trades.14 CBOE
states that the rule change does not set
a size minimum for a stock-option trade
to be exempt from trade through
liability.15
CBOE therefore believes that the QCT
Exemption, even without the Size
Condition, would continue to be in the
public interest and consistent with the
protection of investors. In this regard,
13 Id. A buy-write transaction, for example,
involves the execution of a stock transaction and a
corresponding options transaction.
14 See Securities Exchange Act Release No. 56761
(November 7, 2007), 72 FR 64094 (November 14,
2007).
15 CBOE Exemption Request at 4.
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CBOE believes that the proposed
modification to the exemption would
not change the many benefits that
contingent trades provide to the market.
At the same time, CBOE states that the
remaining conditions from the
exemption will continue to ensure that
the exemption is narrowly drawn to
prevent evasion of Rule 611 and that the
exemption is limited to a small number
of transactions. CBOE believes that
removing the Size Condition will not
result in a large increase in the number
of transactions being exempted from
Rule 611 because smaller contingent
trades represent a very small portion of
the overall amount of stock executions
in listed stocks.16
III. Discussion
After careful consideration and for the
reasons discussed in this order, the
Commission hereby modifies the QCT
Exemption by removing the Size
Condition. A ‘‘qualified contingent
trade’’ now is defined as a transaction
consisting of two or more component
orders, executed as agent or principal,
where:
(1) At least one component order is in
an NMS stock;
(2) all components are effected with a
product or price contingency that either
has been agreed to by the respective
counterparties or arranged for by a
broker-dealer as principal or agent;
(3) the execution of one component is
contingent upon the execution of all
other components at or near the same
time;
(4) the specific relationship between
the component orders (e.g., the spread
between the prices of the component
orders) is determined at the time the
contingent order is placed;
(5) the component orders bear a
derivative relationship to one another,
represent different classes of shares of
the same issuer, or involve the securities
of participants in mergers or with
intentions to merge that have been
announced or since cancelled;17 and
(6) the Exempted NMS Stock
Transaction is fully hedged (without
regard to any prior existing position) as
16 Id.
17 Transactions involving securities of
participants in mergers or with intentions to merge
that have been announced would meet this aspect
of the exemption. Transactions involving cancelled
mergers, however, would constitute qualified
contingent trades only to the extent they involve the
unwinding of a pre-existing position in the merger
participants’ shares. Statistical arbitrage
transactions, absent some other derivative or merger
arbitrage relationship between component orders,
would not satisfy this element of the definition of
a qualified contingent trade.
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Federal Register / Vol. 73, No. 69 / Wednesday, April 9, 2008 / Notices
a result of the other components of the
contingent trade.18
The Commission notes that a trading
center must meet all of the foregoing
elements of a qualified contingent trade
to qualify for the exemption. The
exemption is not restricted to dealers or
the over-the-counter market. It can be
used by any trading center that meets
the terms of the exemption.
The Commission recognizes that
contingent trades can be useful trading
tools for investors and other market
participants, particularly those who
trade the securities of issuers involved
in mergers, different classes of shares of
the same issuer, convertible securities,
and equity derivatives such as options.
Those who engage in contingent trades
can benefit the market as a whole by
studying the relationships between the
prices of such securities and executing
contingent trades when they believe
such relationships are out of line with
what they believe to be fair value.
Contingent trades therefore are one
example of a wide variety of trades that
contribute to the efficient functioning of
the securities markets and the price
discovery process.
As discussed in the QCT Exemptive
Order,19 the Commission believes that
qualified contingent trades potentially
could become too risky and costly to be
employed successfully if they were
required to meet the trade-through
provisions of Rule 611. Absent an
exemption, participants in contingent
trades often would need to use the
Rule’s intermarket sweep order
exception and route orders to execute
against protected quotations with better
prices than an NMS stock component of
the contingent trade. Any executions of
these routed orders could throw the
participants ‘‘out of hedge’’ and
necessitate additional transactions in an
attempt to correct the imbalance. As a
practical matter, the difficulty of
maintaining a hedge, and the risk of
falling out of hedge, could dissuade
participants from engaging in contingent
trades, or at least raise the cost of such
trades. The elimination or reduction of
this trading strategy potentially could
remove liquidity from the market. The
Commission therefore determined to
exempt qualified exempted trades from
Rule 611.20
To minimize the effect of the QCT
Exemption on the objectives of Rule
611, it was narrowly drawn to
encompass only those trades most in
18 A
trading center may demonstrate that an
Exempted NMS Stock Transaction is fully hedged
under the circumstances based on the use of
reasonable risk-valuation methodologies.
19 71 FR at 52831.
20 Id.
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need of relief to remain part of a viable
trading strategy and where execution of
the NMS stock component at a tradethrough price is reasonably necessary to
effect the contingent trade. In particular,
elements (1) through (6) of the
exemption, as set forth above, require a
close connection between any Exempted
NMS Stock Transaction and the other
components of a qualified contingent
trade. This close connection both
significantly limits the number of
Exempted NMS Stock Transactions and
helps assure that the exemption applies
only to those trades most in need of
flexibility to be executed efficiently. For
example, the execution of one
component of the transaction must be
contingent upon the execution of all
other components at or near the same
time, and the Exempted NMS Stock
Transaction must be fully hedged
(without regard to any prior existing
position) as a result of the other
components of the contingent trade.21 In
addition, there must be a specified
relationship between the instruments
involved in the component orders. The
component orders must bear a
derivative relationship to one another,
represent different classes of shares of
the same issuer, or involve the securities
of participants in mergers or with
intentions to merge that have been
announced or since cancelled.22 The
QCT Exemption does not apply to
contingent trades, such as statistical
arbitrage transactions, if their
components do not involve instruments
with a specified relationship.
In the QCT Exemptive Order,23 the
Commission noted that the Size
Condition further limited the QCT
Exemption to those transactions where
an exemption is likely to be most
needed to facilitate the trading strategies
of informed customers. As a national
securities exchange with extensive
experience in executing contingent
options and stock transactions, CBOE
notes that the Size Condition in practice
has served to inhibit retail investors
from engaging in buy-write transactions
21 The requirement that an Exempted NMS Stock
Transaction be fully hedged should significantly
limit the scope of the exemption. For example, a
contingent trade would not qualify for the
exemption if an NMS stock transaction was the
purchase or sale of 50,000 shares, and the only
other component was the purchase or sale of a
small quantity of options on the NMS stock. A
trading center may demonstrate that an Exempted
NMS Stock Transaction is fully hedged under the
circumstances based on the use of reasonable riskvaluation methodologies.
22 Transactions involving cancelled mergers
would be qualified contingent trades only to the
extent that they involve the unwinding of a preexisting position in the merger participants’ shares.
23 71 FR at 52831.
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19273
of modest size.24 This type of options
strategy can be suitable for a broad range
of investors, and the Commission does
not wish unnecessarily to inhibit retail
investors from engaging in useful
investment strategies that are available
to those who trade in larger size. In
addition, there are existing duties that
brokers owe their customers, such as
suitability and best execution of
contingent stock and options
transactions. The Commission therefore
has decided to remove the Size
Condition from the QCT Exemption to
enable the use of a wider range of
options strategies for retail investors. In
this way, buy-write strategies, as well as
other contingent trade strategies, will
not be hampered by the terms of the
QCT Exemption and will be more
readily available to those for whom such
strategies are useful and appropriate. In
addition, removing the Size Condition,
by expanding the range of investors who
can take advantage of the QCT
Exemption, potentially could promote
competition among trading centers.
The Commission does not believe that
removing the Size Condition will result
in the use of contingent trades to evade
the requirements of Rule 611. Elements
(1) through (6) of the exemption, as set
forth above, are sufficient to encompass
only those trades most in need of relief
to remain part of a viable trading
strategy and where execution of the
NMS stock component at a tradethrough price is reasonably necessary to
effect the contingent trade.
Accordingly, the QCT Exemption, as
modified, should provide appropriate
relief in those circumstances where
compliance with Rule 611 could be
most difficult as a practical matter, but
also is limited to a small number of
transactions that should not unduly
undermine the objectives of Rule 611.25
In this regard, the Commission notes
that the exemption, as discussed in the
QCT Exemptive Order, is premised on
an expectation that qualified contingent
trades will continue to be used for
essentially the same valid trading
purposes as they are currently. A
material change in the nature or
frequency of such trades could cause the
Commission to reconsider the terms of
the exemption.
For the foregoing reasons, the
Commission finds that removing the
Size Condition from the QCT Exemption
24 CBOE
Exemption Request at 3.
CBOE Exemption Request at 4
(representing that removal of the Size Condition
will not result in a large increase in the number of
transactions being exempted from Rule 611 because
smaller contingent trades represent a very small
portion of the overall amount of stock executions
in listed stocks).
25 See
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proposed rule change, as amended, from
interested persons.
is necessary and appropriate in the
public interest, and is consistent with
the protection of investors.
IV. Conclusion
It is hereby ordered, pursuant to Rule
611(d) of Regulation NMS, that the Size
Condition is removed from the QCT
Exemption.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.26
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8–7446 Filed 4–8–08; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–57611; File No. SR–NYSE–
2008–20]
Self-Regulatory Organizations; New
York Stock Exchange LLC; Notice of
Filing of Proposed Rule Change and
Amendments No. 1 and 2 Thereto
Relating to Exchange Rule 36
(Communications Between Exchange
and Member’s Offices) To Make
Permanent an Existing Portable Phone
Pilot
April 3, 2008.
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 March 17,
2008, the New York Stock Exchange
LLC (‘‘NYSE’’ or ‘‘Exchange’’) filed with
the Securities and Exchange
Commission (‘‘Commission’’) the
proposed rule change as described in
Items I, II, and III below, which Items
have been substantially prepared by the
Exchange. On March 27, 2008, the
Exchange submitted Amendment No. 1
to the proposed rule change.3 On April
2, 2008, the Exchange submitted
Amendment No. 2 to the proposed rule
change.4 The Commission is publishing
this notice to solicit comments on the
26 17
CFR 200.30–3(a)(82).
U.S.C.78s(b)(1).
2 17 CFR 240.19b–4.
3 In Amendment No. 1, the Exchange included
the rule text of Exchange Rule 36 as originally
approved by the Commission as a pilot and
subsequently amended to include Registered
Competitive Market Makers (‘‘RCMMs’’). See notes
6 and 8 infra. Amendment No. 1 replaced the
original filing in its entirety. See also note 4 infra.
4 Amendment No. 2 replaced Amendment No. 1
in its entirety. In Amendment No. 2, the Exchange
included an inadvertently omitted portion of the
text of Exchange Rule 36. Amendment No. 2
amends Exhibit 5 of the 19b–4 so that it accurately
reflects the existing portable phone pilot and the
text of Exchange Rule 36 as it will appear upon
permanent approval of the pilot.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange is proposing to amend
Exchange Rule 36 (Communications
Between Exchange Member’s Offices) to
make permanent the existing portable
phone pilot (the ‘‘Pilot’’).5
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
Exchange included statements
concerning the purpose of, and basis for,
the proposed rule change. The text of
these statements may be examined at
the places specified in Item IV below.
The Exchange has prepared summaries,
set forth in sections A, B, and C below,
of the most significant aspects of such
statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
Through this rule change, the
Exchange seeks to amend Exchange
Rule 36 to allow Floor brokers and
Registered Competitive Market-Makers
(‘‘RCMMs’’) 4 to use Exchange
authorized and provided portable
phones on the Exchange Floor, provided
certain specified conditions are met.
Such usage has been permitted on a
pilot basis. The current Pilot expires on
April 30, 2008, and the NYSE seeks to
have the amendment to Exchange Rule
36 made permanent.
Background
The Commission originally approved
the Pilot to be implemented for a sixmonth period 5 beginning no later than
June 23, 2003.6 Since the inception of
the Pilot, the Exchange has extended the
Pilot nine times, with the current Pilot
set to expire on April 30, 2008.7 In 2006,
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5 See also note 9 infra. Member Education
Bulletins (‘‘MEBs’’) and acknowledgment forms are
part of the rule proposal.
4 See Exchange Rule 107A, which defines and
governs the registration and dealings of RCMMs.
5 See Securities Exchange Act Release No. 47671
(April 11, 2003), 68 FR 19048 (April 17, 2003) (SR–
NYSE–2002–11).
6 See Securities Exchange Act Release No. 47992
(June 5, 2003), 68 FR 35047 (June 11, 2003) (SR–
NYSE–2003–19) (delaying the implementation date
for portable phones from on or about May 1, 2003,
to no later than June 23, 2003).
7 See Securities Exchange Act Release Nos. 48919
(December 12, 2003), 68 FR 70853 (December 19,
2003) (SR–NYSE–2003–38) (extending the Pilot for
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the Exchange incorporated RCMMs into
the Pilot and subsequently amended the
Pilot to allow RCMMs to use an
Exchange authorized and provided
portable phone on the Exchange Floor to
call to and receive calls from their
booths on the Exchange Floor.8
Exchange Rule 36 governs the
establishment of telephone or electronic
communications between the Exchange
Floor and any other location. Prior to
the Pilot, Exchange Rule 36 prohibited
the use of portable phone
communications between the Exchange
Floor and any off-Floor location. The
only approved communication by Floor
brokers between the Exchange Floor and
an off-Floor location prior to the Pilot
was by means of a telephone located at
a broker’s booth. Communications often
involved a customer calling a broker at
the booth for ‘‘market look’’
information. Prior to the Pilot, a broker
could not use a portable phone in a
trading Crowd at the point of sale to
speak with a person located off the
Exchange Floor.
Under the Pilot, sections .21 and .22
of Exchange Rule 36 delineate the
conditions under which Floor brokers
and RCMMs, respectively, are allowed
to use an Exchange authorized and
provided portable phone on the
Exchange Floor.9 Currently, under the
an additional six months ending on June 16, 2004);
49954 (July 1, 2004), 69 FR 41323 (July 8, 2004)
(SR–NYSE–2004–30) (extending the Pilot for an
additional five months ending on November 30,
2004); 50777 (December 1, 2004), 69 FR 71090
(December 8, 2004) (SR–NYSE–2004–67) (extending
the Pilot for an additional four months ending
March 31, 2005); 51464 (March 31, 2005), 70 FR
17746 (April 7, 2005) (SR–NYSE–2005–20)
(extending the Pilot for additional four months
ending July 31, 2005); 52188 (August 1, 2005), 70
FR 46252 (August 9, 2005) (SR–NYSE–2005–53)
(extending the Pilot for an additional six months
ending January 31, 2006); 53277 (February 13,
2006), 71 FR 8877 (February 21, 2006) (SR–NYSE–
2006–03) (extending the Pilot for an additional six
months ending July 31, 2006); 54276 (August 4,
2006), 71 FR 45885 (August 10, 2006) (SR–NYSE–
2006–55) (extending the Pilot for an additional six
months ending January 31, 2007); 55218 (January
31, 2007), 72 FR 6025 (February 8, 2007) (SR–
NYSE–2007–05) (extending the Pilot for an
additional twelve months ending January 31, 2008);
and 57249 (January 31, 2008), 73 FR 7024 (February
6, 2008) (SR–NYSE–2008–10) (extending the Pilot
for an additional three months ending April 30,
2008).
8 See Securities Exchange Act Release Nos. 53213
(February 2, 2006), 71 FR 7103 (February 10, 2006)
(SR–NYSE–2005–80) and 54215 (July 26, 2006), 71
FR 43551 (August 1, 2006) (SR–NYSE–2006–51).
9 See MEBs 2005–20 (November 28, 2005) and
2005–23 (December 2, 2005). MEBs describe the
conditions for the use of a portable phone by Floor
brokers and RCMMs, the acknowledgement
procedure, and the rule text. These MEBs were
previously filed as exhibits with the Commission in
connection with the operation of the Pilot. See
Securities Exchange Act Release No. 53213
(February 2, 2006), 71 FR 7103 (February 10, 2006)
(SR–NYSE–2005–80). Revised MEBs will be sent to
E:\FR\FM\09APN1.SGM
09APN1
]]>Agencies
[Federal Register Volume 73, Number 69 (Wednesday, April 9, 2008)]
[Notices]
[Pages 19271-19274]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-7446]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-57620]
Order Modifying the Exemption for Qualified Contingent Trades
from Rule 611(a) of Regulation NMS Under the Securities Exchange Act of
1934
April 4, 2008.
I. Introduction
Pursuant to Rule 611(d)\1\ of Regulation NMS \2\ under the
Securities Exchange Act of 1934 (``Exchange Act''), the Securities and
Exchange Commission (``Commission''), by order, may exempt from the
provisions of Rule 611 of Regulation NMS (``Rule 611'' or ``Rule''),
either unconditionally or on specified terms and conditions, any
person, security, transaction, quotation, or order, or any class or
classes of persons, securities, quotations, or orders, if the
Commission determines that such exemption is necessary or appropriate
in the public interest, and is consistent with the protection of
investors.\3\ On August 31, 2006, the Commission granted an exemption
for qualified contingent trades from Rule 611(a) (``QCT
Exemption'').\4\ As discussed below, the Commission is modifying the
QCT Exemption to remove the minimum size limitation that was included
in the exemption as originally granted.
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\1\ 17 CFR 242.611(d).
\2\ 17 CFR 242.600 et seq.
\3\ See also 15 U.S.C. 78mm(a)(1) (providing general authority
for Commission to grant exemptions from provisions of Exchange Act
and rules thereunder).
\4\ Securities Exchange Act Release No. 54389 (August 31, 2006),
71 FR 52829 (September 7, 2006) (``QCT Exemptive Order'').
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II. Background
The Commission adopted Regulation NMS in June 2005.\5\ Rule 611
addresses intermarket trade-throughs of quotations in NMS stocks.\6\
The Rule applies only to quotations that are immediately accessible
through automatic execution. On August 31, 2006, the Commission granted
the QCT Exemption for any trade-throughs caused by the execution of an
order involving one or more NMS stocks (each an ``Exempted NMS Stock
Transaction) that are components of a qualified contingent trade.\7\ In
the QCT Exemptive Order, the Commission defined a ``qualified
contingent trade'' as a transaction consisting of two or more component
orders, executed as agent or principal, where:
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\5\ Securities Exchange Act Release No. 51808 (June 9, 2005), 70
FR 37496 (June 29, 2005) (``Regulation NMS Adopting Release'').
\6\ An ``NMS stock'' means any security or class of securities,
other than an option, for which transaction reports are collected,
processed, and made available pursuant to an effective transaction
reporting plan. See 17 CFR 242.600(b)(46) and (47).
\7\ QCT Exemptive Order, 71 FR at 52831.
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(1) At least one component order is in an NMS stock;
(2) all components are effected with a product or price contingency
that either has been agreed to by the respective counterparties or
arranged for by a broker-dealer as principal or agent;
(3) the execution of one component is contingent upon the execution
of all other components at or near the same time;
(4) the specific relationship between the component orders (e.g.,
the spread between the prices of the component orders) is determined at
the time the contingent order is placed;
[[Page 19272]]
(5) the component orders bear a derivative relationship to one
another, represent different classes of shares of the same issuer, or
involve the securities of participants in mergers or with intentions to
merge that have been announced or since cancelled;\8\
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\8\ Transactions involving securities of participants in mergers
or with intentions to merge that have been announced would meet this
aspect of the exemption. Transactions involving cancelled mergers,
however, would constitute qualified contingent trades only to the
extent they involve the unwinding of a pre-existing position in the
merger participants' shares. Statistical arbitrage transactions,
absent some other derivative or merger arbitrage relationship
between component orders, would not satisfy this element of the
definition of a qualified contingent trade.
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(6) the Exempted NMS Stock Transaction is fully hedged (without
regard to any prior existing position) as a result of the other
components of the contingent trade;\9\ and
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\9\ A trading center may demonstrate that an Exempted NMS Stock
Transaction is fully hedged under the circumstances based on the use
of reasonable risk-valuation methodologies.
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(7) the Exempted NMS Stock Transaction that is part of a contingent
trade involves at least 10,000 shares or has a market value of at least
$200,000 (``Size Condition'').\10\
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\10\ See 17 CFR 242.600(b)(9) (defining ``block size'' with
respect to an order as at least 10,000 shares or $200,000 in market
value).
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The Chicago Board Options Exchange, Inc. (``CBOE'') has requested
that the Commission modify the QCT Exemption by removing the Size
Condition.\11\ According to the CBOE Exemption Request, market
participants find contingent trades to be an efficient means to effect
coupled executions in an option and the underlying stock based on the
pricing spread between the two instruments. CBOE notes that a large
percentage of these contingent trade orders end up unexecuted due to a
variety of factors. CBOE states that one of the factors impeding the
execution of contingent trades is the Size Condition. Contingent trades
involving a stock size under 10,000 shares (or $200,000) cannot be
executed if the stock leg would trade through an automated trading
center's protected quote.\12\ CBOE notes that, due to the need to price
the trade based on the spread between the option and stock leg more so
than on current market quotations for the stock, a contingent trade of
a modest size may still have the stock leg priced outside of a
protected quotation. In CBOE's experience, the Size Condition is a
factor that will continue to make it more difficult to complete
smaller-sized contingent trades. CBOE believes that this impediment has
a greater impact on individual investors who want to effect a buy-write
transaction of modest size than on institutional investors, who tend to
trade in much larger share amounts.\13\
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\11\ Letter to Nancy M. Morris, Secretary, Commission, from
Edward J. Joyce, President and Chief Operating Officer, CBOE, dated
November 28, 2007 (``CBOE Exemption Request'').
\12\ See CBOE Exemption Request at 3.
\13\ Id. A buy-write transaction, for example, involves the
execution of a stock transaction and a corresponding options
transaction.
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CBOE states that, if the Size Condition is removed, the other
conditions--conditions (1) though (6) above--in the QCT Exemption would
continue to ensure that eligible contingent trades are not used in an
abusive manner to avoid compliance with Rule 611. CBOE believes that
the Commission primarily focused on these conditions when it found that
the exemption was narrowly drawn to encompass only those trades most in
need of relief to remain part of a viable trading strategy and where
execution of the NMS stock component at a trade-through price is
reasonably necessary to effect the contingent trade. CBOE notes that
the Commission believed that conditions (1) through (6) of the
exemption require a close connection between any Exempted NMS Stock
Transaction and the other components of a qualified contingent trade,
and that this close connection should both significantly limit the
number of Exempted NMS Stock Transactions and help assure that the
exemption applies only to those trades most in need of flexibility to
be executed efficiently. Finally, CBOE believes that a key rationale
behind the Qualified Contingent Trade Exemption is that contingent
trades are not priced based on current market quotations, but rather
the pricing relationship between two related instruments. CBOE believes
that the rationale holds as true for a small contingent trade that
meets all the requirements of the exemption as it does for a large
trade. In this regard, CBOE notes that the Commission recently approved
a proposed rule change of the options exchanges to amend the definition
in the Intermarket Linkage Plan of ``complex trade'', which is exempt
from trade through liability, to include stock-option trades.\14\ CBOE
states that the rule change does not set a size minimum for a stock-
option trade to be exempt from trade through liability.\15\
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\14\ See Securities Exchange Act Release No. 56761 (November 7,
2007), 72 FR 64094 (November 14, 2007).
\15\ CBOE Exemption Request at 4.
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CBOE therefore believes that the QCT Exemption, even without the
Size Condition, would continue to be in the public interest and
consistent with the protection of investors. In this regard, CBOE
believes that the proposed modification to the exemption would not
change the many benefits that contingent trades provide to the market.
At the same time, CBOE states that the remaining conditions from the
exemption will continue to ensure that the exemption is narrowly drawn
to prevent evasion of Rule 611 and that the exemption is limited to a
small number of transactions. CBOE believes that removing the Size
Condition will not result in a large increase in the number of
transactions being exempted from Rule 611 because smaller contingent
trades represent a very small portion of the overall amount of stock
executions in listed stocks.\16\
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\16\ Id.
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III. Discussion
After careful consideration and for the reasons discussed in this
order, the Commission hereby modifies the QCT Exemption by removing the
Size Condition. A ``qualified contingent trade'' now is defined as a
transaction consisting of two or more component orders, executed as
agent or principal, where:
(1) At least one component order is in an NMS stock;
(2) all components are effected with a product or price contingency
that either has been agreed to by the respective counterparties or
arranged for by a broker-dealer as principal or agent;
(3) the execution of one component is contingent upon the execution
of all other components at or near the same time;
(4) the specific relationship between the component orders (e.g.,
the spread between the prices of the component orders) is determined at
the time the contingent order is placed;
(5) the component orders bear a derivative relationship to one
another, represent different classes of shares of the same issuer, or
involve the securities of participants in mergers or with intentions to
merge that have been announced or since cancelled;\17\ and
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\17\ Transactions involving securities of participants in
mergers or with intentions to merge that have been announced would
meet this aspect of the exemption. Transactions involving cancelled
mergers, however, would constitute qualified contingent trades only
to the extent they involve the unwinding of a pre-existing position
in the merger participants' shares. Statistical arbitrage
transactions, absent some other derivative or merger arbitrage
relationship between component orders, would not satisfy this
element of the definition of a qualified contingent trade.
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(6) the Exempted NMS Stock Transaction is fully hedged (without
regard to any prior existing position) as
[[Page 19273]]
a result of the other components of the contingent trade.\18\
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\18\ A trading center may demonstrate that an Exempted NMS Stock
Transaction is fully hedged under the circumstances based on the use
of reasonable risk-valuation methodologies.
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The Commission notes that a trading center must meet all of the
foregoing elements of a qualified contingent trade to qualify for the
exemption. The exemption is not restricted to dealers or the over-the-
counter market. It can be used by any trading center that meets the
terms of the exemption.
The Commission recognizes that contingent trades can be useful
trading tools for investors and other market participants, particularly
those who trade the securities of issuers involved in mergers,
different classes of shares of the same issuer, convertible securities,
and equity derivatives such as options. Those who engage in contingent
trades can benefit the market as a whole by studying the relationships
between the prices of such securities and executing contingent trades
when they believe such relationships are out of line with what they
believe to be fair value. Contingent trades therefore are one example
of a wide variety of trades that contribute to the efficient
functioning of the securities markets and the price discovery process.
As discussed in the QCT Exemptive Order,\19\ the Commission
believes that qualified contingent trades potentially could become too
risky and costly to be employed successfully if they were required to
meet the trade-through provisions of Rule 611. Absent an exemption,
participants in contingent trades often would need to use the Rule's
intermarket sweep order exception and route orders to execute against
protected quotations with better prices than an NMS stock component of
the contingent trade. Any executions of these routed orders could throw
the participants ``out of hedge'' and necessitate additional
transactions in an attempt to correct the imbalance. As a practical
matter, the difficulty of maintaining a hedge, and the risk of falling
out of hedge, could dissuade participants from engaging in contingent
trades, or at least raise the cost of such trades. The elimination or
reduction of this trading strategy potentially could remove liquidity
from the market. The Commission therefore determined to exempt
qualified exempted trades from Rule 611.\20\
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\19\ 71 FR at 52831.
\20\ Id.
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To minimize the effect of the QCT Exemption on the objectives of
Rule 611, it was narrowly drawn to encompass only those trades most in
need of relief to remain part of a viable trading strategy and where
execution of the NMS stock component at a trade-through price is
reasonably necessary to effect the contingent trade. In particular,
elements (1) through (6) of the exemption, as set forth above, require
a close connection between any Exempted NMS Stock Transaction and the
other components of a qualified contingent trade. This close connection
both significantly limits the number of Exempted NMS Stock Transactions
and helps assure that the exemption applies only to those trades most
in need of flexibility to be executed efficiently. For example, the
execution of one component of the transaction must be contingent upon
the execution of all other components at or near the same time, and the
Exempted NMS Stock Transaction must be fully hedged (without regard to
any prior existing position) as a result of the other components of the
contingent trade.\21\ In addition, there must be a specified
relationship between the instruments involved in the component orders.
The component orders must bear a derivative relationship to one
another, represent different classes of shares of the same issuer, or
involve the securities of participants in mergers or with intentions to
merge that have been announced or since cancelled.\22\ The QCT
Exemption does not apply to contingent trades, such as statistical
arbitrage transactions, if their components do not involve instruments
with a specified relationship.
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\21\ The requirement that an Exempted NMS Stock Transaction be
fully hedged should significantly limit the scope of the exemption.
For example, a contingent trade would not qualify for the exemption
if an NMS stock transaction was the purchase or sale of 50,000
shares, and the only other component was the purchase or sale of a
small quantity of options on the NMS stock. A trading center may
demonstrate that an Exempted NMS Stock Transaction is fully hedged
under the circumstances based on the use of reasonable risk-
valuation methodologies.
\22\ Transactions involving cancelled mergers would be qualified
contingent trades only to the extent that they involve the unwinding
of a pre-existing position in the merger participants' shares.
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In the QCT Exemptive Order,\23\ the Commission noted that the Size
Condition further limited the QCT Exemption to those transactions where
an exemption is likely to be most needed to facilitate the trading
strategies of informed customers. As a national securities exchange
with extensive experience in executing contingent options and stock
transactions, CBOE notes that the Size Condition in practice has served
to inhibit retail investors from engaging in buy-write transactions of
modest size.\24\ This type of options strategy can be suitable for a
broad range of investors, and the Commission does not wish
unnecessarily to inhibit retail investors from engaging in useful
investment strategies that are available to those who trade in larger
size. In addition, there are existing duties that brokers owe their
customers, such as suitability and best execution of contingent stock
and options transactions. The Commission therefore has decided to
remove the Size Condition from the QCT Exemption to enable the use of a
wider range of options strategies for retail investors. In this way,
buy-write strategies, as well as other contingent trade strategies,
will not be hampered by the terms of the QCT Exemption and will be more
readily available to those for whom such strategies are useful and
appropriate. In addition, removing the Size Condition, by expanding the
range of investors who can take advantage of the QCT Exemption,
potentially could promote competition among trading centers.
---------------------------------------------------------------------------
\23\ 71 FR at 52831.
\24\ CBOE Exemption Request at 3.
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The Commission does not believe that removing the Size Condition
will result in the use of contingent trades to evade the requirements
of Rule 611. Elements (1) through (6) of the exemption, as set forth
above, are sufficient to encompass only those trades most in need of
relief to remain part of a viable trading strategy and where execution
of the NMS stock component at a trade-through price is reasonably
necessary to effect the contingent trade.
Accordingly, the QCT Exemption, as modified, should provide
appropriate relief in those circumstances where compliance with Rule
611 could be most difficult as a practical matter, but also is limited
to a small number of transactions that should not unduly undermine the
objectives of Rule 611.\25\ In this regard, the Commission notes that
the exemption, as discussed in the QCT Exemptive Order, is premised on
an expectation that qualified contingent trades will continue to be
used for essentially the same valid trading purposes as they are
currently. A material change in the nature or frequency of such trades
could cause the Commission to reconsider the terms of the exemption.
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\25\ See CBOE Exemption Request at 4 (representing that removal
of the Size Condition will not result in a large increase in the
number of transactions being exempted from Rule 611 because smaller
contingent trades represent a very small portion of the overall
amount of stock executions in listed stocks).
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For the foregoing reasons, the Commission finds that removing the
Size Condition from the QCT Exemption
[[Page 19274]]
is necessary and appropriate in the public interest, and is consistent
with the protection of investors.
IV. Conclusion
It is hereby ordered, pursuant to Rule 611(d) of Regulation NMS,
that the Size Condition is removed from the QCT Exemption.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\26\
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\26\ 17 CFR 200.30-3(a)(82).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-7446 Filed 4-8-08; 8:45 am]
BILLING CODE 8011-01-P
