FOR IMMEDIATE RELEASE                               2000-190

SEC Staff Report Describes Development of Payment for Order Flow
and Internalization in the Options Markets

     Washington, DC, December 19, 2000 -- The staffs of the
Commission's Office of Compliance Inspections and Examinations
and Office of Economic Analysis today issued a report entitled
"Payment for Order Flow and Internalization in the Options
Markets."  Text of the report, requested by Chairman Levitt in
July of this year, is available on the Commission's website at
http://www.sec.gov/news/studies/ordpay.htm.

     In August 1999, the options exchanges began to multiply list
many options that had previously traded on only one exchange,
giving brokers a choice of where to send their customers' orders.
Accordingly, exchanges and their members are competing intensely
for those orders.  With increased competition for options order
flow, options market participants have begun to offer cash
payments to brokers in return for brokers agreeing to route their
customers' order flow to them.  Other indirect inducements also
have arisen in the options markets, such as "internalization" of
retail options orders, i.e., firms trading as counter-parties
with their customer orders.  In July 2000, the options exchanges
began facilitating their members' payment for order flow
strategies.
     
     Firms are obligated to seek the best possible executions for
their customers' orders, irrespective of payment for order flow
or other order routing inducements.  However, payment for order
flow and internalization create conflicts of interest for brokers
because of the tension between the firms' interests in maximizing
payment for order flow or trading profits generated from
internalizing their customers' orders, and this fiduciary
obligation to route their customers' orders to the best markets.

     Today's staff report describes  current payment for order
flow and internalization practices, and outlines how the
practices of payment for order flow and internalization have
affected order routing decisions and the execution quality of
customer options orders.  Among other things, the staff found the
following:

  *  The number of retail customer options orders paid for
  pursuant to payment for order flow arrangements has steadily
  increased.  In March 2000, in those options classes reviewed by
  the Staff, specialists paid brokers for 14% of the retail options
  orders sent to them.  By August 2000, specialists paid brokers
  for over 75% of the retail options orders sent to them.

  *  During the period of November 1999 to September 2000,
  options specialists paid over $33 million to brokers to induce
  them to route their customer orders to the specialists.

  *  As of September 2000, 19 of the 24 brokers examined by the
  Staff accepted payments for their customers' order flow.  Four of
  the 24 firms reviewed maintained policies not to accept payment
  for order flow.

  *  One broker has received in excess of $6 million, and six
  brokers have received in excess of $2 million in payments for
  their order flow.  As of November 30, 2000, these firms have not
  passed along to retail customers the benefits of payments
  received for order flow in the form of reduced retail commissions
  or direct rebates.  In fact, only one firm has significantly
  reduced retail customer commissions for executing listed options
  orders, and another firm maintains a policy to rebate payments
  received for order flow to customers.

  *  Payment for order flow has had an impact on order routing
  decisions.  Firms that maintained policies not to accept payment
  for order flow re-routed significantly fewer options classes to
  specialists that pay for order flow than did firms that maintain
  policies to accept payment for order flow.  In fact, four of the
  19 firms reviewed that accept payment for order flow re-routed
  75% or more of their customers' options orders in at least 8 of
  the 12 classes reviewed by the Staff to specialists that paid
  them for order flow.  Four other firms similarly re-routed 25% or
  more of their customers' options orders in at least 8 of the 12
  classes to specialists that paid them for order flow.

  *  Brokers do not have adequate market execution quality
  information to reliably compare the quality of executions between
  specialist firms.

  *  Internalization of retail customer options orders is not yet
  a prevalent practice in the options industry.  Only two brokers
  reviewed have developed systems to trade against retail
  customers' options orders.

  *  The trend in quoted spreads (along with other measurements
  of quoting behavior discussed in this report) suggest a decline
  in aggressive quoting that may be related to a concurrent growth
  of payment for order flow and other forms of internalization.

  *  Effective spreads have remained generally constant after an
  initial decline following the advent of multiple-listing.

  *  Given that order flow payments are made by specialists and
  specialists are compensated based on effective spreads, the
  growth of payment for order flow intuitively could be expected,
  all other things being equal, to be accompanied by a widening of
  effective spreads.  The absence of such widening during the
  review period indicates that other market forces are at work.