FOR IMMEDIATE RELEASE                                   2000-97

      Commission To Study Effect of Payment for Order Flow
           and Internalization in the Options Markets

     Washington, DC, July 19, 2000 - The Securities and Exchange
Commission will conduct a study of the development of payment for
order flow and internalization arrangements in the options
markets and any changes in market quality since multiple trading.
The goal of the study, which will be conducted by the Office of
Economic Analysis along with the Office of Compliance,
Inspections and Examinations, is to better inform the Commission
about the nature, scope, and prevalence of these arrangements and
their influence on order routing patterns.  In addition, and more
fundamentally, the study will attempt to determine the effect of
these practices on quote competition, spreads, and execution
quality.  Because payment for order flow and internalization is a
new development in the options market, the data from the previous
year may offer a unique opportunity to isolate and examine causal
relationships between the practices and changes in execution
quality.  The Commission intends to make the findings of the
study public in November.
     
Background
     
     Nearly a year has passed since most exchange-listed options
began trading on multiple exchanges.  This period has been
characterized by intense competition for options order flow among
options market makers and exchanges.  In the first month of
multiple trading, spreads in some actively traded options
tightened by between 15 and 44 percent, according to an analysis
performed by the Commission's Office of Economic Analysis.  By
the end of October, the spread in more than three quarters of all
options that began trading on multiple exchanges since August had
declined by 15 percent or more.

     More recently, payment for order flow and internalization
arrangements have proliferated in the options markets.  Some
market participants and investors have expressed alarm in
response to these developments.  Options exchanges also have
noted serious reservations, with one exchange calling for a
moratorium on payment for order flow in the options markets in
January of this year.

     Since its growth in the 1980s in the equities markets, the
Commission has made clear its concern about the practice of
payment for order flow.  It has repeatedly recognized that the
practice constitutes a potential conflict for brokers handling
customer orders, and that it may present a threat to aggressive
quote competition.  At the same time, we have acknowledged that
payment for order flow is not necessarily inconsistent with a
broker's duty of best execution, and that it has become a feature
of competition among our equity market centers.  The Commission
decided not to ban payment for order flow in the early 1990s.  In
considering the arrangements, the Commission noted that payment
for order flow is, in substance, the economic equivalent of
internalization.
     
     The Commission continues to believe that a ban on payment
for order flow is not adequate to address the concerns presented
by internalization.  Given the diversity of economic models
represented by our five options exchanges, the many possible
forms of internalization in those markets, and the highly dynamic
competition among them at this moment, the Commission is
extremely reluctant to take action that would prescribe the form
of intermarket competition.  While we remain steadfast in our
commitment to foster competition among and within options
markets, our role is not to pick winners or losers, directly or
indirectly.
     
     The Commission remains deeply concerned, however, about
practices or arrangements, including payment for order flow and
internalization, that may reduce the level of interaction between
buyers and sellers in the options markets, or otherwise
compromise quote competition.  It is critically important that we
understand their effects as fully as possible.
     
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