[Federal Register: March 31, 2006 (Volume 71, Number 62)]
[Notices]
[Page 16353-16387]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr31mr06-104]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-53539; File No. SR-NYSE-2004-05]
Self-Regulatory Organizations; New York Stock Exchange LLC; Order
Approving Proposed Rule Change and Amendment Nos. 1, 2, 3, and 5
Thereto and Notice of Filing and Order Granting Accelerated Approval to
Amendment Nos. 6, 7, and 8 to the Proposed Rule Change to Establish the
Hybrid Market
March 22, 2006.
I. Introduction
II. Description of the Proposal
A. Proposed Automated Market
1. Automated Access to Display Book System
2. Liquidity Available for Automatic Execution
(a) Specialist Interest Filed and Reserve
(b) Floor Broker Agency Interest File and Reserve
3. Autoquote
4. Automatic Executions
(a) Priority, Parity, and Precedence
(b) Automated Routing Away
(c) Tick-Restricted Orders, Stop Orders, and Other Orders
Eligible for Automatic Execution
5. Availability of Direct+
(a) Liquidity Replenishment Points
(1) Sweep LRPs
(2) MLRPs
B. Role of the Specialists in the Hybrid Market
1. Specialist Algorithms
(a) Quoting Messages
(b) Trading Messages
(1) Specialists' Ability to Systematically Price Improve
Incoming Orders
(2) Specialists' Ability to Hit Bids or Take Offers
2. Limitations on Members' Trading Because of Customers'
Orders--NYSE Rule 92
3. Policy for Communicating with the Specialist Algorithm
4. Specialist Algorithm Record Requirements
C. Proposal to Make Direct+ Permanent
D. Auction Limit Orders and Auction Market Orders
E. Other Changes
1. Intermarket Sweep Order
2. Record of Orders/Order Tracking
3. NYSE Rule 91
F. Hybrid Market Implementation Plan
1. Phase 1--Floor Broker Agency Interest Files, Specialist
Interest Files, and Systematic Integration of Priority, Parity, and
Yielding Requirements
[[Page 16354]]
2. Phase 2--API and Specialist Algorithms
3. Phase 3--Automatic Routing of Orders, Elimination of Direct+
Restrictions, ``Slow'' Market Indicators, and Gap Quoting
4. Phase 4--Floor Broker Reserve Features, Sweeps, LRPs, and New
Order Types
5. Phase 5--New Reporting Templates and Elimination of
Suspensions of Autoquote and Automatic Executions
G. Limited Hybrid Market Pilot
III. Summary of Comments and NYSE's Response
A. Liquidity Available for Automatic Executions
1. Specialist Interest File and Specialist Reserve
(a) Specialists' Parity
2. Floor Broker Agency Interest Files and Reserve
B. Automatic Executions
1. Sweeping the Display Book System
2. Automated Routing to Other Markets
C. Availability of Direct+ and Liquidity Replenishment Points
D. Role of the Specialist in the Hybrid Market
1. Specialist Algorithm
2. Specialists' Ability to Systematically Price Improve Incoming
Orders
E. Auction Limit and Auction Market Orders
IV. Discussion
A. Increased Access to Display Book System
1. Liquidity Replenishment Points
B. Autoquote
C. Liquidity Available for Automatic Execution
D. Automatic Executions
E. Role of Specialist in the Hybrid Market
1. Price Improvement
2. Ability to Hit Bids or Take Offers
3. NYSE Rule 92
4. Communicating with the Specialist Algorithm
F. Changes to the Auction Market and New Order Types
G. Intermarket Sweep Order
H. Implementation Plan
I. Interpretive Issues
V. Accelerated Approval of Amendment Nos. 6, 7, and 8
VI. Solicitation of Comments on Amendment Nos. 6, 7, and 8
VII. Conclusion
I. Introduction
On February 9, 2004, the New York Stock Exchange LLC (``NYSE'' or
``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to create a ``Hybrid Market'' by,
among other things, increasing the availability of automatic executions
in its existing automatic execution facility, NYSE Direct+[supreg]
(``Direct+''), and providing a means for participation in the expanded
automated market by its floor members.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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On August 2, 2004, NYSE filed Amendment No. 1 to the proposed rule
change.\3\ The Commission published the proposed rule change, as
amended by Amendment No. 1, for comment in the Federal Register on
August 16, 2004.\4\ On August 26, 2004, the Commission extended the
public comment period with respect to the First Notice to September 22,
2004.\5\ In response to the First Notice, the Commission received 17
comment letters from 15 commenters.\6\
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\3\ See Letter from Darla C. Stuckey, Corporate Secretary, NYSE,
to Nancy J. Sanow, Assistant Director, Division of Market Regulation
(``Division''), Commission, dated July 30, 2004, and accompanying
Form 19b-4, which replaced the original filing in its entirety
(``Amendment No. 1'').
\4\ See Securities Exchange Act Release No. 50173 (August 10,
2004), 69 FR 50407 (``First Notice'').
\5\ See Securities Exchange Act Release No. 50277, 69 FR 53759
(September 2, 2004).
\6\ See Letters from Eric D. Roiter, Senior Vice President and
General Counsel, Fidelity Management & Research Company, dated
August 10, 2004 (``Fidelity Letter I''); James L. Rothenberg, Esq.,
dated August 20, 2004 (``Rothenberg Letter''); Donald E. Weeden,
dated August 31, 2004 (``Weeden Letter''); Thomas Peterffy,
Chairman, and David M. Battan, Vice President, Interactive Brokers
Group, dated September 7, 2004 (``IBG Letter I''); Jose L. Marques,
PhD, Managing Member, Telic Management LLC, dated September 21, 2004
(``Telic Letter''); Junius W. Peake, Monfort Distinguished Professor
of Finance, Kenneth W. Monfort College of Business, University of
Northern Colorado, dated September 22, 2004 (``Peake Letter I'');
Ari Burstein, Associate Counsel, Investment Company Institute, dated
September 22, 2004 (``ICI Letter I''); Kim Bang, President and Chief
Executive Officer, Bloomberg Tradebook LLC, dated September 22, 2004
(``Bloomberg Letter I''); Ellen L.S. Koplow, Executive Vice
President and General Counsel, Ameritrade, Inc., dated September 22,
2004 (``Ameritrade Letter''); Lisa M. Utasi, President, and Kimberly
Unger, Executive Director, The Security Traders Association of New
York, Inc., dated September 22, 2004 (``STANY Letter''); George W.
Mann Jr., EVP & General Counsel, Boston Stock Exchange, dated
September 22, 2004 (``BSE Letter''); Bruce Lisman, Bear, Stearns &
Co. Inc., dated September 28, 2004 (``Bear Stearns Letter''); Donald
D. Kittell, Executive Vice President, Securities Industry
Association, dated October 1, 2004 (``SIA Letter I''); Edward J.
Nicoll, Chief Executive Officer, Instinet Group, dated October 25,
2004 (``Instinet Letter''); Eric D. Roiter, Senior Vice President
and General Counsel, Fidelity Management & Research Company, dated
October 26, 2004 (``Fidelity Letter II''); Philip Angelides,
Treasurer, State of California, dated November 23, 2004 (``Angelides
Letter''); and Eric D. Roiter, Senior Vice President and General
Counsel, Fidelity Management & Research Company, dated December 8,
2004 (``Fidelity Letter III'').
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On November 8, 2004 and November 9, 2004, the Exchange filed
Amendment Nos. 2 and 3, respectively.\7\ The Commission published the
proposed rule change, as further amended by Amendment Nos. 2 and 3, for
comment in the Federal Register on November 22, 2004.\8\ In response to
the Second Notice, the Commission received nine comment letters from
eight commenters.\9\
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\7\ See Form 19b-4 dated November 8, 2004 (``Amendment No. 2'')
and Partial Amendment dated November 9, 2004 (``Amendment No. 3'').
\8\ See Securities Exchange Act Release No. 50667 (November 15,
2004), 69 FR 67980 (``Second Notice'').
\9\ See Letters from Gregory van Kipnis, Managing Partner,
Invictus Partners, LLC, dated December 10, 2004 (``Invictus
Letter''); Ari Burstein, Associate Counsel, Investment Company
Institute, dated December 13, 2004 (``ICI Letter II''); Ann L.
Vlcek, Vice President and Associate General Counsel, Securities
Industry Association, dated December 13, 2004 (``SIA Letter II'');
Thomas Peterffy, Chairman, and David M. Battan, Vice President,
Interactive Brokers Group, dated December 14, 2004 (``IBG Letter
II''); William R. Power, Member and Director, Chicago Board Options
Exchange, Incorporated, dated December 21, 2004 (``Power Letter'');
Marc L. Lipson, Associate Professor, Terry College of Business, The
University of Georgia, dated January 4, 2005 (``Lipson Letter'');
Edward S. Knight, The Nasdaq Stock Market, dated January 26, 2005
(``Nasdaq Letter''); and George Rutherfurd, Consultant, dated March
10, 2005 (``Rutherfurd Letter I'') and April 8, 2005 (``Rutherfurd
Letter II'').
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On June 17, 2005, the Exchange filed Amendment No. 5 to the
proposed rule change.\10\ The Commission published the proposed rule
change, as further amended by Amendment No. 5, for comment in the
Federal Register on June 29, 2005.\11\ In response to the Third Notice,
the Commission received six comment letters.\12\
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\10\ See Form 19b-4 dated June 17, 2005 (``Amendment No. 5'').
The Exchange submitted Amendment No. 4 to the proposed rule change
on May 25, 2005, and subsequently withdrew Amendment No. 4 on June
17, 2005.
\11\ See Securities Exchange Act Release No. 51906 (June 22,
2005), 70 FR 37463 (``Third Notice'').
\12\ See Letters from George U. Sauter, Managing Director, The
Vanguard Group, Inc., dated July 20, 2005 (``Vanguard Letter''); Ari
Burstein, Associate Counsel, Investment Company Institute, dated
July 20, 2005 (``ICI Letter III''); Donald D. Kittell, Executive
Vice President, Securities Industry Association, dated July 20, 2005
(``SIA Letter III''); George Rutherfurd, Consultant, dated July 20,
2005 (``Rutherfurd Letter III''); Kim Bang, President and Chief
Executive Officer, Bloomberg Tradebook LLC, dated July 28, 2005
(``Bloomberg Letter II''); and Frank A. Torino, dated September 27,
2005 (``Torino Letter'').
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In total, the Commission received 43 comment letters on the amended
proposal (including 32 comment letters with respect to the First,
Second, and Third Notices).\13\ On September 21,
[[Page 16355]]
2005, the Exchange filed a response to the comment letters.\14\
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\13\ See supra notes 6, 9, and 10. The Commission received a
comment letter on Amendment No. 4, which was withdrawn by the
Exchange. See Letter from Junius W. Peake, Monfort Distinguished
Professor of Finance, Kenneth W. Monfort College of Business,
University of Northern Colorado, dated June 17, 2005 (``Peake Letter
II''). In addition, the Commission received three comment letters
from the same commenter in response to Amendment Nos. 6 and 7. See
Letters from George Rutherfurd, Consultant, dated November 1, 2005
(``Rutherfurd Letter IV''), November 8, 2005 (``Rutherfurd Letter
V''), and November 17, 2005 (``Rutherfurd Letter VI''). Finally, the
Commission received seven other comment letters from two commenters.
See Letters from Warran P. Meyers, President, Independent Broker
Action Committee, Inc., dated December 7, 2005 (``IBAC Letter I''),
February 2, 2006 (``IBAC Letter II''), and March 17, 2006 (``IBAC
Letter III''), and George Rutherfurd, Consultant, dated December 11,
2005 (``Rutherfurd Letter VII''), December 17, 2005 (``Rutherfurd
Letter VIII''), February 1, 2006 (``Rutherfurd Letter IX''), and
February 13, 2006 (``Rutherfurd Letter X'').
\14\ See Letter from Mary Yeager, Assistant Secretary, NYSE, to
Jonathan G. Katz, Secretary, Commission, dated September 21, 2005
(``Response to Comments'').
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On September 16, 2005, the Exchange filed Amendment No. 6 to the
proposed rule change.\15\ In Amendment No. 6, the Exchange proposes to
amend NYSE Rule 104 to state that specialists may only provide price
improvement to incoming orders that are marketable. In addition, NYSE
proposes to amend NYSE Rule 70.20 to limit the ability of interest in
the floor broker agency interest file to trade on parity with orders in
the customer limit order display book (``Book'') during a sweep.
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\15\ See Form 19b-4 dated September 16, 2005 (``Amendment No.
6'').
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On October 11, 2005, the Exchange filed Amendment No. 7 to the
proposed rule change.\16\ In Amendment No. 7, the Exchange made non-
substantive stylistic, conforming, and technical changes to certain
Exchange rules governing the Hybrid Market. In Amendment No. 7, the
Exchange also proposes to amend NYSE Rule 92 to reflect the operation
of the specialist systems that employ algorithms to generate quoting
and trading messages (``Specialist Algorithms''). Specifically, the
Exchange proposes that the specialist would not be deemed to have
``knowledge'' of a particular incoming order that is viewed by the
Specialist Algorithm if the Specialist Algorithm is designed in a
manner that prevents a quoting or trading message from being affected
by a later incoming order. In addition, NYSE proposes in Amendment No.
7 to amend NYSE Rule 13.30 and the definitions of stop and stop limit
orders to reflect the automatic execution of elected stop and stop
limit orders in the Display Book system.\17\
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\16\ See Form 19b-4 dated October 11, 2005 (``Amendment No.
7'').
\17\ The Display Book system (``Display Book system'') is an
order management and execution facility. The Display Book system
receives and displays orders to the specialists, contains the Book,
and provides a mechanism to execute and report transactions and
publish the results to the Consolidated Tape. In addition, the
Display Book system is connected to a variety of other Exchange
systems for the purposes of comparison, surveillance, and reporting
information to customers and other market data and national market
systems, that is, the Intermarket Trading System, Consolidated Tape
Association, Consolidated Quotation System, etc.
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On March 14, 2006, the Exchange filed Amendment No. 8 \18\ to the
proposed rule change. In Amendment No. 8, NYSE proposes to: (1) Amend
proposed NYSE Rules 13 and 124 to specify that a round lot portion of a
part of round lot (``PRL'') order is an ``Auto Ex Order'' \19\ and that
the odd lot portion of a PRL order would be executed at the same price
as the round lot portion of the PRL order and processed in the Odd-Lot
Execution System; \20\ (2) amend proposed NYSE Rule 13 to reflect that
stop orders and stop limit orders may still be represented manually by
a floor broker in the trading ``Crowd;'' \21\ (3) amend the definition
of immediate or cancel (``IOC'') order in proposed NYSE Rule 13 to: (a)
Propose an IOC order that is designed to be in compliance with
Regulation NMS; (b) specify that NYSE IOC orders would be eligible to
be routed away during a sweep; and (c) eliminate the previously
proposed changes to the treatment of commitments to trade received
through the Intermarket Trading System (``ITS Commitments''); \22\ (4)
amend its proposed definition of Intermarket Sweep order in proposed
NYSE Rule 13 to specify that this type of order would be permitted to
sweep the Display Book system, and the portion that was not executed
would be immediately cancelled; (5) amend proposed NYSE Rule 36 to
state that a specialist may only use a wired or wireless device that
has been registered with the Exchange to communicate with the
Specialist Algorithms and provide that specialist firms must create and
maintain records of all messages generated by the Specialist Algorithm;
(6) amend proposed NYSE Rule 60 to: (a) Set forth the instances during
which Autoquote \23\ will update the quote even if automatic executions
are not available; (b) set forth the instances during which Autoquote
will update the quote when Autoquote and automatic execution are
suspended and disseminate a 100 share quote in certain situations; and
(c) propose to use an indicator when the NYSE quote is not available
for automatic execution due to a gapped quotation or liquidity
replenishment point (``LRP'') to signify that the NYSE quote is not
firm; (7) amend proposed NYSE Rule 70.20 to: (a) Permit a floor broker
to leave the Crowd without canceling its floor broker agency interest
file \24\ to recharge its handheld device and (b) specify the
procedures for entering interest in the floor broker agency interest
file before the open; (8) amend proposed NYSE Rule 72 to specify the
priority and parity rules for instances when there are shares remaining
after a sweep that triggers an LRP; (9) amend NYSE Rule 76 to reflect
that it would not apply to elected stop or stop limit orders other than
those manually represented in the Crowd by a floor broker; (10) amend
proposed NYSE Rule 104 to: (a) Permit specialists to manually layer
dealer interest in the specialist interest file; (b) permit specialists
to enter certain quoting messages when automatic executions and
Autoquote are suspended; (c) amend the definition of ``meaningful
amount'' for purposes of determining when a specialist could provide
price improvement; and (d) require specialists to hire independent
auditors to review their algorithms on an annual basis; (11) amend
proposed NYSE Rule 123A.30 to: (a) Provide systematic conversion of
elected or converted percentage orders that are converted on a
destabilizing tick and that permit the specialist to trade on parity
(``CAP-DI orders'') on the same side as a specialist when the
specialist is bidding (offering) or trading and an automatic execution
occurs against a specialist's proprietary interest and (b) clarify the
execution of contra-side elected and converted CAP-DI orders; (12)
amend proposed NYSE Rule 123F to codify that NYSE may execute an
Auction Limit (``AL'') order or market order at a price that matches a
better away market; (13) amend proposed NYSE Rule 1000 to: (a) Clarify
that automatic executions will resume in the same manner as Autoquote;
(b) prohibit short sale orders, except those for Regulation SHO \25\
pilot securities, from sweeping the Display Book system; (c) eliminate
the provision that would have suspended the operation of Direct+ when
an away market disseminates a better quote; (d) eliminate the proposal
that would have permitted automatic executions to continue while the
specialist reports a block trade until the quote decremented to 100
shares; (e) specify the process for determining when a security that is
priced at $300.00 or more would be eligible for automatic executions;
(f) specify that automatic executions would be suspended on one side of
the market when a bid (offer) is
[[Page 16356]]
outside the momentum LRP; \26\ (g) specify that any shares remaining
after an execution in IOC orders, NYSE IOC orders, or Intermarket Sweep
orders would be cancelled after sweeping the Display Book system; and
(h) clarify that auto ex limit orders, except IOC orders, that are not
able to be immediately executed due to a suspension of Direct+ would be
placed in the Book; and (14) amend Rule 1001.
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\18\ See Form 19b-4 dated March 14, 2006 (``Amendment No. 8'').
\19\ See note 29 infra and accompanying text for a description
of ``Auto Ex Order.''
\20\ See note 34 infra.
\21\ See note 46 infra and accompanying text for a description
of ``Crowd.''
\22\ Similarly, NYSE also proposes to eliminate previously
proposed changes to the treatment of ITS Commitments in NYSE Rule
15A.60.
\23\ See note 58 infra and accompanying text for a description
of Autoquote.
\24\ See note 43 infra and accompanying text for a description
of the floor broker agency interest file.
\25\ See Securities Exchange Act Release No. 50103 (July 28,
2004), 69 FR 48008 (August 6, 2004).
\26\ See note infra and accompanying text for a description of
momentum LRPs.
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On December 14, 2005, the Commission approved on an accelerated
basis a proposed rule change by the Exchange to implement and test
certain proposed functions of the Hybrid Market, known as Phase 1 of
the Hybrid Market, on a pilot basis (``Pilot'').\27\
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\27\ See Securities Exchange Act Release No. 52954, 70 FR 75519
(December 20, 2005). See also Third Notice, supra note 11, for a
description of Phase 1 of the Hybrid Market implementation plan. The
Commission notes that it received one comment letter opposing the
implementation of the Pilot. See Letter from George Rutherfurd,
Consultant, dated December 13, 2005. On February 21, 2006, the
Exchange filed a proposed rule change pursuant to Section
19(b)(3)(A) of the Act and Rule 19b-4(f)(5) thereunder to amend the
manner in which CAP-DI orders convert in certain situations (``Pilot
Amendment''). See Securities Exchange Act Release No. 53359
(February 24, 2006), 71 FR 10736 (March 2, 2006). On March 13, 2006,
the Exchange filed a proposed rule change pursuant to Section
19(b)(3)(A) of the Act and Rule 19b-4(f)(6) thereunder to extend the
Pilot until March 24, 2006 (``Pilot Extension''). See Securities
Exchange Act Release No. 53487 (March 15, 2006), 71 FR 14278 (March
21, 2006).
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This order approves the proposed rule change, as amended by
Amendment Nos. 1, 2, 3, 5, 6, 7, and 8. The Commission is also
providing notice and soliciting comments on Amendment Nos. 6, 7, and 8
to the proposed rule change.
II. Description of the Proposal
Currently, NYSE is primarily a floor-based auction market. NYSE
members operate on the NYSE floor, representing their customers' orders
for execution in a largely manual environment. NYSE provides limited
automated access to its market through its automatic execution
facility, Direct+. According to NYSE, automatic executions represent
approximately 11% of its market share volume, with the bulk of
executions occurring manually in its floor-based auction.\28\ With this
proposed rule change, NYSE has proposed to alter the way its market
operates by allowing more orders to be executed automatically in
Direct+. In essence, NYSE has proposed to move from a floor-based
auction market with limited automated order interaction to a more
automated market with limited floor-based auction market availability.
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\28\ See NYSE Market Statistics (visited on March 9, 2006),
http://www.nyse.com/Frameset.html?displayPage=/ marketinfo/
1022221393893.html (noting that Direct+ volume, for the year ended
December 31, 2005, is 11.4% of NYSE volume).
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To create its Hybrid Market, NYSE has proposed changes to its
current Direct+ rules to make the system available to more order types
and to limit the instances when automatic executions are not available.
In addition, NYSE has proposed to permit its floor members to
participate in its expanded automated market in an electronic fashion.
Specifically, NYSE has proposed to permit specialists and floor brokers
to electronically provide liquidity that would be available for
automatic executions.
In addition, NYSE has proposed changes to its auction market to
accommodate those investors that wish to continue to have their orders
exposed for price improvement. To this end, NYSE has proposed to create
a new order type--the Auction Limit order, and to amend the way market
orders are handled in the auction.
A. Proposed Automated Market
1. Automated Access To Display Book System
Currently, Direct+ is only available, with respect to stocks, to
designated marketable limit orders, without tick restrictions, of 1,099
shares or less (``Auto Ex Orders'').\29\ In addition, multiple Auto Ex
Orders are not allowed to be entered for the account of the same person
within a 30-second time period from the entry of an initial Auto Ex
Order.\30\ Auto Ex Orders trade only against interest reflected in the
Exchange's published quotation--that is, the NYSE best bid or offer
(``BBO''). Eligible limit orders are not required to be entered as Auto
Ex Orders. Rather, the member organization entering the order (or its
customer if enabled by the member organization) must make a specific
designation to choose to enter an order into Direct+.
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\29\ See NYSE Rules 13 and 1000. Orders in Investment Company
Units (as defined in paragraph 703.16 of the Listed Company Manual),
Trust Issued Receipts (as defined in NYSE Rule 1200), streetTRACKS
Gold Shares (as defined in NYSE Rule 1300), or any product subject
to the same rules as Investment Company Units (collectively
``ETFs''), however, may be entered in a size greater than 1,099
shares. See Securities Exchange Act Release No. 52160 (July 28,
2005), 70 FR 44963 (August 4, 2005) (amending NYSE Rules 13 and 1005
to eliminate the 10,000 share restriction and the 30-second order
entry restriction for Auto Ex Orders in ETFs).
\30\ See NYSE Rule 1005.
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NYSE proposes to broaden access to Direct+ for stocks and ETFs.\31\
Specifically, NYSE has proposed to amend its Rule 13 to define an Auto
Ex Order to include: (1) All marketable limit orders; \32\ (2)
designated market orders; (3) designated IOC orders; \33\ (4) elected
stop and stop limit orders that have been systematically delivered to
the Display Book system; (5) buy minus, sell plus, and short sale
orders systematically delivered to the Display Book system; (6) CAP-DI
Orders; (7) the round lot portion of a PRL order; \34\ (8) orders that
were initially eligible for automatic execution that have been
cancelled and replaced with a subsequent Auto Ex Order; \35\ and (9)
Intermarket Sweep orders.\36\ In addition,
[[Page 16357]]
NYSE proposes to eliminate the size restrictions for Auto Ex Orders and
eliminate the 30-second order entry restriction.
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\31\ See proposed NYSE Rule 1002.
\32\ Marketable limit orders, i.e., limit orders to buy (sell)
priced at or above (below) the best offer (bid) at the time the
order is routed to the Display Book system, would no longer need to
be designated as requesting an automatic execution in Direct+. All
marketable limit orders would be automatically executed with or
without designation. See proposed NYSE Rule 13. Non-marketable limit
orders would be routed to the Display Book system, even if
designated auto ex, and would be displayed as limit orders on the
Book. See proposed NYSE Rule 1000(d)(v); see also Amendment No. 8.
These booked orders would be available to participate in sweep
transactions. When such orders become marketable, they would be
included in the quote and could participate in automatic executions.
\33\ NYSE proposes two types of IOC orders. See proposed NYSE
Rule 13; see also Amendment No. 8. One would be for the purposes of
Regulation NMS which would not be routed to away markets during a
sweep. Instead, if an away market is disseminating a better
protected bid or offer, the IOC order would be cancelled. The other
type of IOC order, the NYSE IOC order, would allow NYSE to route
portions to away markets to satisfy better protected bids or offers
and would cancel once it was no longer able to receive an execution
on NYSE. The Exchange also proposes to amend the definition of an
IOC order to permit the entry of IOC orders before the opening of
the Exchange for participation in the opening trade. If not executed
as part of the opening trade, the order would be treated as
cancelled.
\34\ See proposed NYSE Rule 13; see also Amendment No. 8. Odd-
lot orders and odd-lot portions of PRLs would not be eligible for
automatic execution in Direct+. The Exchange noted that, under NYSE
Rule 124, odd-lot orders are received, processed, and executed by an
Exchange system designated for such purpose with the specialist as
the contra-party at the price of certain round-lot transactions
(``Odd-Lot Execution System''). Accordingly, the Odd-Lot Execution
System provides a type of automatic execution that is governed by
NYSE Rule 124, not the rules governing Direct+. The Exchange also
clarified in the Third Notice that when automatic executions are
suspended, odd-lot executions also would be suspended to prevent
odd-lots from trading at prices unrelated to round-lot orders in the
same security and to provide consistency in the availability of
automatic executions.
\35\ Currently, the Display Book system changes an order that
cancels and replaces an Auto Ex Order to a non-Auto Ex Order. Under
the Hybrid Market, the Display Book system would no longer make this
change, so that a cancel/replace order of an Auto Ex Order would now
be eligible for automatic execution.
\36\ A few order types would be ineligible for automatic
execution, including CAP, ``opening only'' (OPG), ``limit on close''
(LOC), ``market on close'' (MOC), and ``basis'' (BAS) orders.
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2. Liquidity Available for Automatic Execution
Currently, the Display Book system contains the Book, which is
operated and represented by the specialist. The Book contains limit
orders routed to NYSE though SuperDOT \37\ or left with the specialist
by floor brokers for representation. The Display Book system also may
reflect specialist quotes at the NYSE BBO. Auto Ex Orders interact with
the interest displayed on the Display Book system at the NYSE BBO.
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\37\ SuperDOT is an electronic order-routing system used by NYSE
member firms to send market and limit orders to NYSE. SuperDOT is
also referred to as DOT.
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To further automate its market, NYSE has proposed to permit its
floor members--that is, specialists and floor brokers--to place
liquidity in the Display Book system at various prices, in newly-
created separate files that would be available for execution against
incoming Auto Ex Orders. This would allow floor members and the
investors they represent on the floor to more fully participate in
automatic executions.
(a) Specialist Interest File and Reserve
Specialists would have the ability to manually and systematically
place in a separate file (``specialist interest file'') within the
Display Book system their dealer interest at prices at or outside the
Exchange BBO.\38\ NYSE intends the specialist interest file to assist
the specialist, in an automated environment, to fulfill its obligations
to provide capital, bridge temporary gaps in supply and demand, and
dampen volatility. In addition, the specialist interest file would
allow specialists to provide increased liquidity at prices at or
outside the Exchange BBO, which could potentially improve the prices at
which Auto Ex Orders are executed.\39\
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\38\ See proposed NYSE Rules 104(b)(i) and 104(c)(viii); see
also Amendment No. 8 and Pilot.
\39\ See Response to Comments, supra note 14.
---------------------------------------------------------------------------
The Exchange also proposes to provide specialists with the ability
to maintain undisplayed reserve interest on behalf of their dealer
accounts at the Exchange BBO, provided that they display at least 2,000
shares of dealer interest at that price on the same side of the market
as the reserve.\40\ After an execution against a specialist's displayed
bid (offer), if the specialist has reserve interest remaining at that
best bid (offer), the amount of displayed interest would be
automatically replenished by the specialist's reserve interest, if any,
so that at least 2,000 shares of specialist interest is displayed (or
whatever specialist interest remains at the best bid (offer), if less
than 2,000 shares).\41\
---------------------------------------------------------------------------
\40\ See proposed NYSE Rule 104(d)(i).
\41\ See proposed NYSE Rule 104(d)(ii).
---------------------------------------------------------------------------
Specialist interest at the Exchange BBO would be disseminated;
specialist reserve and specialist interest away from the Exchange BBO
ordinarily would not be disseminated. Each specialist, however, has the
option to disseminate its interest away from the Exchange BBO via
OpenBook \42\ or another Exchange data distribution channel.
---------------------------------------------------------------------------
\42\ OpenBook is a compilation of limit order data for all NYSE
traded securities that the Exchange provides to market data vendors,
broker-dealers, private network providers, and other entities
through a data feed. See Securities Exchange Act Release No. 44138
(December 7, 2001), 66 FR 64895 (December 14, 2001).
---------------------------------------------------------------------------
(b) Floor Broker Agency Interest File and Reserve
Floor brokers, similarly, would be permitted to represent
electronically the orders they hold by including these orders in a
separate file (``floor broker agency interest file'') within the
Display Book system.\43\ Floor brokers would be permitted to place
liquidity electronically at or outside the Exchange BBO. In addition,
floor broker agency interest files would be allowed to participate in
the opening trade.\44\ Floor brokers would not be permitted to enter in
the floor broker agency interest files any interest that restricts the
specialist's ability to trade on parity with the floor broker agency
interest file.\45\
---------------------------------------------------------------------------
\43\ See proposed NYSE Rule 70.20(a)(i).
\44\ See proposed NYSE Rule 70.20(j)(i). Floor broker agency
interest entered before the open could participate in the opening
trade on parity with the Book in accordance with Exchange policies
that govern the open.
\45\ See proposed NYSE Rule 70.20(a)(i).
---------------------------------------------------------------------------
A floor broker would be required to be in close physical proximity
to the post for the security--that is, in the Crowd \46\ --while it has
orders in its floor broker agency interest file.\47\ NYSE would require
that a floor broker's agency interest file be cancelled when the floor
broker leaves the Crowd.\48\ If the floor broker nevertheless leaves
the Crowd without canceling its agency interest files, and one or more
executions occur with its agency interest, the floor broker would be
held to such executions.\49\
---------------------------------------------------------------------------
\46\ See proposed NYSE Rule 70.30. The Exchange proposes to
define a Crowd as being any five contiguous panels at any one post
where securities are traded. A floor broker would be considered to
be in the Crowd if it is physically present at one of the five
contiguous panels. However, the requirement that a floor broker be
in the Crowd to have agency interest files would not apply to orders
governed by section 11(a)(1)(G) of the Act (``G'' orders), 15 U.S.C.
78k(a)(1)(G). See proposed NYSE Rule 70.20(a)(ii).
\47\ A floor broker could enter interest in its agency interest
file prior to the open regardless of its location on the floor, but
would have to be in the Crowd at the open to participate in the
opening trade. Any agency interest entered prior to the open would
have to be cancelled before the open, if the floor broker is not in
the Crowd. See proposed NYSE Rule 70.20(j)(ii); see also Amendment
No. 8.
\48\ See proposed NYSE Rule 70.20(f). However, a floor broker
could leave the Crowd to recharge its handheld device without
canceling its interest. See id. See also Amendment No. 8.
\49\ See proposed NYSE Rule 70.20(f).
---------------------------------------------------------------------------
Because the floor broker agency interest file is part of the
Display Book system and because of the specialist's obligation to
maintain a fair and orderly market, the Exchange proposes to allow the
specialist ordinarily to see the aggregate number of shares of all
floor broker agency interest files at each price.\50\ A floor broker,
however, would have the option to exclude all of its floor broker
agency interest file from the information available to the
specialist.\51\ A floor broker's ability to exclude volume from the
aggregate agency interest information available to the specialist would
not be available during the open.\52\ Floor broker agency interest
excluded from the aggregated agency interest information available to
the specialist would be able to participate in automatic executions,
but would not participate in a manual execution unless the floor broker
represents the interest manually.\53\ Furthermore, floor broker agency
interest that has been excluded from the aggregate information
available to the specialist would not participate in the closing
trade.\54\
---------------------------------------------------------------------------
\50\ See proposed NYSE Rule 70.20(g). Specialists would not be
able to see individual orders represented in the floor broker agency
interest file.
\51\ See id.
\52\ See proposed NYSE Rule 70.20(k).
\53\ See proposed NYSE Rule 70.20(h).
\54\ See proposed NYSE Rule 70.20(k).
---------------------------------------------------------------------------
The Exchange proposes to permit floor brokers to maintain
undisplayed reserve interest at the Exchange BBO provided that a
minimum of 1,000 shares of the floor broker's agency interest is
displayed at that price.\55\ If an execution at the Exchange BBO occurs
that does not exhaust the broker's interest at that price, the
displayed interest would be automatically replenished from the floor
broker's reserve interest, if any, so that at least 1,000 shares (or
whatever amount remains, if less than 1,000 shares) is displayed.\56\
There would be no reserve capability for floor broker agency
[[Page 16358]]
interest entered into the files during the open and close.\57\
---------------------------------------------------------------------------
\55\ See proposed NYSE Rule 70.20(c)(ii).
\56\ See proposed NYSE Rule 70.20(c)(iii).
\57\ See proposed NYSE Rule 70.20(k).
---------------------------------------------------------------------------
The floor broker agency interest file at the Exchange BBO, except
reserve, would be disseminated. Floor broker agency interest away from
the BBO would not be displayed in OpenBook or other Exchange data
distribution channel.
3. Autoquote
Autoquote is part of the Display Book system that immediately
displays customer limit orders received on the Exchange.\58\ Autoquote
immediately updates the NYSE BBO when a customer limit order is
received by NYSE that improves the NYSE quote.\59\ In addition,
Autoquote updates the NYSE BBO when an execution occurs to reflect a
new NYSE BBO from interest held in the Display Book system. The
Exchange proposes to amend its Rule 60 to modify the circumstances
under which Autoquote would be suspended.
---------------------------------------------------------------------------
\58\ This system was developed to facilitate specialists'
compliance with the Commission's Limit Order Display Rule. See 17
CFR 242.604.
\59\ NYSE Rule 60(e).
---------------------------------------------------------------------------
Specifically, Autoquote would be suspended in three circumstances:
(1) When the specialist manually reports a block size transaction that
involves orders in the Display Book system; (2) when the specialist
gaps the quote; \60\ or (3) when a LRP is reached.\61\ When Autoquote
is suspended due to a manual report of a block trade that involves
orders in the Display Book system,\62\ Autoquote would resume when the
manual reporting is concluded.\63\ When Autoquote is suspended
following a gap quote, Autoquote would resume upon the report of a
manual transaction or the publication of a non-gapped quotation.\64\
---------------------------------------------------------------------------
\60\ See note 139 infra, for a description of gapped quotations.
\61\ See proposed NYSE Rule 60(e)(i). See Section II(A)(5)(a)
infra, and proposed NYSE Rule 1000(a)(iv) for a description of LRPs.
\62\ See proposed NYSE Rule 1000(a)(v). See Section II(A)(5)
infra.
\63\ See proposed NYSE Rule 60(e)(ii)(B).
\64\ See proposed NYSE Rule 60(e)(ii)(A).
---------------------------------------------------------------------------
When Autoquote is suspended by an LRP that is reached by an Auto Ex
Order that sweeps to the LRP price,\65\ and if the Auto Ex Order is
filled or if its unfilled balance is not capable of trading at a price
beyond the sweep LRP price, then Autoquote would resume in no more than
five seconds after the LRP is reached.\66\ If the Auto Ex Order is
capable of trading at a price beyond the LRP price, and would not
create a locked or crossed market if quoted, then Autoquote would
resume upon the report of a manual transaction or the publication of a
new quote by the specialist, but in any event in no more than ten
seconds.\67\ Finally, if the Auto Ex Order is capable of trading at a
price beyond the LRP price but would create a locked or crossed market
if quoted, then Autoquote would resume upon a manual transaction or the
publication of a new quote by the specialist.\68\
---------------------------------------------------------------------------
\65\ See Section II(A)(5)(a)(1) infra.
\66\ See proposed NYSE Rule 60(e)(ii)(C).
\67\ See id.
\68\ See id. In Amendment No. 8, the Exchange represented that
it would implement an alert for specialists to facilitate their
compliance with the Commission's Limit Order Display Rule, 17 CFR
242.604.
---------------------------------------------------------------------------
When Autoquote is suspended by a momentum LRP (``MLRP''),\69\
Autoquote would resume in no more than ten seconds unless the Auto Ex
Order would create a locked or crossed market.\70\ If a locked or
crossed market exists, Autoquote would resume once a manual transaction
is reported.\71\
---------------------------------------------------------------------------
\69\ See Section II(A)(5)(a)(2) infra.
\70\ See proposed NYSE Rule 60(e)(iii).
\71\ See id. See also note 68 supra.
---------------------------------------------------------------------------
Autoquote would update the quote in the following situations even
though automatic executions are not available. First, when the Exchange
best bid (offer) is outside a MLRP, and such MLRP has not yet been
reached, the Exchange would permit Autoquote to continue to operate,
while automatic executions are not available.\72\ Second, NYSE would
keep Autoquote active when an order or a cancellation of an order
arrives that would not result in a locked or crossed market in a
security priced at $300 or more that has been determined to be
ineligible for automatic execution (``high-priced security'') \73\ or a
manual execution takes place in such security.\74\ Third, if there is a
cancellation of the Exchange best bid (offer) in a high-priced security
when the market in such security is internally locked or crossed, and
autoquoting of the next best bid (offer) would create a locked or
crossed market on the Exchange, NYSE would automatically generate a
quote of 100 shares at the bid (offer) price that existed at the time
of the cancellation.\75\
---------------------------------------------------------------------------
\72\ See proposed NYSE rule 60(e)(iv)(a); see also Amendment No.
8.
\73\ See note 142 infra and accompanying text on the definition
of high-priced security.
\74\ See proposed NYSE rule 60(e)(iv)(b)(i); see also Amendment
No. 8.
\75\ See proposed NYSE rule 60(e)(iv)(b)(ii); see also Amendment
No. 8.
---------------------------------------------------------------------------
Finally, in the following situations, the Exchange would update its
quote even though Autoquote is suspended due to an LRP or a gapped
quotation, and automatic executions are not available: (1) If part of
the existing Exchange best bid (offer) cancels, the Exchange would use
Autoquote to update its quote to reflect the remaining volume;\76\ (2)
if the entire existing Exchange best bid (offer) cancels, the Exchange
would automatically generate a quote of 100 shares at the bid (offer)
price that existed at the time of the cancellation;\77\ or (3) if there
is a cancellation of the Exchange best bid (offer) when the market is
internally locked or crossed, and autoquoting of the next best bid
(offer) would create a locked or crossed market on the Exchange, NYSE
would automatically generate a quote of 100 shares at the bid (offer)
price that existed at the time of the cancellation.\78\
---------------------------------------------------------------------------
\76\ See proposed NYSE rule 60(e)(iv)(c)(i); see also Amendment
No. 8.
\77\ See proposed NYSE rule 60(e)(iv)(c)(ii); see also Amendment
No. 8.
\78\ See proposed NYSE rule 60(e)(iv)(c)(iii); see also
Amendment No. 8.
---------------------------------------------------------------------------
4. Automatic Executions
Currently, an Auto Ex Order equal to or greater than the size of
the Exchange's BBO trades with the entire published bid or offer,\79\
and a new bid or offer is then published. If any shares of an Auto Ex
Order remain available for execution after it trades with the published
quote, the remaining shares are routed to the floor and represented in
the auction market.\80\ Auto Ex Orders that cannot be immediately
executed are placed in the Book and represented as limit orders in the
auction market.\81\ When the national best bid or offer (``NBBO'') is
disseminated by another market and an Auto Ex Order is delivered to the
specialist, it must either match the better price displayed by the
other market or send an ITS Commitment to the other market.\82\
---------------------------------------------------------------------------
\79\ See NYSE Rule 1000(a).
\80\ See NYSE Rule 1001(b).
\81\ See NYSE Rule 1000.
\82\ See NYSE Rule 15A.
---------------------------------------------------------------------------
As proposed, Auto Ex Orders would execute against interest at the
Exchange BBO including displayed interest and reserve.\83\ Once an Auto
Ex Order trades with interest at the BBO, NYSE proposes to permit Auto
Ex Orders, except ITS Commitments, to automatically ``sweep'' the
Display Book system by trading with liquidity that is outside the BBO.
Specifically, after exhausting the volume at the BBO, the shares of the
Auto Ex Order that remain (the ``residual'') would trade with existing
orders in the Book, floor broker agency interest files, and the
specialist interest file, until the Auto Ex Order is executed, its
limit price, if any, is
[[Page 16359]]
reached, or a LRP is reached, whichever occurs first.\84\
---------------------------------------------------------------------------
\83\ See proposed NYSE Rule 1000(d).
\84\ See proposed NYSE Rule 1000(d)(ii)(A)-(D).
---------------------------------------------------------------------------
During a sweep, the residual would trade with the orders in the
Display Book system, floor broker agency interest, and any specialist
interest capable of execution, at a single price (the ``clean-up
price''), such that any price improvement is given to the orders and
interest in the Display Book system rather than the Auto Ex Order.\85\
Accordingly, orders in the Book, floor broker agency interest, and any
specialist interest capable of trading with the residual would receive
the clean-up price.\86\ Any specialist interest that remains at the
clean-up price after the residual has traded would be automatically
cancelled by the Exchange.\87\
---------------------------------------------------------------------------
\85\ See proposed NYSE Rule 1000(d)(iii)(A).
\86\ See proposed NYSE Rule 1000(d)(iii)(B).
\87\ See proposed NYSE Rule 1000(d)(iii)(C)(ii).
---------------------------------------------------------------------------
Any residual remaining after the sweep would become a bid (offer)
at the order's limit price, if any, or the LRP price, whichever is
lower (higher).\88\ If the residual can execute at the price at which
it is bidding (offering), it would have priority for one trade over
other interest at that price.\89\ If the residual executes at a
different price--within the parameters of its limit, if any--it would
trade on parity.\90\ If an Auto Ex Order is designated IOC, any
unfilled balance remaining after the sweep would be automatically
cancelled.\91\
---------------------------------------------------------------------------
\88\ See proposed NYSE Rule 1000(d)(iv).
\89\ See proposed NYSE Rule 72(j); see also Amendment No. 8.
\90\ See id.
\91\ See proposed NYSE Rule 1000(d)(iv).
---------------------------------------------------------------------------
Current NYSE Rule 1001(a)(iv) provides that the specialist shall be
the contra party for any automatic execution of an Auto Ex Order where
the interest reflected in the published bid or offer is no longer
available. This obligation exists regardless of the tick associated
with the automatic execution. NYSE Rule 104, however, restricts the
specialist's ability to purchase stock on direct plus ticks or sell
stock on direct minus ticks. As part of its initial proposal
establishing Direct+, the Exchange sought and received Commission
approval of an interpretation of NYSE Rule 104 that provides that any
instance in which the specialist is effecting such a direct tick
transaction only because it has been required to assume the contra-side
of an automatic execution shall be deemed to be a ``neutral''
transaction for purposes of NYSE Rule 104, and shall not be deemed a
violation of the Exchange rule.\92\ The Exchange requests that the
Commission extend this interpretation to its Hybrid Market proposal.
---------------------------------------------------------------------------
\92\ See note 203 infra.
---------------------------------------------------------------------------
Automatic executions of Auto Ex Orders may elect stop orders, stop
limit orders, and percentage orders electable at the price of such
executions.\93\ Currently, any stop orders so elected are executed
pursuant to Exchange auction market procedures and are not guaranteed
an execution at the same price as subsequent automatic executions of
Auto Ex Orders.\94\ The Exchange previously sought and the Commission
approved an interpretation \95\ that, for the purposes of NYSE Rule
123A, the specialist is not required to fill any stop orders elected by
an execution of an Auto Ex Order at the price of the electing sale in
any instance where the specialist was required by NYSE Rule 1001(a)(iv)
to take the contra-side of a Direct+ execution. NYSE proposes to retain
this interpretation.
---------------------------------------------------------------------------
\93\ See NYSE Rule 1004.
\94\ See id.
\95\ See note 203 infra.
---------------------------------------------------------------------------
(a) Priority, Parity, and Precedence
NYSE executions are governed by its rules of priority, parity, and
precedence.\96\ These rules dictate which order or quote is able to
execute against an incoming order and the allotment of shares, if more
than one order or quote is at the BBO. Generally, the first bid (offer)
at the BBO has priority to execute against the next incoming order.\97\
Once a trade occurs with the bid (offer) that has priority, other bids
(offers) at that price (including any remaining interest from the bid
(offer) that had priority) generally trade on parity, meaning they
split evenly the remainder of the incoming order, up to the size of
their own order.\98\
---------------------------------------------------------------------------
\96\ See NYSE Rules 72, 104, and 108.
\97\ See NYSE Rule 72 I(a). A bid (offer) that establishes the
Exchange BBO is entitled to priority at that price for one trade,
except a specialist bid or offer entitled to priority must yield to
limit orders on the Book at the same price.
\98\ See NYSE Rule 72 III. When bids (offers) are on parity,
Exchange rules dictate that in certain circumstances, a particular
participant is guaranteed a portion of an order based on the size of
its bid (offer), i.e., precedence based on size. See NYSE Rule 72
I(c).
---------------------------------------------------------------------------
A specialist must always yield priority to the orders it represents
on the Book,\99\ and today is limited somewhat in its ability to trade
with orders represented by floor brokers. Specifically, when the
specialist is decreasing or liquidating its dealer position, the
specialist is entitled to trade on parity with orders represented by
floor brokers, unless the floor broker (or its customer) requests that
the specialist refrain from trading along with the order the floor
broker represents.\100\ When a specialist is establishing or increasing
its dealer position, NYSE Rule 108 states that the specialist is not
``entitled'' to parity with orders represented on the floor. According
to NYSE, it has interpreted this rule to permit specialist trading on
parity when establishing or increasing a position if the specialist is
granted permission from the floor broker (or its customer) to do
so.\101\
---------------------------------------------------------------------------
\99\ See NYSE Rule 92.
\100\ See NYSE Rule 104.10(6)(i)(C).
\101\ See NYSE Information Memo 05-81 (October 26, 2005)
(interpreting NYSE Rule 108(a) as permitting a specialist to be on
parity with orders in the Crowd when the specialist is establishing
or increasing its position, provided that the brokers representing
orders in the Crowd permit the specialist to trade along with them
by not objecting to such participation). See Securities Exchange Act
Release No. 53208 (February 2, 2006), 71 FR 6804 (February 9, 2006).
---------------------------------------------------------------------------
In its Hybrid Market, the Exchange proposes to amend its rules that
govern priority, parity, and precedence with respect to interest placed
in the Display Book system. Generally, an incoming Auto Ex Order would
trade first with the displayed bid (offer) that established the
BBO.\102\ If the Auto Ex Order is of greater size than the bid (offer)
that has priority, the remaining balance of the Auto Ex Order would
trade with other displayed interest at the BBO.\103\ The additional
displayed interest would trade on parity.\104\ Thereafter, if the Auto
Ex Order has size remaining to be executed, it would then execute
against undisplayed specialist or floor broker reserve at the BBO,
which would trade on parity.\105\
---------------------------------------------------------------------------
\102\ See proposed NYSE Rule 1000(d)(i). If the specialist
establishes the BBO, however, it would have to yield to all interest
in the Book.
\103\ See proposed NYSE Rule 1000(d)(ii). As noted above, floor
brokers would not be permitted to enter interest into its floor
broker agency interest files that restricts the specialist's ability
to trade on parity. In addition, specialists would not be permitted
to trade on parity until orders in the Book at the same price are
executed in full.
\104\ See proposed NYSE Rule 1001(a)(i).
\105\ See proposed NYSE Rules 1000(d)(ii)(A), 70.20(c)(iv), and
104(d)(iii).
---------------------------------------------------------------------------
The Exchange proposes that all floor broker agency interest files
at the same price be on parity with each other, except a floor broker
agency interest file that establishes the BBO would be entitled to
priority in accordance with NYSE Rule 72.\106\ Finally, with respect to
transactions against the published bid or offer, no published bid or
offer may claim precedence based on size with respect to executions
against Auto Ex Orders.\107\
---------------------------------------------------------------------------
\106\ See proposed NYSE Rule 70.20(b).
\107\ See proposed NYSE Rule 1001(b). This reflects the current
NYSE Rule 1001(c), which is proposed in this filing to be renumbered
as NYSE Rule 1001(b).
---------------------------------------------------------------------------
[[Page 16360]]
In Amendment No. 6, the Exchange proposes to amend NYSE Rule
70.20(d)(i) to provide that, during a sweep, the amount of floor broker
agency interest that would have been displayed had the clean-up price
become the Exchange BBO would trade on parity with displayed interest
(i.e., orders on the Book) at that price.\108\ The amount of any floor
broker agency interest that would have been placed in the broker's
reserve, however, would yield to displayed interest.\109\
---------------------------------------------------------------------------
\108\ As noted earlier, floor broker agency interest would not
be disseminated unless at the Exchange's BBO.
\109\ See proposed NYSE Rule 70.20(d)(ii). Floor brokers would
have to indicate when entering interest in the floor broker agency
interest file the amount that would be displayed and the amount that
would be placed in reserve if the price becomes the BBO.
---------------------------------------------------------------------------
The Exchange proposes that interest reflected in the specialist
interest file would be entitled to trade on parity with interest in the
floor broker agency interest file, regardless of whether the specialist
is increasing or decreasing its position, but, in all cases, specialist
interest would have to yield to orders in the Book. Specifically,
during a sweep, if no orders remain on the Book capable of trading at
the clean-up price, specialist interest could trade and would be on
parity with floor broker interest at that price.\110\ During a sweep,
neither the specialist interest file nor the floor broker agency
interest file could claim precedence based on size.\111\
---------------------------------------------------------------------------
\110\ See proposed NYSE Rule 1000(d)(iii)(C)(i).
\111\ See proposed NYSE Rule 72 I(c)-(e).
---------------------------------------------------------------------------
The Exchange also proposes to modify NYSE Rule 72 III to add that a
cancellation of an entire bid or offer entitled to priority under the
rule would clear the floor, after which all bids and offers would be
deemed to be re-entered and on parity.\112\ The Exchange believes this
amendment is warranted because a cancellation of a bid or offer that
was entitled to priority has the same effect as a trade.
---------------------------------------------------------------------------
\112\ Currently, a transaction ``clears the floor,'' after which
all bids and offers are deemed resubmitted simultaneously and are on
parity, except that specialists must yield to limit orders on the
Book. Cancellation of part of an order retains priority for the
uncancelled portion of such order. However, canceling an order and
replacing it with a larger order would result in a loss of priority
for the original order.
---------------------------------------------------------------------------
To summarize, the following describes the sequence of execution
against an incoming Auto Ex Order in the Hybrid Market:
Interest at Exchange BBO
An incoming Auto Ex Order would first trade with displayed interest
at the Exchange BBO. Within this category, the order of execution would
be:
First, interest that clearly establishes the BBO would be
entitled to priority at that price for one trade, except that
specialist interest that clearly established the BBO would yield to all
later-arriving limit orders at the BBO on the Book. If there are no
limit orders on the Book at the BBO, specialist interest that clearly
established the BBO would be entitled to priority over the floor broker
agency interest file for one trade.
Second, all other displayed interest at the BBO would
trade on parity, except that specialist interest displayed at the BBO
could not trade until all limit orders on the Book at the BBO are
filled. If there are no limit orders on the Book at the BBO, specialist
interest displayed at that price would trade on parity with the floor
broker agency interest files displayed at the BBO. A specialist's
ability to trade on parity with the floor broker agency interest files
would not be restricted by the specialist's proprietary position (i.e.,
the specialist would trade on parity whether establishing/increasing or
liquidating/decreasing its position).\113\
---------------------------------------------------------------------------
\113\ However, NYSE Rule 104 would continue to restrict a
specialist's ability to trade on parity.
---------------------------------------------------------------------------
Third, reserve interest (i.e., non-displayed interest) of
the specialist or floor broker at the BBO would trade on parity.
Additional specialist interest (i.e., other non-displayed interest
generated by the Specialist Algorithm) at the BBO would trade only if
no other interest exists at the BBO.\114\
---------------------------------------------------------------------------
\114\ See infra Section II(B)(1) for a description of this
``additional specialist interest.''
---------------------------------------------------------------------------
Interest Outside Exchange BBO That Participates in a Sweep
Orders on the Book outside the Exchange BBO would trade at
the clean-up price on parity with the amount of floor broker agency
interest that would have been displayed had the clean-up price become
the Exchange BBO. The amount of any floor broker agency interest that
would have been placed in the broker's reserve would yield to displayed
interest.
Specialist interest would participate in the sweep
provided there are no limit orders on the Book remaining at the clean-
up price. Specialist interest participating in the sweep would trade on
parity with any remaining floor broker agency interest at the clean-up
price.
(b) Automated Routing Away
In the case of all orders submitted to the Exchange electronically,
except for certain IOC orders, ITS Commitments, and Intermarket Sweep
orders, where a better bid or offer is published by another ITS
participating market center in which an automatic execution is
available, or a published bid or offer is otherwise protected from a
trade-through by Commission rule or the Intermarket Trading System
plan, and the specialist has not systematically matched the price
associated with that better bid or offer, the Exchange would
automatically route to such other market center a commitment to trade
that satisfies that published bid or offer, unless the member entering
the order indicates that it has contemporaneously satisfied the better
published bid or offer.\115\ If the commitment to trade is not filled
or not filled in its entirety, the balance would be returned to the
Exchange and handled consistent with the order's instructions, which
includes automatic execution, if available.\116\ The order entry time
associated with this returned portion of the order would be the time of
its return, not the time the order was first entered on the
Exchange.\117\ With respect to the operation of sweeps, automated bids
(offers) published by away markets that are better than the clean-up
price would be satisfied in their entirety unless the order is an IOC
order \118\ or an Intermarket Sweep order.\119\
---------------------------------------------------------------------------
\115\ See proposed NYSE Rule 15A.50
\116\ See id.
\117\ See id.
\118\ In such case, the IOC order would be cancelled by NYSE to
prevent trading through the away market.
\119\ See proposed NYSE Rule 1000(d)(III)(D) and Rule 600(b)(30)
of Regulation NMS, 17 CFR 242.600(b)(30).
---------------------------------------------------------------------------
(c) Tick-Restricted Orders, Stop Orders, and Other Orders Eligible for
Automatic Execution
Tick-restricted orders in the Display Book system would be filled
electronically and participate in automatic executions and sweeps as
their ticks and limits, if any, allow.\120\ Specifically, buy sweeps
would cause short sales and sell plus orders to be executed above the
offer, while sell sweeps would cause buy minus orders to be executed
below the bid. Sell short orders, other than those involving Regulation
SHO pilot securities, would not sweep the Display Book system after
automatically executing against the bid,
[[Page 16361]]
as the sweep transaction would occur on a minus tick.\121\
---------------------------------------------------------------------------
\120\ Specifically, the Exchange proposes in NYSE Rule 13 that
sell ``plus'' limit orders, buy ``minus'' limit orders, sell
``plus'' market orders, and by ``minus'' market orders designated
for automatic execution that are systematically delivered to the
Display Book system be eligible to be automatically executed in
accordance with NYSE Rules 1000-1004.
\121\ See proposed NYSE Rule 1000(d)(iii)(E); see also Amendment
No. 8.
---------------------------------------------------------------------------
Under the proposal, stop orders (including stop limit orders) on
the Display Book system would be electronically elected and may
participate in automatic executions.\122\ Elected stop orders on the
same side of the market as the Auto Ex Order could trade at the
electing bid (offer) price after the Auto Ex Order is filled to the
extent that there is volume available.\123\ In addition, an execution
at the clean-up price could also elect stop orders. Elected stop orders
on the same side of the market as a sweeping Auto Ex Order could trade
at the clean-up price after the Auto Ex Order is filled to the extent
that there is volume available.\124\
---------------------------------------------------------------------------
\122\ See proposed NYSE Rule 13.
\123\ Elected stop orders on the contra side of the market of
the Auto Ex Order could trade with the Auto Ex Order at the electing
bid (offer) price after interest in the Display Book system at such
price has been filled to the extent that there is volume available
from the Auto Ex Order.
\124\ Elected stop orders on the contra side of the market of
the Auto Ex Order could trade with the Auto Ex Order at the clean-up
price after interest in the Display Book system at such price has
been filled to the extent that there is volume available from the
Auto Ex Order.
---------------------------------------------------------------------------
Furthermore, under proposed amendments to NYSE Rule 123A, the
elected or converted portion of a CAP-DI order could be automatically
executed and participate in a sweep. An elected or converted CAP-DI
order on the same side of the market as an automatically executed
electing order could participate in a transaction at the bid (offer)
price if there is volume associated with the bid (offer) remaining
after the electing order is filled in its entirety.\125\ An elected or
converted CAP-DI order on the same side of the market as an
automatically executed electing order that sweeps the Display Book
system could also participate in a transaction at the clean-up price if
there is volume remaining on the Display Book system or from contra-
side elected CAP-DI orders at that price.\126\ Furthermore, an elected
or converted CAP-DI order on the contra-side of the market of an
automatically executed electing order could execute against the Auto Ex
Order at the electing price if there is volume remaining after the Auto
Ex Order executes against interest in the Display Book system at the
bid (offer) price.\127\ An elected or converted CAP-DI order on the
contra-side of the market of an automatically executed electing order
that sweeps the Display Book system could execute against the Auto Ex
Order at the clean-up price if there is volume remaining from the Auto
Ex Order, from contra-side elected CAP-DI orders, or other interest at
that price.\128\ Finally, when a specialist is bidding (offering) or
trading and an automatic execution occurs against such specialist
proprietary interest, marketable CAP-DI orders on the same side as the
specialist's interest would be automatically converted to participate
in such execution.\129\ If the execution elects a contra-side stop or
stop limit order and the specialist is required to execute the elected
stop or stop limit order, then CAP-DI orders on the same side of the
market as the specialist would be automatically converted to
participate in the execution of the stop or stop limit orders.\130\
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\125\ See proposed NYSE Rule 123A.30(a)(i).
\126\ See id.
\127\ See proposed NYSE Rule 123A.30(a)(ii); see also Amendment
No. 8.
\128\ See proposed NYSE Rule 123A.30(a)(ii); see also Amendment
No. 8.
\129\ See proposed NYSE Rule 123A.30(a)(iii); see also Pilot
Amendment.
\130\ See id.
---------------------------------------------------------------------------
Stop orders and CAP-DI orders could be elected at the same time by
automatic executions and sweeps. If there is insufficient volume to
fill the elected orders, stop orders could be executed first as they
become market or marketable limit orders upon their election, whereas
the elected portion of CAP-DI orders would revert to CAP-DI status if
it is unable to trade. Elected CAP-DI orders are on parity with each
other, which could affect the sequence in which elected stop and CAP-DI
orders would trade.\131\
---------------------------------------------------------------------------
\131\ See NYSE Rule 123A.30.
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5. Availability of Direct+
Current Exchange rules provide that automatic executions are
available from the time the Exchange disseminates a published bid or
offer until 3:59 p.m. for stocks and Trust Issued Receipts, or 4:14
p.m. for Investment Company Units, or within one minute of any other
closing time of the Exchange's floor market.\132\ Auto Ex Orders
entered prior to the dissemination of a bid or offer or after 3:59
p.m./4:14 p.m. or within one minute of any other closing time, are
handled in the auction market. The Exchange proposes to extend the
availability of automatic executions through the close of regular
trading for a particular product (e.g., 4 p.m./4:15 p.m.).\133\
---------------------------------------------------------------------------
\132\ See NYSE Rule 1002.
\133\ See proposed NYSE Rule 1002.
---------------------------------------------------------------------------
Currently, Direct+ is not available during the trading day at the
following times: (1) When the NYSE published quotation is in the non-
firm quote mode; (2) when the execution price would be more than five
cents away from the last reported transaction price in the subject
security on the Exchange; (3) when a better price exists in another ITS
participating market center; (4) when NYSE's published bid or offer is
100 shares (on the side the order would be executed against); (5) when
a block size transaction outside NYSE's published bid or offer pursuant
to NYSE Rule 127 is in the process of being completed, in which case
the specialist should publish a bid and/or offer that is more than five
cents away from the last reported transaction price in the subject
security on the Exchange; \134\ or (6) when trading in the subject
security has been halted.\135\
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\134\ On January 17, 2006, the Exchange filed a proposed rule
change seeking to amend the procedure for suspending automatic
execution in connection with a block size transaction. See Form 19b-
4 dated January 17, 2006 (SR-NYSE-2006-01). The Exchange proposes to
require specialists to publish a 100 x 100 share market quote that
reflects the last reported transaction in connection with a block
size transaction.
\135\ See NYSE Rule 100(a)(i)-(vi).
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NYSE proposes to limit the instances when Direct+ is
unavailable.\136\ Specifically, pursuant to proposed NYSE Rule
1000(a),\137\ automatic executions in Direct+ would not occur when: (1)
The NYSE published quotation is in non-firm quote mode; (2) trading in
a security has been halted; \138\ (3) the quote is gapped in accordance
with Exchange procedures; \139\ (4) trading on the Exchange reaches a
LRP; (5) a block size transaction, as defined in NYSE Rule 127.10,\140\
that involves
[[Page 16362]]
orders in the Display Book system is being manually reported; \141\ or
(6) an Auto Ex Order is entered for a security whose closing price (or
the closing bid price if there were no transactions on the previous
trading day) on the Exchange is $300 or more.\142\ Direct+ would be
unavailable on both sides of the market in these situations.\143\ NYSE
proposes to disseminate an indicator to alert investors when automatic
executions are not available against its quote. In addition, when
automatic executions are not available due to a LRP or gapped
quotation, NYSE would disseminate an indicator to signify that the NYSE
quotation is not firm.\144\ In any instance where the automatic
execution feature is not available, Auto Ex Orders would be directed to
the Exchange's auction market for representation.\145\
---------------------------------------------------------------------------
\136\ In Amendment No. 8, NYSE proposes to remove its previously
proposed rule that would have made Direct+ unavailable when a better
price was published by an away market. As noted above, NYSE proposes
to automatically route orders, except Intermarket Sweep orders and
certain IOC orders, to ITS participant markets that make automatic
execution immediately available and are protected from trade
throughs, unless the specialist matches the better price.
\137\ See proposed NYSE Rule 1000(a)(i)-(vi).
\138\ No executions, either automatic or manual, would be
possible on the Exchange when trading has been halted.
\139\ A specialist could cause a non-auto-executable quote by
gapping the quotation due to an order imbalance in accordance with
the policies and procedures of the Exchange. Gap quotes are used to
signal an imbalance so as to attract contra-side liquidity in an
attempt to mitigate volatility. The size of an imbalance suitable
for gapped quoting is at least 10,000 shares or a quantity of stock
having a value of $200,000 or more, although depending on the
trading characteristics of the security, the appropriate conditions
for gapped quoting could be higher. See NYSE Information Memo 04-27
(June 9, 2004).
When the quotation is gapped, automatic executions and Autoquote
would be suspended, and the NYSE quote would be identified as non-
firm. Incoming orders and cancellations would update the Book
electronically. Once a trade occurs or a non-gapped quote is
published, Autoquote and automatic execution would resume.
\140\ NYSE Rule 127.10 defines a ``block'' size as at least
10,000 shares or a quantity of stock having a market value of
$200,000 or more, whichever is less. See Amendment No. 8.
\141\ The Exchange originally proposed to permit automatic
executions to continue while a block size transaction was manually
reported until the bid (offer) decremented to 100 shares. In
Amendment No. 8, NYSE proposes to suspend both Autoquote and
automatic executions as soon as the report template is opened by the
specialist to report a block size transaction that involves orders
on the Display Book system. See proposed NYSE Rule 60(e)(ii)(B) and
NYSE Rule 1000(a)(v).
\142\ See proposed NYSE Rule 1000(a)(vi); see also Amendment No.
8. In addition, in Amendment No. 8, NYSE proposes to suspend
automatic executions for such securities on both sides of the
market.
\143\ Automatic executions would be suspended on only one side
of the market when an execution at the NYSE quote would trigger the
MLRP. See proposed NYSE Rule 1000(c). See also proposed NYSE Rule
60(e)(iv)(a).
\144\ See proposed NYSE Rule 60(c)(2)(b); see also Amendment No.
8.
\145\ See NYSE Rule 1000(d)(v).
---------------------------------------------------------------------------
(a) Liquidity Replenishment Points
The Exchange proposes LRPs as pre-determined price points that
would halt automatic executions for varying periods of time depending
on the price and remaining size, if any, of an Auto Ex Order. LRPs may
be triggered by a sweep or electronic trading that results in rapid
price movement over a short period. A LRP converts the electronic
market to an auction market on a temporary basis, with the intent of
moderating volatility in the security by affording an opportunity for
new orders, the Crowd, and the specialist to add liquidity. The
Exchange proposes two LRPs--a price-based or sweep LRP and a momentum
LRP.
(1) Sweep LRPs
The sweep LRP price would be set at the nearest five-cent increment
outside the Exchange BBO, rounded away to the next nearest nickel.\146\
When a sweep LRP is reached, the sweeping order would trade at that
price to the extent of the volume available at that price. If there is
a residual remaining after a sweep that has triggered an LRP, it would
be bid (offered) at the LRP price, unless the order is NYSE IOC, IOC or
Intermarket Sweep, in which case it would be cancelled.\147\
---------------------------------------------------------------------------
\146\ See proposed NYSE Rule 1000(a)(iv)(A).
\147\ See proposed NYSE Rule 1000(d)(iv). If an Auto Ex Order
sweeps to its limit price and has residual remaining at the price,
the residual would be bid (offered) at its limit price.
---------------------------------------------------------------------------
Automatic executions and Autoquote would then be suspended, but
incoming orders and cancellations would continue to be reflected
automatically in the Display Book system, although new incoming orders
would not be displayed.\148\ However, if a displayed bid (offer)
cancels, a new bid (offer) would be autoquoted.\149\
---------------------------------------------------------------------------
\148\ See Second Notice, supra note . According to the Exchange,
the Display Book system has the ability to accept incoming orders
and cancellations when automatic executions and Autoquote are
suspended; however, only the specialist would be able to view this
information. These incoming orders and cancellations are held in the
Display Book system in the sequence that they are received, until
Autoquote and automatic executions are available.
\149\ See proposed NYSE Rule 60(e)(iv)(c); see also Amendment
No. 8.
---------------------------------------------------------------------------
Under the proposal, automatic executions and Autoquote would resume
in no more than five seconds when the sweeping order is filled in its
entirety (i.e., no residual exists), when the residual is cancelled
(i.e., the sweeping order is IOC), or when the residual is not capable
of trading at a price above (in the case of a buy order) or below (in
the case of a sell order) the sweep LRP (that is, when the residual has
a limit price equal to the LRP).\150\ Automatic executions and
Autoquote would resume in no more than 10 seconds when the residual is
able to trade at a price above (below) the sweep LRP, but that price
would not create a locked or crossed market.\151\ Automatic executions
and Autoquote would resume earlier if the specialist has manually
traded or quoted the market before 10 seconds have elapsed. NYSE
expects the specialist to quote or trade before 10 seconds have
elapsed, unless an imbalance exists, a trade is being put together in
the Crowd, or market conditions otherwise prevent such actions from
occurring.
---------------------------------------------------------------------------
\150\ See proposed NYSE Rules 60(e)(ii)(C) and 1000(b); see also
Amendment No. 8.
\151\ See id.
---------------------------------------------------------------------------
Finally, where a residual is able to trade at a price above (below)
the sweep LRP, and that price would create a locked or crossed market,
or when a locked or crossed market results from the entry of orders or
cancellations during the 5- and 10-second periods described above,
automatic executions and Autoquote would resume with a manual trade or
the publication of a new quote by the specialist.\152\ In this
circumstance, there is no maximum time period after which automatic
executions and Autoquote would automatically resume.\153\ If the
locking or crossing residual order cancels, automatic executions and
Autoquote would resume within the relevant 5- or 10-second timeframe
described above, unless a manual trade or quote occurs before
then.\154\ If the displayed bid (offer) on the contra-side of the
locking or crossing residual order cancels, a new bid (offer) would be
autoquoted.
---------------------------------------------------------------------------
\152\ See proposed NYSE Rules 60(e)(ii)(C) and 1000(b).
\153\ Specialists would still be required to immediately display
customer limit orders. See Rule 604 of Regulation NMS, 17 CFR
242.604. See also proposed NYSE Rule 60(e)(ii)(C) and 60(e)(iii).
\154\ See Second Notice, supra note 8.
---------------------------------------------------------------------------
(2) MLRPs
The momentum LRP would be triggered by a specified price movement
over a specified period during a trading session. The Exchange is
proposing a LRP based on price movement over a period of time because
it is concerned that excessive volatility could arise in situations
other than electronic sweeps. MLRPs are designed to limit the amount of
price change that can occur within a 30-second time period to the
greater of 25 cents or 1% of the security price (rounded to the nearest
cent).
The MLRP range at any time may be calculated as follows. First, the
low MLRP range is calculated by taking the high transaction price of
the security within the prior 30 seconds and subtracting the greater of
(a) 25 cents or (b) 1% of the security's price (rounded to the nearest
cent).\155\ Next, the high MLRP range is calculated by taking the low
transaction price of the security within the prior 30 seconds and
adding the greater of (a) 25 cents or (b) 1% of the security's price
(rounded to the nearest cent).\156\ For example, assume that during the
prior 30 seconds, the high transaction price is $20.15, the low
transaction price is $19.92, and the last sale price was $20.15. The
low MLRP range would be $19.90, calculated by subtracting $0.25 ($0.25
is greater than 1% of the security's price) from the high transaction
price of $20.15. The high MLRP range would be $20.17, calculated by
adding $0.25 to the low transaction price of $19.92. The MLRP
[[Page 16363]]
range could change based on an event (e.g., a new trade) or the passage
of time.
---------------------------------------------------------------------------
\155\ See proposed NYSE rule 1000(a)(iv)(B)(ii).
\156\ See id.
---------------------------------------------------------------------------
If there was no transaction on the Exchange within 30 seconds, the
MLRP range would be based off the last transaction on the
Exchange.\157\ For example, if the last sale price was $20.15 and no
transactions have occurred within the prior 30 seconds, the low MLRP
range would be $19.90 and the high MLRP range would be $20.40.
Automatic executions could occur at prices at or within the MLRP range.
Automatic executions that would occur at prices outside the MLRP range
would cause the suspension of automatic executions and Autoquote. An
Auto Ex Order that reaches the MLRP price would trade at that price to
the extent possible, and thereafter automatic executions and Autoquote
would be suspended.\158\ The Display Book system would be automatically
updated by incoming orders and cancellations, although new incoming
orders would not be displayed.\159\
---------------------------------------------------------------------------
\157\ See proposed NYSE rule 1000(a)(iv)(B)(iii).
\158\ See proposed NYSE Rule 1000(a)(iv)(B).
\159\ See Second Notice, supra note 8. See also supra note 148.
---------------------------------------------------------------------------
Once automatic executions and Autoquote have been suspended due to
a MLRP, they generally would resume in no more than 10 seconds.\160\
The Exchange expects, similar to a sweep LRP, that the specialist will
trade or requote the stock in less than 10 seconds unless conditions in
the stock prevent this. Where incoming orders and cancellations cause a
locked or crossed market, Autoquote and automatic executions would
resume upon a manual transaction.\161\
---------------------------------------------------------------------------
\160\ See proposed NYSE Rules 60(e)(iii) and 1000(b); see also
Amendment No. 8.
\161\ See id.
---------------------------------------------------------------------------
In addition, if the NYSE published bid or offer is at a price
beyond the MLRP range, automatic executions on that side of the market
would be suspended because an automatic execution could not occur at
that price.\162\ This is the only instance when automatic executions
would be suspended on one side of the market. Autoquote would continue,
and orders and cancellations would update the Display Book system.\163\
Automatic executions would resume when a bid or offer within the MLRP
range is autoquoted or the MLRP range changes as a result of the moving
30-second timeframe.\164\
---------------------------------------------------------------------------
\162\ see proposed NYSE Rule 1000(c); see also Amendment No. 8.
\163\ See supra note 148.
\164\ See id.
---------------------------------------------------------------------------
B. Role of the Specialist in the Hybrid Market
1. Specialist Algorithms
The Exchange proposes to allow specialists to participate
automatically in the Hybrid Market and replicate the performance of
certain specialist privileges and obligations in an electronic way. For
instance, specialists would be permitted to establish electronic
connections to the Display Book system that would provide them with
access to certain information before other market participants, and be
permitted to make a range of specified quoting and trading decisions
based on that information.
Specifically, the Exchange proposes to provide specialists with the
ability to implement systems that use proprietary algorithms, based on
predetermined parameters, to electronically participate in the Hybrid
Market (``Specialist Algorithm'').\165\ The Specialist Algorithm would
communicate with the Display Book system via an Exchange-owned external
application program interface (``API'').\166\ The Specialist Algorithm
is intended to replicate electronically some of the activities
specialists are permitted to engage in on the floor in the auction
market, and to facilitate specialists' ability to fulfill their
obligations to maintain a fair and orderly market.
---------------------------------------------------------------------------
\165\ See proposed NYSE Rule 104(b).
\166\ In Amendment No. 8, the Exchange clarified that
specialists would develop Specialist Algorithms to communicate with
the Display Book system via the API.
---------------------------------------------------------------------------
The Specialist Algorithm would receive information via the API,
including information about orders entering NYSE systems, before that
information is available to other market participants.\167\ NYSE
systems would enforce the proper sequencing of incoming orders and
algorithmically-generated messages.\168\ The Specialist Algorithm and
the specialists on the floor would not have the ability to affect the
arrival of orders at the Display Book system, or the sequence in which
orders and algorithmically-generated messages are processed by the
Display Book system.\169\ The Specialist Algorithm, however, would be
able to generate certain specified quoting and trading messages based
on the information it receives through the API. Once an algorithmic
message has been generated, it cannot be stopped, changed, or cancelled
on its way to the Display Book system.
---------------------------------------------------------------------------
\167\ The Specialist Algorithm would have access to the
following information: (1) Specialist dealer position; (2) quotes;
(3) information about orders in the Display Book system such as
limit orders, percentage orders, stop orders, and AL orders and
market orders not designated for automatic execution (``AM orders'')
(``state of the book''); (4) any publicly available information the
specialist firm chooses to supply to the algorithm, such as the
Consolidated Quote stream; and (5) incoming orders as they are
entering NYSE systems. The Specialist Algorithm would not have
access to the following types of information: (1) Information
identifying the firms entering orders, customer information, or an
order's clearing broker; (2) floor broker agency interest files or
aggregate floor broker agency interest available at each price; or
(3) order cancellations, except for cancel and replace orders. See
proposed NYSE rule 104(c)(ii).
\168\ See proposed NYSE Rule 104(b)(ii)(A).
\169\ See proposed NYSE Rule 104(b)(ii)(B).
---------------------------------------------------------------------------
The Display Book system would not accept algorithmically-generated
messages from the Specialist Algorithm when automatic executions are
unavailable except in certain specified situations.\170\ Specifically,
when automatic executions are suspended, but Autoquote is active, the
Display Book system would accept algorithmically-generated messages
from the Specialist Algorithm to generate a bid or offer that improves
the Exchange BBO or supplements the size of the existing BBO.\171\
---------------------------------------------------------------------------
\170\ See proposed NYSE Rule 104(c)(vi).
\171\ See proposed NYSE Rule 104(c)(vi)(i); See also Amendment
No. 8.
---------------------------------------------------------------------------
In addition, when Autoquote and automatic executions are suspended,
the Display Book system would: (1) Process algorithmically-generated
messages to layer specialist interest outside the published Exchange
quotation and (2) permit specialists to manually layer specialist
interest at prices within a previously established locking or crossing
quotation.\172\
---------------------------------------------------------------------------
\172\ See proposed NYSE Rule 104(c)(vi)(ii) and 104(c)(viii);
See also Amendment No. 8.
---------------------------------------------------------------------------
Furthermore, the Display Book system would not process
algorithmically-generated messages from the Specialist Algorithm during
the time a block size transaction involving orders in the Display Book
system is being manually reported \173\ or when the messages would
trigger the automatic execution of an AL order or an AM order, or would
result in such order's execution with an existing contra-side
specialist bid or offer.\174\ However, the Display Book system would
process algorithmically-generated messages from the Specialist
Algorithm to provide price improvement to AL and AM orders in
accordance with the price improvement parameters described below.\175\
Algorithmically generated messages would not be permitted to create a
[[Page 16364]]
locked or crossed market \176\ and would have to comply with all SEC
and NYSE rules, policies, and procedures governing specialist
proprietary trading.\177\
---------------------------------------------------------------------------
\173\ See proposed NYSE Rule 104(c)(v).
\174\ See proposed NYSE Rule 104(c)(vii) and infra Section
II(D).
\175\ See proposed NYSE Rule 104(c)(vii).
\176\ See proposed NYSE Rule 104(c)(iv).
\177\ See proposed NYSE Rule 104(c)(iii). NYSE has represented
that prior to the rollout of the third phase of the Hybrid Market,
it will develop guidance to clarify how it expects specialists to
comply with the NYSE Rule 104 in the Hybrid Market. Telephone call
between Catherine R. Kinney, President and Co-Chief Operating
Officer, NYSE Group, Inc. and Richard G. Ketchum, Chief Regulatory
Officer, NYSE Regulation, Inc., and Kelly M. Riley, Assistant
Director, Division, SEC, on March 22, 2006. See also Amendment No.
8.
---------------------------------------------------------------------------
(a) Quoting Messages
The Exchange proposes to allow the Specialist Algorithm to generate
quoting messages to: (1) Supplement the size of the existing Exchange
BBO; (2) place within the Display Book system specialist reserve
interest at the Exchange BBO; (3) layer within the Display Book system
specialist interest at varying prices outside the Exchange BBO; \178\
(4) establish the Exchange BBO; and (5) withdraw previously established
specialist interest at the Exchange BBO.\179\
---------------------------------------------------------------------------
\178\ In Amendment No. 8, NYSE proposes to permit specialists to
manually place interest in the specialist interest files at and
outside the BBO. Such interest would remain in the Display Book
system until it is traded with or cancelled. See proposed NYSE Rule
104(c)(viii); see also Pilot.
\179\ See proposed NYSE Rule 104(b)(i)(A)-(E).
---------------------------------------------------------------------------
A quoting message would not be able to interact with the order that
preceded it. In addition, the Specialist Algorithm could move its quote
away from the inside market only after the order it is reacting to has
been processed.
(b) Trading Messages
The Exchange proposes to allow the Specialist Algorithm to generate
trading messages to: (1) Provide ``additional specialist volume'' to
partially or completely fill an order at the Exchange BBO; \180\ (2)
match better bids and offers published by other market centers where
automatic executions are immediately available; (3) provide price
improvement to an order, subject to the conditions outlined below; and
(4) trade with the Exchange published quotation `` that is, ``hit
bids'' or ``take offers.'' \181\
---------------------------------------------------------------------------
\180\ Specialists could supply additional trading volume at the
BBO beyond the amount in the specialist's reserve, if any. The
Exchange proposes to amend NYSE Rule 104 to provide that this
additional volume, which is not part of the reserve and which is not
displayed, could complete an order, thereby providing a single-
priced execution, or partially fill the remainder of the order. See
proposed NYSE Rule 104(b)(i)(F). Additional specialist volume would
yield to displayed and reserve interest.
\181\ See proposed NYSE Rule 104(b)(i)(F)-(I).
---------------------------------------------------------------------------
The generation of algorithmic messages to trade in response to a
particular order does not guarantee that the specialist would be able
to interact with that order or that the specialist has priority in
trading with that order.\182\ For example, specialist interest may not
trade with the order identified by the algorithmic message because the
specialist's message did not arrive in the Display Book system in time
or the specialist has to yield to the Book. Such interest would be
automatically cancelled.\183\
---------------------------------------------------------------------------
\182\ See proposed NYSE Rule 104(c)(i)(C).
\183\ See proposed NYSE Rule 104(c)(i)(D).
---------------------------------------------------------------------------
(1) Specialists' Ability To Systematically Price Improve Incoming
Orders
The Specialist Algorithm would enable specialists, on behalf of
their dealer accounts, to electronically provide price improvement to
all or part of a marketable incoming order, including an AL order or AM
order,\184\ provided the following conditions are met: (i) The
specialist is represented in a ``meaningful amount'' in the bid with
respect to price improvement provided to an incoming sell order, or in
the offer with respect to price improvement provided to an incoming buy
order; and (ii) the price improvement provided by the specialist is (a)
at least three cents where the quotation spread is more than five
cents, (b) at least two cents where the quotation spread is three,
four, or five cents, or (c) one cent where the quotation spread is two
cents.\185\ NYSE proposes to define the term ``meaningful amount'' as
at least 1,000 shares for the 100 most active securities on the
Exchange based on average daily volume and at least 500 shares for all
other securities on the Exchange.\186\ Specialist systematic price
improvement would only be available for incoming orders that are
marketable (i.e., that can trade with the published bid or offer).\187\
In addition, the Exchange proposes to amend NYSE Rule 123A.30 to
provide for systematic conversion of marketable CAP-DI orders
previously entered with the specialist to allow these orders to
participate on parity with the specialist when the specialist is price
improving an incoming order.\188\
---------------------------------------------------------------------------
\184\ Specialist Algorithms could price improve AL orders and AM
orders, consistent with the requirements noted above, by generating
a message to trade with the AL or AM order before it is processed by
the Display Book system, or executing the AL or AM order at its
quoted price once the order has been processed by the Display Book
system. Algorithmic messages that would trigger the automatic
execution of AL or AM orders or that would result in such orders
trading with the specialist's existing contra-side bid or offer
would be prohibited. See proposed NYSE Rule 104(c)(vii).
\185\ See proposed NYSE Rule 104(e)(i)(A)-(D).
\186\ See proposed NYSE Rule 104(e)(ii); see also Amendment No.
8. NYSE would disseminate a list of the 100 most active securities
on a quarterly basis, or more frequently as the Exchange may
determine from time to time. See proposed NYSE Rule 104(e)(ii).
\187\ See proposed NYSE Rule 104(e)(i). With respect to incoming
orders that are not marketable (i.e., those orders that would
establish a new best bid or best offer), the specialist could not
trade with such order until the new bid or offer is publicly
disseminated.
\188\ See proposed NYSE Rule 123A.30(a)(iii).
---------------------------------------------------------------------------
(2) Specialists' Ability To Hit Bids or Take Offers
Specialists' messages to trade with the Exchange published quote
must include information that indicates the quote has been publicly
disseminated.\189\ In addition, to ensure that a specialist's
algorithmic message to trade with the Exchange published quotation does
not possess any speed advantage in reaching the Display Book system,
Exchange systems would process such messages in a manner that gives
specialists and other market participants a similar opportunity to
trade with the Exchange's published quotation, by delaying the
processing of this type of trading message from the Specialist
Algorithm.\190\
---------------------------------------------------------------------------
\189\ See proposed NYSE Rule 104(c)(i)(A).
\190\ See proposed NYSE Rule 104(b)(ii). Based upon the average
transit time from the Common Message Switch (CMS) system to the
Display Book system, the Exchange would determine the appropriate
amount of time to delay the processing of algorithmic messages to
trade with the Exchange published quotation. The delay parameter
would be adjusted periodically to account for changes to the average
transit time resulting from capacity and other upgrades to Exchange
systems. See Third Notice, supra note 11.
---------------------------------------------------------------------------
2. Limitations on Members' Trading Because of Customers' Orders--NYSE
Rule 92
NYSE Rule 92(a) generally prohibits members from causing the entry
of an order to buy (sell) any Exchange-listed security for any account
in which such member is directly or indirectly interested, if the
person responsible for entering such order has knowledge of any
particular unexecuted customer's order to buy (sell) such security
which could be executed at the same price. The Exchange has proposed to
amend NYSE Rule 92 to reflect the operation of the Specialist
Algorithm.
Specifically, NYSE proposes that the specialist would not be deemed
to have knowledge about a particular incoming order that is viewed by
the Specialist Algorithm until such incoming order is ``processed'' by
the Specialist Algorithm.\191\ According to the Exchange, there may be
times when the Specialist Algorithm could ``possess'' more than one
order at the same time.
[[Page 16365]]
In addition, there could be times when a permissible algorithmic
message has been generated, but before such message has been processed
by the Display Book system, the Specialist Algorithm has ``read'' or
``is reading'' a new incoming order. This new order could be priced at
the same price as the algorithmically-generated order or otherwise be
able to trade with the order to which the algorithmic message reacted,
but, as a result of proper time sequencing within the Display Book
system, the algorithmic message would be processed before the new
incoming order. NYSE has proposed to amend Rule 92 to provide that, if
the Specialist Algorithm is designed and operated in a manner that
prevents a quoting or trading message generated in response to an order
from being affected by the receipt of a subsequent order, then for
purposes of Rule 92, the specialist would not be deemed to have
knowledge of the subsequent order.\192\
---------------------------------------------------------------------------
\191\ See proposed NYSE Rule 92.15. See also Amendment No. 7.
\192\ See id.
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3. Policy for Communicating With the Specialist Algorithm
NYSE proposes to permit specialists on the floor to control the
Specialist Algorithms.\193\ For example, specialists could activate or
deactivate the firm's algorithms or adjust the firm's pre-set
parameters that guide an algorithm's decision-making.\194\ Specialists
would not, however, have the ability to prevent the processing by the
Display Book system of an algorithmically-generated message. NYSE
proposes to allow specialists to interact with the Specialist Algorithm
via a wired or wireless device that has been registered with the
Exchange, such as a computer terminal or laptop. Each specialist firm
would be required to certify, in the time, frequency, and manner
prescribed by the Exchange, that such wired or wireless devices operate
in accordance with all SEC and Exchange rules, policies, and
procedures.\195\ In addition, specialists would be required to create
and maintain records of all messages generated by the firm's wired or
wireless devices.\196\
---------------------------------------------------------------------------
\193\ See proposed NYSE Rule 36.30.
\194\ See id. See also proposed NYSE Rule 104(g).
\195\ See proposed NYSE Rule 36.30; see also Amendment No. 8.
\196\ See id.
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4. Specialist Algorithm Record Requirements
Every algorithmically-generated message generated by the Specialist
Algorithm would have to include a code identifying the reason for the
algorithmic action (e.g., ``match ITS,'' ``price improvement,'' ``hit
bid,'' etc.), the unique identifiers of the order to which the
algorithmically-generated message is reacting (if any), the order
immediately preceding the generation of the algorithmically-generated
message, and any other information the Exchange may require.\197\ The
Exchange would automatically cancel algorithmically-generated messages
that are unable to interact with the order or quotation identified by
the message, where the reason code and the proposed algorithmic action
are inconsistent, where message activity would create a locked or
crossed market, where the identifiers described above are not included,
and in other similar situations.\198\
Furthermore, the Exchange would require that each specialist firm
maintain an electronic log of all algorithmically-generated messages,
including the date and time of each algorithmically-generated message
and such other information as the Exchange shall designate.\199\ Such
log would have to be maintained in accordance with SEC and Exchange
rules regarding books and records, and be capable of being provided to
the Exchange upon request, in such time and in such format as the
Exchange shall designate.\200\ In addition, each specialist firm would
be required to notify the Exchange in writing, within such time as the
Exchange shall designate, whenever its Specialist Algorithm or an
individual algorithm is not operating and the time, cause, and duration
of such non-operation.\201\ Finally, each specialist would be required
to have an independent third party auditor review, on an annual basis,
all Specialist Algorithms to ensure that they operate in accordance
with all SEC and Exchange rules, policies, and procedures.\202\
---------------------------------------------------------------------------
\197\ See proposed NYSE Rule 104(c)(i).
\198\ See proposed NYSE Rule 104(c)(i)(D).
\199\ See proposed NYSE Rule 104(f)(i). NYSE Rule 132A requires
members and member firms to synchronize the business clocks they use
to record dates and times of any event the Exchange requires to an
Exchange-designated time source.
\200\ See id.
\201\ See proposed NYSE Rule 104(f)(ii)
\202\ The Exchange would have the right to request originals and
copies of any report, notes, analysis, documents, and similar types
of materials prepared by the independent auditor. See proposed NYSE
Rule 104(h); see also Amendment No. 8.
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C. Proposal To Make Direct+ Permanent
Direct+ was originally approved as a one-year pilot program ending
on December 21, 2001.\203\ The pilot was subsequently extended for five
additional one-year periods, and is currently scheduled to end on
December 23, 2006.\204\ The Exchange proposes to make Direct+
permanent.\205\
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\203\ See Securities Exchange Act Release No. 43767 (December
22, 2000), 66 FR 834 (January 4, 2001).
\204\ See Securities Exchange Act Release Nos. 45331 (January
24, 2002), 67 FR 5024 (February 1, 2002); 46906 (November 25, 2002),
67 FR 72260 (December 4, 2002); 48772 (November 12, 2003), 68 FR
65756 (November 21, 2003); 50828 (December 9, 2004), 69 FR 75579
(December 17, 2004); and 53014 (December 22, 2005), 70 FR 77228
(December 29, 2005).
\205\ This would also have the effect of superseding four
filings that have been approved by the Commission during the Direct+
pilot, which were made part of the pilot. See Securities Exchange
Act Release Nos. 47024 (December 18, 2002), 67 FR 79217 (December
27, 2002); 47353 (February 12, 2003), 68 FR 8318 (February 20,
2003); 47463 (March 7, 2003), 68 FR 12122 (March 13, 2003); and
47614 (April 2, 2003), 68 FR 17140 (April 8, 2003).
---------------------------------------------------------------------------
D. Auction Limit Orders and Auction Market Orders
While NYSE has proposed to significantly increase the availability
of Direct+, it would still retain its auction market on the floor.
Investors would be able to submit orders to floor brokers for
representation on the floor (or in the electronic market if the floor
broker sends this interest to the floor broker agency interest file).
Investors also would be able to submit certain order types
electronically through DOT that would be represented by the specialist
to seek price improvement opportunities.
Specifically, NYSE has proposed one new order type--AL orders, and
has proposed to amend its rules governing the execution of market
orders that are not designated as auto ex eligible, i.e., AM
orders.\206\ Specialists would represent these orders in the auction
market, where the Crowd or Auto Ex Orders could offer an opportunity
for execution at a price better than the Exchange BBO, while retaining
as a backup the possibility of automatic execution in case the floor is
unable to offer price improvement promptly.
---------------------------------------------------------------------------
\206\ See proposed NYSE Rule 13.
---------------------------------------------------------------------------
Under the proposal, AL and AM orders would be automatically
executed when they arrive at the Display Book system if the Exchange
quotation is at the minimum variation of one cent.\207\ Where a better
bid (offer) is published by another ITS participating market center in
which an automatic execution is immediately available and such better
bid (offer) creates a minimum variation market compared with the
Exchange best offer (bid), an AL or AM order (or the requisite portion
thereof) would be automatically routed to such other market center for
execution, unless the
[[Page 16366]]
specialist matches the price of the better away offer (bid).\208\
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\207\ See proposed NYSE Rule 123F(a)(i)(A) and (b)(ii)(A).
\208\ See proposed NYSE Rule 123F(a)(i)(B) and (b)(ii)(B).
---------------------------------------------------------------------------
If not automatically executed or routed away upon entry, AM orders
to buy and AL orders to buy with a limit price that is at or above the
Exchange best offer when they reach the Display Book system would be
autoquoted the minimum variation better than the Exchange best bid,
thereby becoming the Exchange best bid.\209\ Similarly, AM orders to
sell and AL orders to sell with a limit price that is at or below the
Exchange best bid when they reach the Display Book system would be
autoquoted the minimum variation better than the Exchange best offer,
thereby becoming the Exchange best offer.\210\ The size associated with
the bid or offer would be the size of the AL or AM order.\211\ The size
of subsequent AL and AM orders on the same side of the market would be
aggregated in the bid (offer) and executed based on time priority,
consistent with AL orders' limit prices.\212\
---------------------------------------------------------------------------
\209\ See proposed NYSE Rule 123F(a)(ii) and (b)(iii).
\210\ See id.
\211\ See id.
\212\ See id.
---------------------------------------------------------------------------
An AL or AM order could miss the market while attempting to obtain
price improvement,\213\ but according to the Exchange, electronic
representation should limit that possibility. Once on the Book, an AL
or AM order could participate in any execution, including automatic
executions and sweeps. Furthermore, if an AL or AM order has not been
executed within 15 seconds after reaching the Display Book system, it
would automatically execute (i.e., buy orders would execute against the
displayed offer, and sell orders would execute against the displayed
bid),\214\ provided Autoquote and automatic executions are
available.\215\ In addition, three events would cause automatic
execution of an AL or AM order before 15 seconds has elapsed. The three
events are: (i) The arrival of a subsequent order at a better price on
the same side of the market as an AL or AM order; (ii) the execution of
an order on the same side of the market as an AL or AM order that
exhausts some or all of the displayed contra-side volume available in
the Exchange quotation; and (iii) the cancellation of some or all of
the displayed contra-side volume, or the improvement of the displayed
contra-side price that creates a minimum variation market or allows
execution of the AL or AM order with price improvement.\216\ In these
situations, the order causing the AL or AM order to automatically
execute would trade first.\217\ If a trade that causes an automatic
execution of an AL or AM order also elects stop orders and CAP-DI
orders, the AL and AM orders would execute first because they are
executable at the time of entry (but seek an opportunity for price
improvement), and CAP-DI and stop orders would execute after the AL and
AM orders because they are contingent orders that are not executable
until elected.
---------------------------------------------------------------------------
\213\ See proposed NYSE Rule 123F(a)(iv) and (b)(v).
\214\ See proposed NYSE Rule 123F(a)(iii)(D) and (b)(iv)(D).
\215\ If another market displays a price better than the AL or
AM orders, the Exchange would execute the AL or AM order at a price
(consistent with the AL order's limit) that matches the immediately
accessible better away quote. See proposed NYSE Rule 123F(a)(i)(C)
and (b)(ii)(C); see also Amendment No. 8.
\216\ See proposed NYSE Rule 123F(a)(iii)(A)-(C) and (b)(iv)(A)-
(C).
\217\ As noted above, a Specialist Algorithm trading message
cannot cause the automatic execution of an AL or AM order. See
proposed NYSE Rule 104(c)(vii).
---------------------------------------------------------------------------
An AL order to buy with a limit price that is not at or above the
Exchange best offer when it reaches the Book or an AL order to sell
with a limit price that is not at or below the Exchange best bid when
it reaches the Book, would be displayed on the Book at its limit
price.\218\ An AL order that is unable to automatically execute because
of its limit price would be handled as a regular limit order.\219\
---------------------------------------------------------------------------
\218\ See proposed NYSE Rule 123F(a)(v).
\219\ See id.
---------------------------------------------------------------------------
E. Other Changes
1. Intermarket Sweep Order
To implement the requirements of Regulation NMS,\220\ the Exchange
proposes to amend NYSE Rule 13 to adopt another new order type--the
Intermarket Sweep order. An Intermarket Sweep order would be a limit
order designated for automatic execution in a particular security that
meets the following requirements: (1) It is identified as an
Intermarket Sweep order in the manner prescribed by the Exchange; and
(2) simultaneously with the routing of the Intermarket Sweep order to
the Exchange, one or more additional limit orders, as necessary, are
routed to execute against the full displayed size of any protected bids
(offers).\221\ These additional routed orders would have to be marked
as intermarket sweep orders. Intermarket Sweep orders would be
automatically executed upon receipt against the displayed bid (offer)
and would then sweep the Display Book system. Any portion not executed
would be immediately and automatically cancelled. Intermarket Sweep
orders would be identified as such on the Consolidated Tape.
---------------------------------------------------------------------------
\220\ 17 CFR 242.600(b)(30).
\221\ See proposed NYSE Rule 13.
---------------------------------------------------------------------------
2. Record of Orders/Order Tracking
The Exchange proposes in NYSE Rule 123(e) that no order may be
represented for execution on the floor or placed in a floor broker
agency interest file within the Display Book system unless certain
details of the order and the floor broker agency interest file have
been first recorded in an electronic system on the floor. Furthermore,
the floor member would have to identify which orders or portions
thereof are being made part of the floor broker agency interest file.
Since NYSE Rule 123(e)(7) provides that the type of order be designated
and recorded, the Exchange proposes that AL orders and auto ex market
orders be added to this rule.
NYSE Rule 132B prescribes requirements and procedures with respect
to orders in any security listed on the Exchange received or originated
by a member. It requires a member to immediately record data elements
as detailed in the rule. If an order is transmitted to another member
or is transmitted to another department of the same member, or is
modified or cancelled, information detailed in the rule must be
recorded. Additionally, the recipient of the order must record the
order details as provided in the rule.
The Exchange proposes similar changes to NYSE Rule 132B(b)(9) with
regard to the designation of an order as in proposed NYSE Rule
123(e)(7). Furthermore, NYSE Rule 132B(a)(1)(D) is proposed to be
amended to require that members and member organizations identify which
orders or portions thereof are being made part of the floor broker
agency interest file pursuant to such procedures as required by the
Exchange. This would conform NYSE Rule 132B with changes made to NYSE
Rule 123(e).
3. NYSE Rule 91
NYSE Rule 91 includes transaction confirmation requirements in
instances in which the specialist participates in a transaction as both
principal and agent. The Exchange sought and received Commission
approval \222\ of its interpretation that NYSE Rule 91 does not apply
where the specialist is the contra-party to an automatic execution, as
the specialist does not accept an Auto Ex Order for execution or act as
agent in the execution of such order. NYSE
[[Page 16367]]
proposes to extend this interpretation to its Hybrid Market.
---------------------------------------------------------------------------
\222\ See supra note 203.
---------------------------------------------------------------------------
F. Hybrid Market Implementation Plan
The Exchange proposes to implement the Hybrid Market in five phases
over a period of months.\223\ The Exchange believes that this would
help ensure proper functioning of the Exchange, specialists, floor
brokers, vendor-based systems, and Hybrid Market-related
functionalities, and would promote the seamless integration of Hybrid
Market facilities into the marketplace. In addition, the phased
implementation plan would provide time for market participants to
become familiar with the different functions and features, so that they
would be adequately prepared to employ them properly once the Hybrid
Market is fully functional. Within each phase, the various functions
that would become operational during that phase would be made available
over a period of several weeks.
---------------------------------------------------------------------------
\223\ See Amendment No. 8. In Amendment No. 8, the Exchange
modified the implementation plan by moving: (1) Floor brokers'
ability to exclude their interest in the floor broker agency
interest file from the aggregate information available to the
specialist from Phase 2 to Phase 4; (2) the ability of floor brokers
to hide their reserve interest from the specialist from Phase 2 to
Phase 4; (3) the specialist's ability to disseminate information
regarding its layered interest via OpenBook or another Exchange data
distribution channel from Phase 2 to Phase 4; (4) the availability
of sweeps, LRPs, and AL/AM orders from Phase 3 to Phase 4; (5) the
availability of Intermarket Sweep orders and use of indicators to
identify executions involving an Intermarket Sweep order from Phase
3 to Phase 4; and (6) the implementation of new Display Book system
templates and programming that will eliminate the suspension of
Autoquote and automatic executions from Phase 4 to Phase 5, and by
adding: (1) The specialist's ability to manually enter reserve
interest to Phase 4 and (2) the availability of IOC (consistent with
Regulation NMS) orders for automatic executions to Phase 4.
---------------------------------------------------------------------------
In Amendment No. 8, the Exchange committed to provide notice to its
members and others using its facilities, through information memoranda
and its Web site, of the specific rules that would be effective during
each phase.
1. Phase 1--Floor Broker Agency Interest Files, Specialist Interest
Files, and Systematic Integration of Priority, Parity, and Yielding
Requirements
During the first phase of implementation, the Exchange contemplates
activating the floor broker agency interest file to permit floor
brokers to enter their interest at or outside the BBO. This would
enable floor brokers to gain experience using this tool. Floor brokers
would be able to populate the reserve file; however, the reserve file
would be visible to the specialist in this phase. The feature
permitting floor brokers to exclude their interest from the aggregate
information available to the specialist would not be available in this
phase; the Exchange contemplates making the exclusion feature
operational in Phase 4. In addition, commencing in Phase 4, floor
broker reserve interest would not be visible to the specialist if
chosen as an option by the floor broker.
Specialists would be able to manually layer their interest at and
outside the BBO during the first phase. However, they would not be able
to disseminate this information via OpenBook or another Exchange data
distribution channel until Phase 4. The API would not be activated
during Phase 1; accordingly, specialists would not be able to use
Specialist Algorithms to layer their interest or to otherwise trade or
quote, nor would the specialists' reserve capability be operational.
During Phase 1, the systematic programming of priority, parity, and
yielding requirements, other than the yielding requirements for
additional specialist interest, would be completed, enabling ``G''
order interest to be included in the floor broker agency files and to
be handled by the Display Book system. Other system changes would be
made to enhance systematic reporting of transactions and associated
audit trail, such as eliminating specialist responsibility for
allocation of volume in automatic executions.\224\ Finally, the
Exchange would implement the automation of CAP-DI orders and stop or
stop limit orders.
---------------------------------------------------------------------------
\224\ See NYSE Rule 1001(a)(3).
---------------------------------------------------------------------------
During Phase 1, Direct+ would continue to operate as it does under
the current rules and would be subject to the same restrictions and
availability as set forth in NYSE Rules 1000--1005. Accordingly, the
Exchange anticipates that most trading would continue to be effected in
the auction market, subject to the same rules and conditions as trading
on the Exchange today. The Exchange began testing the Phase 1 functions
for 168 securities in the Pilot.\225\ Upon approval of the Hybrid
Market, the Exchange would implement Phase 1 for all its
securities.\226\
---------------------------------------------------------------------------
\225\ See Pilot. See Section II(G), supra, for a discussion of
the Pilot.
\226\ See Amendment No. 8.
---------------------------------------------------------------------------
2. Phase 2--API and Specialist Algorithms
Phase 2 would see the introduction of the API and Specialist
Algorithm. During this phase, the specialist's systematic trading and
quoting abilities would become operational. For example, the specialist
would be able to provide algorithmic price improvement pursuant to the
formula described in the proposal, regardless of the size of the
incoming order. Algorithmic trading with the bid and offer, algorithmic
ability to make new bids and offers and to withdraw previously made
bids and offers, to add size to an existing bid and offer, to match
better bids and offers away, and to layer specialist interest at prices
outside the BBO, would also be available. Specialist reserve file
capability and the yielding requirements for additional specialist
interest would become operational during this phase.
As in Phase 1, Direct+ would continue to operate according to the
same restrictions and availability as set forth in NYSE Rules 1000-1005
today, and the Exchange anticipates that most trading would continue to
be effected in the auction market.
3. Phase 3--Automatic Routing of Orders, Elimination of Direct+
Restrictions, ``Slow'' Market Indicators, and Gap Quoting
During Phase 3, the following changes would be implemented:
Automatic routing of orders to automated markets posting
better bids and offers in accordance with Regulation NMS;
Availability of NYSE IOC orders for automatic executions;
Use of indicators to identify quotations that are not
immediately available for automatic executions;
Implementation of gap quoting procedures;
Elimination of size restrictions for automatic executions;
Elimination of 30-second restriction on the entry of Auto
Ex Orders from the same person;
Availability of automatic executions through the close;
Elimination of Direct+ availability only to straight limit
orders;
Elimination of Direct+ suspensions due to price (i.e., a
trade at a price that would be more than five cents from the last trade
in the stock on the Exchange);
Elimination of Direct+ suspensions due to size (i.e., a
100-share published bid or offer);
Conversion of marketable limit orders automatically to
Auto Ex Orders; and
Automatic executions of designated market orders.
Not all of these features would be made available at the same time
during this phase, but instead would be made available in all
securities over a period of time.
4. Phase 4--Floor Broker Reserve Features, Sweeps, LRPs, and New Order
Types
Phase 4 would implement the following:
[[Page 16368]]
Use of indicators to identify an execution involving an
Intermarket Sweep order;
Floor brokers' ability to exclude interest, including
reserve, from the aggregate information available to the specialist;
Sweep functionality for automatic executions;
Activation of LRPs (both sweep and momentum), and the
publication via OpenBook or another Exchange data distribution channel
of the most restrictive LRP;
Availability of new order types--AL and AM orders and
Intermarket Sweep orders;
Specialists' ability to disseminate their layered interest
via OpenBook or another Exchange data distribution channel;
Specialists' ability to manually enter reserve interest;
and
Availability of IOC orders for automatic executions.
5. Phase 5--New Reporting Templates and Elimination of Suspensions of
Autoquote and Automatic Executions
In Phase 5, NYSE proposes to implement the new Display Book system
templates and programming that would eliminate the suspension of
Autoquote and automatic executions.
G. Limited Hybrid Market Pilot
As noted earlier, the Commission approved the testing of certain
functions the Hybrid Market on December 14, 2005, on a limited basis
and for a pilot period expiring on March 24, 2006.\227\ The Pilot
implemented testing, with respect to a limited group of securities, the
specialist interest files, the floor broker agency interest files, and
the priority, parity, and yielding rules as proposed in the Hybrid
Market.\228\
---------------------------------------------------------------------------
\227\ See Pilot Extension, supra note 27.
\228\ See also Pilot Amendment, supra note 27.
---------------------------------------------------------------------------
Specifically, the Pilot allows specialists to manually layer their
proprietary trading interest outside the NYSE BBO into the Display Book
system.\229\ Specialists' proprietary interest remains in the Display
Book system until cancelled or executed. The Pilot also allows floor
brokers to electronically represent their customers' orders in the
floor broker agency interest files.\230\ Floor brokers could enter
interest in the floor broker agency interest files directly either at
the BBO or outside the BBO and could enter reserve size at the BBO so
long as 1,000 shares are displayed. In addition, the Pilot automates
the priority, parity, and yielding rules. The Pilot permits specialists
to trade on parity with orders represented by floor brokers when
specialists are increasing or decreasing their position and eliminates
floor brokers' ability to object to specialist parity. Finally, the
Pilot implemented the automation of CAP-DI orders and stop orders.\231\
---------------------------------------------------------------------------
\229\ Prior to the Pilot, specialists could only manually place
their proprietary trading interest at the NYSE BBO.
\230\ Prior to the Pilot, floor brokers could only enter their
customers' orders in the Display Book system through the specialist.
\231\ In Amendment No. 8, the Exchange represented that it has
not encountered any systematic difficulties in connection with the
Pilot.
---------------------------------------------------------------------------
III. Summary of Comments and NYSE's Response
The Commission received a total of 43 comment letters on the Hybrid
Market proposal.\232\ In addition to the amendments filed by the
Exchange that addressed many questions raised in the comment letters,
NYSE also filed the Response to Comments to address other specific
concerns raised in the comment letters.\233\
---------------------------------------------------------------------------
\232\ See supra notes 6, 9, 12, and 13.
\233\ See Response to Comments, supra note 14.
---------------------------------------------------------------------------
A few commenters supported the NYSE's proposal to create a Hybrid
Market.\234\ Several commenters generally supported further automation
of the NYSE market,\235\ and some of these commenters claimed that the
Exchange had not gone far enough to create the automated mar ket that
Exchange users desire.\236\ A few commenters expressed dissatisfaction
with the proposal.\237\ Some of these commenters believed that the
Exchange failed to create a genuine hybrid market that would blend
floor-based and screen-based trading, that the proposed market did not
provide for any true inter-market competition, and that it gave
preferential treatment to specialists and/or floor brokers.\238\
---------------------------------------------------------------------------
\234\ See IBG Letter II, Invictus Letter, and Power Letter.
\235\ See, e.g., Ameritrade Letter, IBG Letters I and II, ICI
Letters I, II, and III, SIA Letters I, II and III, STANY Letter,
Telic Letter, and Vanguard Letter. However, one commenter suggested
that while the proposal could turn out well for liquid stocks, the
Exchange should consider separate and distinct rules for illiquid
securities. See Bear Stearns Letter.
\236\ See, e.g., ICI Letters I and III and Telic Letter.
\237\ See, e.g., Bloomberg Letters I and II, IBAC Letters I, II,
and III, Peake Letter I, Rutherfurd Letters I, II, III, IV, V, VI,
VII, VIII, IX, and X, Telic Letter, Torino Letter, and Weeden
Letter. See also Fidelity Letter III (urging the Commission to
consider a study indicating that NYSE's Hybrid Market would be a
substantially more costly trading environment than that of fully
electronic markets). However, see also Lipson Letter (stating that
the data does not justify Fidelity Letter III's conclusion).
\238\ See, e.g., Bloomberg Letter I, IBAC Letters I and II,
Rutherfurd Letters I, III, and V, Telic Letter, Weeden Letter. In
particular, one of these commenters argued that specialists and
floor brokers in the proposed Hybrid Market should not be able to
charge floor brokerage commission on any orders that are executed
automatically in the Display Book system and not by the specialist
or floor broker personally. See Rutherfurd Letter I. Another
commenter was concerned that NYSE's ultimate plans would be to move
past any true ``hybrid'' and phase out the auction market entirely,
which the commenter believed would disadvantage the investing public
that relies on the face-to-face interaction on the floor to achieve
the best prices. See IBAC Letters I and II.
---------------------------------------------------------------------------
Initially, most commenters had questions about the rules that the
Exchange had proposed. Specifically, in response to the First Notice, a
majority of commenters requested that NYSE provide more details and
specific trading examples showing how the Hybrid Market proposal would
work.\239\ Several commenters raised specific issues. For example,
several commenters on the First Notice questioned how the LRPs would
work,\240\ how specialists would participate in the Hybrid Market,\241\
how the floor broker agency interest file would interact with orders on
the Book,\242\ and how AL and AM orders would be handled.\243\ In
addition, several commenters requested more detail on automatic
execution.\244\ Specifically, commenters requested detail on how the
priority and parity rules would operate with the specialist interest
file and floor broker agency interest file,\245\ and the instances when
automatic executions would not be available.\246\
---------------------------------------------------------------------------
\239\ See, e.g., Ameritrade Letter, Angelides Letter, Bear
Stearns Letter, Bloomberg Letter I, BSE Letter, Fidelity Letters I
and II, IBG Letter I, ICI Letter I, Instinet Letter, Peake Letter,
SIA Letter I, STANY Letter, and Telic Letter. After the Second and
Third Notices, a few commenters continued to believe that the
proposal did not fairly and accurately describe exactly what the
NYSE intended, and still had explicit questions relating to the
Hybrid Market. See also Bloomberg Letter II, IBAC Letters I and II,
and Rutherfurd Letters I, II, III, and V.
\240\ See IBG Letter I and ICI Letter I. The Commission notes
that NYSE did not specifically define the parameters of its MLRP in
the First Notice.
\241\ See IBG Letter I and ICI Letter I.
\242\ See IBG Letter I and ICI Letter I.
\243\ See IBG Letter I.
\244\ See BSE Letter, Fidelity Letter I, and STANY Letter.
\245\ See Fidelity Letter I, SIA Letter I, and STANY Letter.
\246\ See BSE Letter, Instinet Letter, and STANY Letter.
---------------------------------------------------------------------------
Several commenters also questioned how the Hybrid Market would
interact with other markets. For example, one commenter questioned
whether ITS would be capable of handling NYSE's increased interaction
with ``away markets'' and whether the Exchange had a contingency plan
to ensure that adequate linkages will be in place to accommodate the
enhancement to
[[Page 16369]]
Direct+.\247\ Other commenters questioned how the Hybrid Market would
operate in compliance with the ITS trade-through rule or the then-
proposed Regulation NMS.\248\
---------------------------------------------------------------------------
\247\ See, e.g., STANY Letter. See also Ameritrade Letter
(voicing concern that Direct+ and ITS would fall short of today's
technological standards and create a slow, automated trading
environment for listed securities).
\248\ See, e.g., Ameritrade Letter, Bloomberg Letters I and II,
BSE Letter, Fidelity Letters I and II, and SIA Letter I. See note
and accompanying text for a complete discussion of the comments on
this issue.
---------------------------------------------------------------------------
The Exchange responded to the initial comments in its Amendment
Nos. 2 and 3, which the Commission published as the Second Notice.\249\
In addition to providing more detail on its proposal, NYSE submitted
detailed trading examples to demonstrate how its proposed Hybrid Market
would operate.\250\ Soon after the Second Notice was published, the
Commission reproposed its Regulation NMS.\251\ Commenters generally
asked the Commission to refrain from acting on NYSE's proposal until it
had made a decision on Regulation NMS to allow commenters to consider
the operation of the Hybrid Market in conjunction with Regulation
NMS.\252\ Several commenters, however, raised specific concerns about
NYSE's proposal as described in the Second Notice. For example,
commenters questioned whether it would be appropriate to allow
undisplayed floor broker interest to trade on parity with displayed
orders on the Book,\253\ whether it would be appropriate to allow
specialists to have access to non-public information about incoming
orders,\254\ and whether the sweep functionality would result in less
favorable executions of customer orders.\255\
---------------------------------------------------------------------------
\249\ See note 8, supra.
\250\ The Commission published these trading examples as Exhibit
A to the Second Notice.
\251\ See Securities Exchange Act Release No. 50870 (December
16, 2004), 69 FR 77424 (December 27, 2004).
\252\ See, e.g., ICI Letter III, Nasdaq Letter, and SIA Letters
II and III. See also Ameritrade Letter. A few commenters also urged
the Commission to examine the Hybrid Market proposal alongside
Regulation NMS. See, e.g., Angelides Letter, Fidelity Letter II,
Nasdaq Letter, and SIA Letters I, II and III.
\253\ See Rutherfurd Letter II and Invictus Letter.
\254\ See Rutherfurd Letter II, Invictus Letter, and ICI Letter
II.
\255\ See Rutherfurd Letter II. See also Bloomberg Letters I and
II.
---------------------------------------------------------------------------
After the Third Notice, certain commenters continued to question
several aspects of the proposal that they believed raised investor
fairness and logistical issues.\256\ Some of these commenters
encouraged the Exchange to modify its proposal to give priority to
investor orders and to encourage the display of limit orders.\257\
---------------------------------------------------------------------------
\256\ See, e.g., IBAC Letters I and II (arguing that the
Commission should reject the Hybrid Market proposal because it lacks
the statutorily required information on possible impacts on
competition and because the proposal would indeed impair competition
and unfairly discriminate against floor brokers and investors), ICI
Letter III, Rutherfurd Letters IV, V, VI, VII, VIII, IX, and X, and
Vanguard Letter.
\257\ See, e.g., ICI Letter III and Vanguard Letter.
---------------------------------------------------------------------------
A number of commenters emphasized the significance of NYSE's
proposal.\258\ In fact, one commenter stated that NYSE's proposal was
``among the most significant SRO rule changes that the Commission has
had to evaluate for quite some time.'' \259\ Although the same
commenter favored a quick approval and implementation of the
proposal,\260\ other commenters cautioned the Commission to proceed
slowly in considering the NYSE's rule change, to give the industry and
investors an opportunity to gain a full understanding of the proposal's
effect.\261\ Some commenters believed that Direct+ should be subject to
a pilot program or have a phase-in period so that there would be an
opportunity to review the impact of the proposed changes before they
become a permanent fixture of the equities markets.\262\
---------------------------------------------------------------------------
\258\ See Fidelity Letter I, IBG Letter I, and Weeden Letter.
\259\ See IBG Letter I.
\260\ See IBG Letter II.
\261\ See, e.g., Angelides Letter, Bear Stearns Letter, SIA
Letter I, and Weeden Letter. A few commenters believed that the
Commission should hold a public hearing on the proposal. See, e.g.,
Angelides Letter, Fidelity Letter I, IBAC Letter II, and STANY
Letter.
\262\ See, e.g., Bear Stearns Letter, Invictus Letter, SIA
Letter III, and STANY Letter.
---------------------------------------------------------------------------
In its response, the Exchange stated that the proposed enhancements
to Direct+ were responsive to customer requests for greater electronic
access to the liquidity on the Exchange. The Exchange believed that
this, along with the new opportunities for price improvement via AL and
AM orders, would make for a better market, would encourage the display
of liquidity, and would allow customers to access this liquidity in the
manner that best suits their needs. In response to commenters' concerns
over the implementation of the Hybrid Market, the Exchange proposed, in
the Third Notice, to launch the Hybrid Market proposal in phases. The
Exchange believes this phased implementation should help ensure the
proper functioning of market participants' Hybrid Market-related
systems, promote the integration of Hybrid Market facilities into the
marketplace, and allow market participants adequate time to become
familiar with the features of the Hybrid Market.\263\
---------------------------------------------------------------------------
\263\ In addition, as noted above, the Exchange implemented a
limited pilot to begin testing some of its Hybrid Market systems and
to give its floor members an opportunity to utilize its
functionality in live trading. See discussion of the Pilot in
Section II(G), supra.
---------------------------------------------------------------------------
A. Liquidity Available for Automatic Executions
Several commenters argued that off-floor participants should be
able to place liquidity on the Display Book system without the use of a
floor member.\264\ Two commenters argued that the NYSE's proposal
failed to provide any material inducement to non-NYSE liquidity
providers to participate in the Hybrid Market.\265\ One of these
commenters stated that the proposal would ``perpetuate asymmetric
information between specialists, floor brokers and customers that only
serves to discourage competing liquidity providers * * *'' from
providing better prices and more liquidity.\266\
---------------------------------------------------------------------------
\264\ See Rutherfurd Letters I and V, ICI Letter III, and
Vanguard Letter. But see ICI Letter II (noting that it did not
object to the Exchange providing floor brokers with the ability to
represent their customers as they do today).
\265\ See Telic Letter and Weeden Letter.
\266\ See Telic Letter.
---------------------------------------------------------------------------
1. Specialist Interest File and Specialist Reserve
As discussed earlier, specialists would have the ability to
manually and systematically place in the Display Book their dealer
interest at prices at or outside the Exchange BBO.\267\ In addition, a
specialist would be able to maintain undisplayed reserve interest on
behalf of its dealer account at the Exchange BBO, provided that the
specialist displayed at least 2,000 shares at that price on the same
side of the market.\268\ Specialist interest at the Exchange BBO would
be disseminated; specialist reserve would not be disseminated. In
addition, specialist interest away from the Exchange BBO could be
disseminated, at the option of the specialist, via the NYSE's OpenBook
data feed.
---------------------------------------------------------------------------
\267\ See proposed NYSE Rule 104(b)(i) and 104(c)(viii).
\268\ See proposed NYSE Rule 104(d)(i).
---------------------------------------------------------------------------
Many comments questioned the appropriateness of creating an
undisplayed interest file for those market participants that have a
time and place advantage relative to the rest of the marketplace.\269\
One commenter advised that the Exchange either continually monitor the
specialist's dealer position in real time to preclude unlawful trading
activity or require the specialist interest file to yield to all orders
in all instances.\270\
---------------------------------------------------------------------------
\269\ See, e.g., Bloomberg Letters I and II, Rutherfurd Letters
I, III and V, and SIA Letter I.
\270\ See Rutherfurd Letter I.
---------------------------------------------------------------------------
[[Page 16370]]
The Exchange responded that it believes that the specialist
interest file would allow specialists to provide value by committing
capital and layering the Display Book system outside the BBO. According
to NYSE, such interest would benefit the marketplace by increasing
liquidity at prices outside the BBO, bridging temporary gaps in supply
and demand, dampening volatility, and potentially improving clean-up
prices. Additionally, the Exchange noted that specialists would have
the option to display all of their specialist interest file away from
the BBO in the aggregate price/volume information disseminated via NYSE
OpenBook.
(a) Specialists' Parity
The Exchange also has proposed to amend its Rule 108 to provide
that the specialist interest file would be entitled to trade on parity
with interest in the floor broker agency interest files regardless of
whether the specialist is increasing or decreasing its position.
Specialist interest would, however, continue to yield to orders on the
Book. Three commenters opposed these proposed changes to NYSE Rule
108.\271\ Two believed that placing specialist proprietary trading on
parity with investors' orders would misalign the interests of
participants on the Exchange and likely contribute to the
ineffectiveness of the Hybrid Market.\272\ The other commenter
considered this change to be a contravention of the specialists'
negative obligation to trade only when reasonably necessary to maintain
a fair and orderly market.\273\ According to this commenter, specialist
parity acquisitions would amount to unnecessary dealer intervention
because there would be no market ``necessity'' for the specialist to
effect proprietary trades in these situations, where public orders
could otherwise fully satisfy contra-side interest.\274\
---------------------------------------------------------------------------
\271\ See IBAC Letters I and II, ICI Letter III, and Rutherfurd
Letters III, IV, V, VI, VII, VIII, IX, and X. Two of these
commenters also challenged NYSE's interpretation of NYSE Rule 108
that provides that specialists can trade on parity with orders in
the Crowd when establishing or increasing their position, provided
that the floor broker or its customer does not object. See, e.g.,
IBAC Letter I and Rutherfurd Letters III, IV, V, VI, VII, VIII, IX,
and X.
\272\ See IBAC Letters I (also contending that it would increase
volatility in the market) and II and ICI Letter III.
\273\ See Rutherfurd Letters III, IV, V, VI, VII, VIII, IX, and
X. According to the commenter, since Section 11A of the Act promotes
the objective of public order interaction without dealer
intervention, specialist parity acquisitions would constitute an
example of unnecessary dealer intervention and could not be
reconciled with Section 11A. See Rutherfurd Letter III. See also
IBAC Letter I.
\274\ See Rutherfurd Letters III, IV, V, VI, VII, VIII, IX, and
X.
---------------------------------------------------------------------------
In response, the Exchange noted that, under current practice, floor
brokers in the Crowd may permit the specialist to be on parity with
their orders. The Exchange stated its belief that parity provides an
incentive for specialists to participate in the price discovery process
at the point of sale, and has the beneficial effects of dampening
volatility and lowering execution costs for investors. In response to
the concern that a specialist trading on parity when establishing or
increasing its position could be inconsistent with the negative
obligation, the Exchange clarified that the general negative obligation
incorporated into NYSE Rule 104.10 would continue to apply to all
specialist trading on the NYSE.\275\
---------------------------------------------------------------------------
\275\ See also note infra and accompanying text.
---------------------------------------------------------------------------
2. Floor Broker Agency Interest Files and Reserve
NYSE proposes to permit floor brokers to participate in the Hybrid
Market by allowing them to systematically provide liquidity at varying
prices at or outside the BBO with respect to orders the broker is
representing, but only while standing in the Crowd.\276\ While a floor
broker's agency interest, except reserve, would be displayed as part of
the quotation when it is at the BBO, floor broker agency interest
outside of the BBO would not be displayed. NYSE proposes to allow floor
broker agency interest to trade on parity with the specialist interest
file,\277\ and in many cases, with orders on the Book.
---------------------------------------------------------------------------
\276\ However, as noted earlier, a floor broker would be
permitted to leave the Crowd without canceling its agency interest
files to recharge its handheld device. See proposed NYSE Rule
70.20(f).
\277\ The specialist interest file would only trade on parity
with the floor broker agency interest file when there are no orders
on the Book executable at a particular price.
---------------------------------------------------------------------------
The Commission received one comment letter criticizing the
requirement that floor brokers be physically present in the Crowd to
place interest in its floor broker agency interest file.\278\ Most of
the other comments regarding floor broker agency interest file focused
on the Exchange's proposal to not require the display of such interest
that is outside of the BBO while providing this interest with the
ability to trade on parity with displayed interest.\279\ Specifically,
several commenters questioned the fairness of allowing non-displayed
floor broker agency interest to trade on parity with disclosed orders
on the Book.\280\ Some commenters argued that this practice would be
inconsistent with the Exchange's goal of providing incentives to place
limit orders on the Exchange, and predicted that investors would be
reluctant to place limit orders on the Book knowing that they might not
be fully rewarded for displaying those orders.\281\
---------------------------------------------------------------------------
\278\ See Invictus Letter. This commenter believed that the
proposed requirement that a floor broker agency interest file be
cancelled when the floor broker leaves the Crowd and the proposed
definition of a Crowd would be at odds with the direction of
technology, greater speed, productivity, and liquidity. Because
floor brokers are equipped with hand held computers and can act in a
virtual capacity at any post where they have customer interest
files, this commenter believed that limiting them to a distance of
five contiguous panels at the same post would be arbitrary and
unnecessarily restrictive and would put customers who use
independent floor brokers at a disadvantage. In response to this
criticism, the Exchange explained that, like the current floor today
where a floor broker has to be in the Crowd to participate in the
auction, the floor broker agency interest file was designed to allow
the floor broker to continue participation in the auction, but in an
automatic execution environment. In addition, the Exchange believes
that the range of five contiguous panels in the proposed definition
of a Crowd represents the appropriate range of proximity to enable
brokers to also participate in the auction market. Furthermore, the
Exchange pointed out that, if a floor broker must leave the Crowd
and therefore cancel its agency interest file, the broker could
ensure that its customers' orders are still represented in that
Crowd by sending such orders to the specialist, sending the orders
to Direct+ via its handheld devices for automatic execution, or
transferring the orders to another member for representation in the
Crowd. In Amendment No. 8, NYSE proposes to limit this restriction
by allowing a floor broker to leave the Crowd to recharge a handheld
device without canceling its agency interest file.
\279\ See, e.g., Bloomberg Letters I and II, ICI Letters I, II,
and III, Rutherfurd Letters I, II, III, and V, SIA Letter I, STANY
Letter, and Vanguard Letter.
\280\ See, e.g., Bloomberg Letters I and II, ICI Letters I, II,
and III, Rutherfurd Letters I, II, III, and V, SIA Letter I, STANY
Letter, and Vanguard Letter.
While supporting the NYSE's proposal to have the floor broker's
undisplayed reserve interest at the BBO yield to displayed interest
at that price, one commenter questioned why the Exchange did not
extend this concept to its execution priorities at other levels of
the book. See ICI Letter II.
\281\ See, e.g., ICI Letters II and III, Rutherfurd Letters II
and V, STANY Letter, and Vanguard Letter.
---------------------------------------------------------------------------
Commenters also expressed the opinion that the proposal appeared to
be designed to preserve the time and place advantages that floor
members currently enjoy over public investors.\282\ For example, one
commenter believed that, by authorizing this parity structure, the
Exchange would be affording the floor broker agency interest file with
three major execution advantages over orders on the Book: (1) Floor
broker agency interest entered later in time could deny an execution to
public limit orders
[[Page 16371]]
entered earlier in time; \283\ (2) floor broker agency interest would
often be entitled to superior parity splits with the Book, since the
proposed parity structure would treat the Book as only one bidder
(irrespective of the number of orders on the Book, the aggregate number
of shares, and their times of entry); \284\ and (3) floor brokers would
enjoy an informational and order entry advantage that will allow them
to ``see'' the orders on the Book and make trading decisions by
entering floor broker agency interest.\285\
---------------------------------------------------------------------------
\282\ See, e.g., Bloomberg Letters I and II, ICI Letters I, II,
and III, Rutherfurd Letters I, II, and III, and SIA Letter I.
\283\ See Rutherfurd Letters III and V. This commenter believed
that the proposal would allow floor brokers to enter interest in
reaction to their knowledge of public orders on the Book, and
thereby supersede the clearly established price/time priority of
such public limit orders. The commenter believed this to be
fundamentally unfair to public investors and unknown in other major
securities markets. See Rutherfurd Letter V.
\284\ This commenter believed that the Exchange's examples do
not reveal the fact that the Book would be deemed to be only one
``bidder'' regardless of how many individual orders are on the Book
at the same price, while every broker who enters an agency interest
file would be considered a separate ``bidder.'' See Rutherfurd
Letter V. This commenter believed that, if the floor broker agency
interest file is permitted to compete directly with the price/time
priority of the Book, it should be treated as only one bidder. See
Rutherfurd Letter I.
\285\ See Rutherfurd Letters I, III, and V (also claiming that
Amendment No. 6 failed to address the floor brokers' informational
advantage in placing orders and their advantage in being able to
supersede the price/time priority of orders on the Book and in being
treated as a separate ``bidders,'' whereas limit orders on the Book
would be treated as one ``bidder''). The commenter also argued that
the principal beneficiary of the clean up methodology would be
undisplayed floor broker agency interest files, which could be
entered on the Display Book with knowledge of, and in relation to,
the limit orders on the Book to take advantage of possible sweep
executions.
---------------------------------------------------------------------------
Accordingly, commenters insisted that for a floor broker agency
interest file to be on parity with other orders at its price, a broker
should be required to display orders placed in their agency interest
file in the same manner as at the BBO.\286\ If the Exchange believes
that floor brokers' agency interest should be undisplayed, commenters
argued that those orders should not be provided parity with fully-
displayed orders on the Book.\287\
---------------------------------------------------------------------------
\286\ See, e.g., ICI Letters I, II and III, Rutherfurd Letters I
and II, SIA Letter I, and Vanguard Letter.
\287\ See, e.g., ICI Letters I, II and III (recommending that
the Exchange provide execution priority on the same level as fully
displayed investors' orders only to the portion of those orders
represented by the floor brokers that are displayed). See also SIA
Letter I.
---------------------------------------------------------------------------
One commenter suggested that the Exchange give qualified customers
the option either to give their agency interest to a floor broker or
enter it directly in the Display Book system themselves.\288\
Similarly, with respect to a floor broker's ability to place
undisplayed reserve interest at the BBO, two commenters suggested that
the Exchange provide investors with a similar reserve feature where
investors would have the direct ability to conceal a portion of their
orders at the BBO, and not be required to do so solely through the use
of a floor broker.\289\ One of these commenters argued that this aspect
of the proposal would not support economically efficient executions or
the ability of investors to interact directly, and thus would be
inconsistent with the principles of section 11A under the Act.\290\
---------------------------------------------------------------------------
\288\ See Rutherfurd Letters I and III.
\289\ See, e.g., ICI Letters I and III and Vanguard Letter.
\290\ See Vanguard Letter.
---------------------------------------------------------------------------
In general support of the floor broker agency interest file, the
Exchange stated that this feature would allow customers both to take
advantage of floor broker knowledge and trading expertise, as well as
the efficiencies of automatic executions. The Exchange believes that
floor brokers would be able to use the interest file to effectively
represent interest that their customers do not wish to display, and,
simultaneously, permit this interest to be accessed by incoming orders
and participate in automatic executions and sweeps.
Furthermore, in addressing comments that undisplayed floor broker
agency interest should not trade on parity with displayed orders on the
Book, the Exchange proposed in Amendment No. 6 to revise the standing
of orders on the Book and floor broker agency interest during a sweep.
Specifically, the Exchange proposes to revise NYSE Rule 70 to provide
that during a sweep, the amount of floor broker agency interest that
would have been displayed had there been a new quote at the clean-up
price would trade on parity with displayed interest, e.g. orders on the
Book, at that price. The amount of any floor broker agency interest
that would have been placed in the broker's reserve would yield to
displayed interest. The Exchange believes that this amendment is
consistent with the concept that displayed interest at each price point
would execute before non-displayed interest at the same price point and
the corollary principle that non-displayed interest at a better price
would trade ahead of displayed interest at a worse price, while taking
into account the fact that during a sweep there is no opportunity for
floor broker agency interest at the clean-up price to be displayed
before an execution that occurs at that price.\291\
---------------------------------------------------------------------------
\291\ However, see Rutherfurd Letter V. This commenter argued
that the NYSE's revision in Amendment No. 6 to the standing of floor
broker agency interest during a sweep would be ineffective (i.e., no
one would be aware of the floor broker agency interest file except
for the floor broker since the interest would not actually be
displayed prior to a sweep transaction). Accordingly, the commenter
believed that the amendment would not attract liquidity or solve the
problems of unfairness to the Book, since investors with orders on
the Book would still have no information about interest in the floor
broker agency interest files.
---------------------------------------------------------------------------
With respect to suggestions that the floor broker agency interest
file would provide floor brokers with some form of advantage over
public customers, the Exchange emphasized that floor brokers would only
have access to information pertaining to their own agency interest, and
no access to other broker's files. Similarly, the Exchange proposed
that neither specialists on the floor nor the Specialist Algorithms
would have access to any information about specific orders in floor
broker agency interest files.\292\ Under the proposal, specialists
would only be able to view the total aggregated broker agency interest
at each price, except for any interest a broker has elected to not
disclose to the specialist.
---------------------------------------------------------------------------
\292\ Only the specialist on the floor would have access to
limited information pertaining to interest in the files. The
specialist would not know the number of customer orders behind such
volume, who the orders are for, which brokers represent the orders,
or the limit prices for such orders. See Response to Comments, supra
note 14.
---------------------------------------------------------------------------
Furthermore, in response to comments questioning the reserve
feature of the floor broker agency interest file and whether it would
grant too much advantage to floor brokers,\293\ the Exchange argued
that the existence of reserve interest would not be unique to the
Exchange, and that electronic order books in other markets have a
reserve functionality at all price levels, not just the BBO.\294\ In
the Hybrid Market, the Exchange believes that the reserve functionality
would allow floor brokers to use their skills to determine the best way
to represent their customers' interests, whether that be through the
display of some or all of the customer order. Furthermore, the Exchange
believes that the reserve feature would benefit the marketplace as a
whole by providing liquidity and dampening price volatility. Since
reserve interest would yield to
[[Page 16372]]
displayed interest at the Exchange BBO, but would participate in
automatic executions at that price provided there is sufficient contra-
side liquidity, the Exchange believes that reserve interest would
benefit incoming orders by providing more liquidity at the BBO, yet
without disadvantaging displayed interest at the BBO. The Exchange
believes that it would be unable to attract and aggregate liquidity as
effectively if a reserve feature was not offered, as it is in other
competing market centers. In response to comments that investors should
have a similar feature to directly enter interest in reserve, the
Exchange represents that the reserve feature would be available to all
investors through floor brokers. Customers seeking to participate in
the reserve interest file would be able to do so by sending their
orders to floor brokers with appropriate instructions as to how they
want their orders handled. The Exchange believes that creating a
reserve feature exclusively for on-floor participants would provide an
incentive for participating in price discovery at the point of sale,
and would allow differentiation from typical electronic communication
network (ECN) functionality.
---------------------------------------------------------------------------
\293\ See, e.g., Bloomberg Letters I and II, ICI Letter III,
Rutherfurd Letter I, SIA Letter I, and Vanguard Letter.
\294\ However, see Rutherfurd Letter V. This commenter argues
that markets with reserve features are, for the most part, non-
primary, non-price discovery markets whose lack of transparency does
not materially impact the overall price discovery process. However,
the commenter believes that the critical distinction between other
markets that have reserve features and the NYSE's proposed Hybrid
Market is that there is not a similar concept of ``parity'' in those
markets (e.g., a trader cannot enter a reserve order in those
markets that will supersede the price/time priority of a previously
entered order).
---------------------------------------------------------------------------
B. Automatic Executions
1. Sweeping the Display Book System
With respect to sweeps, two commenters noted that incoming
investors' orders that sweep the Display Book system would be executed
at a clean-up price, which could be inferior to other prices placed in
the Display Book system.\295\ Specifically, one commenter believed that
the proposed sweep methodology would result in executions less
favorable to investors than that of the current floor auction, which
allows floor brokers with a large order to trade at intervening price
levels instead of only a clean-up price.\296\ The other commenter
questioned whether the Exchange's proposal would be consistent with
best execution requirements of brokers.\297\
---------------------------------------------------------------------------
\295\ See, e.g., Bloomberg Letters I and II and Rutherfurd
Letters I, III, and V (declaring that the sweep clean up price
methodology would be a benefit only to those trade initiators who
seek such a price; otherwise, there is significant economic
dislocation for them with respect to the traditional pricing of
large orders that cannot be filled at published bid or offer
prices).
\296\ See Rutherfurd Letter I.
\297\ See Bloomberg Letters I and II.
---------------------------------------------------------------------------
Two commenters also suggested that the proposed sweep function
should be considered in relation to the pilot program in Regulation
SHO, e.g. the effect a sell short sweep order would have under the
pilot where consecutive bids were hit.\298\ In Amendment No. 8, the
Exchange proposes in NYSE Rule 1000(d)(iii)(E) to clarify that during a
sweep, sell short orders, other than those involving Regulation SHO
pilot securities, would have to comply with the conditions outlined in
the SEC's Short Sale Rule, Rule 10a-1, and NYSE Rule 440B.
---------------------------------------------------------------------------
\298\ See Rothenberg Letter and SIA Letter I.
---------------------------------------------------------------------------
2. Automated Routing to Other Markets
Initially, a number of commenters generally believed that the
proposal would allow limit orders to be swept on NYSE at prices that
are inferior to prices immediately available at other markets.\299\ In
addition, some commenters initially believed that the proposal did not
clearly indicate how a specialist would be able to match the NBBO on an
away market, and noted that there did not appear to be a minimum size
requirement for specialists to match away markets. Specifically, some
commenters thought that the NYSE specialist could program its systems
to automatically put up a pre-emptive 100 share bid or offer to match
the NBBO at any given time on any other market, and thus would not be
obligated to send trades to another market.\300\
---------------------------------------------------------------------------
\299\ See, e.g., Ameritrade Letter, Bloomberg Letters I and II,
Fidelity Letters I and II, and SIA Letter I.
\300\ See, e.g., Bloomberg Letters I and II, Fidelity Letter I,
SIA Letter I.
---------------------------------------------------------------------------
In addressing these comments, the Exchange emphasized in its Second
Notice and Response to Comments that the proposed Hybrid Market would
operate in full conformity with all SEC rules, including Regulation
NMS. In response to specific comments that the specialist in the Hybrid
Market proposal could trade through better prices on another market
center below the NBBO, the Exchange stressed in the Second Notice that
the operation of sweeps, including the automatic electronic routing of
orders to the market centers displaying better priced bids and offers,
would be consistent with the fundamental tenet of the ITS trade-through
rule and Regulation NMS--that the best bids and offers published by
other market centers are entitled to protection. The Exchange
represented that best bids (offers) published by away markets that are
better than a clean-up price would be satisfied in their entirety. The
Exchange further represented that, as today, best bids and offers in
these markets (i.e., ``top of the book'') would be entitled to price
protection in the Hybrid Market.\301\ The Exchange disagreed with
comments suggesting that it should also provide price protection at
intervening price levels, and argues that while intermarket price-time
priority has been extensively debated, it has not been viewed to be in
the best interest of the national market system.
---------------------------------------------------------------------------
\301\ As discussed earlier, except for IOC and Intermarket Sweep
orders, NYSE proposes to automatically route portions of an Auto Ex
Order that would satisfy a protected quote of an away market, unless
the specialist matches the better published price.
---------------------------------------------------------------------------
Furthermore, the Exchange pointed out that a specialist already has
the option of matching a better published bid or offer rather than
shipping an order to that bid or offer. The Exchange believes that the
proposed rules would simply make this process more efficient by
permitting the specialist to electronically match or ship. During the
sweep, a commitment to trade that satisfies the full amount of any
better bid or offer that is published as the best bid or offer by
another market center would be auto-routed to such market (if a
prohibited trade-through would otherwise occur), which the Exchange
argues is consistent with the ITS trade-through rule and Regulation
NMS.
C. Availability of Direct+ and Liquidity Replenishment Points
Two commenters supported NYSE's proposal to remove order size and
time entry restrictions in Direct+.\302\ Commenters, however, requested
more detail on when automatic executions would not be available.\303\
Specifically, many commenters requested after the First Notice that the
Exchange supply additional details and examples regarding the operation
of LRPs, including the determination and dissemination of the LRP to
the public, the frequency of triggering a LRP, and the specific
parameters of a MLRP.\304\ Some commenters questioned whether LRPs
would be too restrictive or even necessary to dampen volatility, and
expressed concern over the length of time LRPs could stop automatic
execution in the Hybrid Market.\305\ Commenters suggested that the
Exchange reexamine the rules governing halts and resumption of trading
to ensure that the LRP parameters are realistic.\306\ After the Third
Notice, one
[[Page 16373]]
commenter asserted that market volatility should not be artificially
limited through the mechanism of LRPs, but that investors should be
free to place, and interact with, orders at all price points without
unnecessary market center intervention.\307\ Another commenter
expressed concern about the priority of order execution coming out of
an LRP.\308\ This commenter wondered if an order that caused the price
of a security to reach an LRP would be denied priority coming out of
the LRP.
---------------------------------------------------------------------------
\302\ See Rutherfurd Letter III and STANY Letter.
\303\ See, e.g., BSE Letter, Instinet Letter, SIA Letter I, and
STANY Letter.
\304\ See, e.g., Ameritrade Letter, Bear Stearns Letter, BSE
Letter, IBG Letter I, ICI Letters I and II, SIA Letter I, and STANY
Letter.
\305\ See, e.g., Ameritrade Letter, Bear Stearns Letter, ICI
Letters I and II, and SIA Letter I. See also SIA Letter III and
Vanguard Letter. One of these commenters thought that the parameters
of the MLRP could be too restrictive for very liquid stocks. See ICI
Letter II.
\306\ See, e.g., Ameritrade Letter, ICI Letters I, and Vanguard
Letter.
\307\ See Vanguard Letter.
\308\ See SIA Letter III.
---------------------------------------------------------------------------
The Exchange described LRPs as pre-determined price points at which
electronic trading would briefly convert to auction market trading.
With respect to MLRPs, the Exchange believed that excessive volatility
could occur in situations other than electronic sweeps and thus
proposed a LRP based on price movement over a period of time. The
Exchange also described in the Second and Third Notices the specific
parameters of MLRPs, and clarified that automatic executions could
occur within the MLRP range.
In addressing commenters' concerns over the use of LRPs in the
Hybrid Market, the Exchange stated that it believes that LRPs would
promote reasonable price continuity and foster market quality. When a
LRP converts the market exclusively to an auction market on a temporary
basis, the Exchange believes this would provide an opportunity to
moderate volatility by permitting new orders, as well as Crowd and
specialist interest, to add liquidity. Furthermore, the Exchange
represented that the LRP parameters were selected by the Exchange after
careful evaluation and discussions with market participants, and have
been designed to limit automatic executions infrequently. According to
the Exchange, when reached, LRPs would allow buyers and sellers to
react to fast-changing market conditions and provide an opportunity for
orders to interact with Crowd interest not encompassed in the broker
agency interest file and with specialist interest, enabling the auction
market to supplement liquidity and lower volatility. In addition, to
respond to commenters' requests for more details on LRPs, the Exchange
provided additional discussion and examples in the Second Notice, and
also set out the timeframes within which automatic executions and
Autoquote would resume after a LRP is reached.
Similar to the concerns expressed over LRPs, many commenters also
generally questioned the particular methods and frequency of
suspensions of automatic executions in the Hybrid Market.\309\ For
instance, a few commenters requested that the Exchange provide more
information on how often the Exchange could preclude investors from
obtaining an automated sweep of the Display Book and the timeframes
within which the security would remain in an auction capacity or
``slow'' mode.\310\ Like the comments relating to LRPs, commenters
suggested that the proposed rules regarding halts and resumption of
trading be examined to ensure that they are structured in a manner to
permit the least amount of disruption as possible.\311\ One commenter
questioned whether NYSE would be considered reopening its market for
purposes of Regulation NMS each time a LRP is reached or a specialist
has gapped the quote.\312\
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\309\ See, e.g., Ameritrade Letter, Bloomberg Letters I and II,
BSE Letter, Fidelity Letter I, ICI Letter I, Instinet Letter, SIA
Letter I, and STANY Letter.
\310\ See, e.g., Fidelity Letter I, and SIA Letter I.
\311\ See, e.g., ICI Letter III and Vanguard Letter.
More specifically, several commenters also expressed concern
over the suspension of automatic execution when the specialist has
gapped the quote. See BSE Letter, ICI Letter I, Nasdaq Letter, and
SIA Letter III. In justifying the specialist's use of gapped quotes,
the Exchange explained in the Second Notice that gap quotes would be
used by specialists in response to trading scenarios in which price
dislocation is expected, such as a sudden influx of orders on one
side of the market, one or more large-size orders with no off-
setting interest, or when a member proposes to effect a one-sided
block size transaction or a cross at a significant premium or
discount to the prevailing market. In an attempt to mitigate
volatility, specialists would use gap quotes to signal the potential
price movement so as to attract contra-side liquidity. The Exchange
also clarified in the Second Notice that, when the quotation is
gapped, automatic executions and Autoquote would be suspended,
although incoming orders and cancellations would update the Book
electronically. Furthermore, the Exchange explained that better
priced orders would be taken into account in the transaction
resulting from the gapped quotation and that Floor Officials would
oversee the gap quote process, including its duration.
\312\ See Nasdaq Letter. The Commission notes that turning off
automatic executions, for example, for a gap quoting situation, the
triggering of a LRP, or the reporting of a block size transaction,
would not in and of itself halt trading and thus trigger a reopening
pursuant to Rule 611(b)(3) of Regulation NMS. See Securities
Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496 (June 29,
2005).
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In response to these comments, the Exchange represented that
Autoquote and automatic executions would be suspended infrequently and
only in certain limited circumstances, such as when trading on the
Exchange reaches a LRP, when the quote is gapped in accordance with
Exchange procedures, when trading in a security has been halted, when
the quote is not firm, or when a block size transaction involving
orders in the Display Book system is manually reported.\313\ The
Exchange believes that suspension of Autoquote and automatic executions
to report block trades is necessary to protect customer orders on the
Book and facilitate orderly executions in limited ``breakout''
situations and during the reporting of a block size transaction.
---------------------------------------------------------------------------
\313\ Autoquote and automatic executions would resume when the
manual reporting is concluded.
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The Exchange will disseminate a systematic indication, consistent
with Regulation NMS, when automatic executions against its published
quotation are unavailable. In addition, in situations when automatic
executions are suspended due to a gapped quote or LRP, NYSE will notify
members by way of an indicator that the NYSE quotation is not firm.
The Exchange represented that once the Hybrid Market is
implemented, all other instances of manual reporting \314\ would not
suspend Autoquote and automatic executions, and the quote would
automatically update to reflect the entry of better bids and offers and
cancellations. Finally, in the Second Notice, the Exchange represented,
based on its original proposal which proposed to suspend automatic
executions and Autoquote more frequently, that it expected Autoquote
and automatic executions to be available at least 99.7% of the
time.\315\
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\314\ For example, trades occurring within the Crowd or between
the Crowd and the specialist, as either agent or dealer, are
reported manually.
\315\ One commenter argued that automatic executions should be
available 100% of the time because it is during times when news is
disseminated or when there is an imbalance or when there is a fast
market that its customers need certainty of execution. See
Ameritrade Letter. See also ICI Letter I.
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D. Role of the Specialist in the Hybrid Market
1. Specialist Algorithm
The Exchange proposes to allow specialists to participate
automatically in the Hybrid Market by capturing many specialist
functions and replicating certain specialist privileges in an
electronic environment. As discussed earlier, specialists would be
permitted to establish Specialist Algorithms to send specific quoting
and trading messages via the API to the Display Book system.
After the First Notice, the Commission received a number of
comments questioning the operation of the Specialist Algorithm in the
Hybrid Market, including its ability to generate quoting and trading
messages on behalf of the specialist's dealer account and the sequence
of priority and parity rules with respect to the specialist interest
file and incoming orders.\316\ Although one
[[Page 16374]]
commenter appeared to support the amendments to NYSE Rule 104 that
describe the Specialist Algorithm,\317\ several of the comments raised
issues of fairness and transparency in the operation of the Specialist
Algorithm.\318\ Specifically, commenters opposed allowing the
Specialist Algorithm to ``read'' certain information before other
market participants and to interact with incoming orders and quotes on
the Display Book system based on that information.\319\ Two commenters
questioned whether the operation of the Specialist Algorithm was
consistent with the specialist's negative and affirmative
obligations.\320\ One of these commenters opposed providing only the
specialists with the ability to trade algorithmically with incoming
orders and believed it would greatly increase the specialists' speed
advantage and tilt the playing field toward the specialists and away
from the investing public.\321\ These two commenters also viewed as
ineffective the Exchange's proposal to delay the processing of
algorithmic messages (based on the average transit time from the CMS)
to give specialists and other market participants a similar opportunity
to trade with the Exchange's published quotation.\322\
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\316\ See, e.g., Bloomberg Letter I, BSE Letter, IBG Letter I,
ICI Letter I, Peake Letter I, SIA Letter I, STANY Letter, and Telic
Letter. See also Rutherfurd Letter III (advising after the Third
Notice in response to NYSE's proposed change to its Rule 92 that the
Exchange should program its system so that the specialist's dealer
orders can never be executed ahead of a public limit order that is
executable at the same price of the proposed specialist trade).
\317\ See Invictus Letter (stating that proposed NYSE Rule 104
appears constructive as a potential risk management tool and may
speed the process of providing liquidity by specialists). However,
this commenter expressed a concern over the potential of piercing
the information barrier, whereby the data, within the computers
running the algorithms and the staff monitoring the books across all
the specialists within a firm, could be communicated outside the
Exchange and be seen by upstairs traders or other business units
affiliated with the specialists. This commenter believed that there
should be an affirmative statement from the Exchange concerning this
prohibition. In Amendment No. 8, NYSE clarified that its current
information barrier rules would prevent a specialist firm from
sharing information with its affiliated business units.
Specifically, the Exchange represented that pursuant to NYSE Rule
104(i), Specialist Algorithms would have to be designed to comply
with all Exchange rules, policies, and procedures, including NYSE
Rule 98, which requires the existence of information barriers
between the specialist operations and other business operations in
situations where the specialist is part of an integrated firm.
\318\ See, e.g., IBAC Letters I and II, ICI Letters I, II, and
III, Rutherfurd Letters I, III, V, and IX, SIA Letters I and III,
and Vanguard Letter.
\319\ See, e.g., IBAC Letter I, ICI Letters I, II (recommending
that the Hybrid Market proposal be amended to make this information
available to investors as well), and III, Rutherfurd Letters I, III,
and V, SIA Letters I and III, and Vanguard Letter.
\320\ See IBAC Letter I and Rutherfurd Letters I, III, and V.
\321\ See IBAC Letters I (questioning the effectiveness of
NYSE's solution that floor brokers will be able to mitigate the
impact of specialist algorithmic trading by entering bids and offers
into the floor broker agency interest file) and II.
\322\ See IBAC Letter I and Rutherfurd Letter V.
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In support of the API and the Specialist Algorithm, the Exchange
asserted that specialists provide significant value to the market: They
commit capital to narrow quotes, add liquidity, and stabilize
prices.\323\ The Exchange maintained that its proposed rules provide
specialists with the ability to transmit to the Display Book system
algorithmic messages to quote or trade on behalf of their dealer
accounts so that they are able to fulfill their market making
obligations once electronic trading increases. According to the
Exchange, this algorithmically-based trading and quoting would be
permissible only in certain, limited ways that preclude the opportunity
for abuse. By allowing specialists to do electronically that which they
are able to do manually today, the Exchange believes that specialists
would be able to continue to provide value and liquidity in the Hybrid
Market.
---------------------------------------------------------------------------
\323\ The Exchange represented that currently specialists
provide approximately 9% of total volume, approximately 80% of which
is stabilizing in nature. See Response to Comments, supra note 14.
---------------------------------------------------------------------------
In addressing comments that the specialist's ability to access
certain information and then algorithmically trade and quote based on
that information would give the specialist an unfair informational
advantage over other market participants, the Exchange said that
specialists would need to engage in algorithmic trading to effectively
participate in the Hybrid Market and continue to fulfill their market
making obligations in an efficient and effective manner. The Exchange
contends that, without this ability, specialists in an automated
environment would be unable to ensure that there is appropriate price
continuity and depth, in which price movements are accompanied by
appropriate volume, and that unreasonable price variations between
trades are avoided. The Exchange stressed that the Specialist Algorithm
would not be privy to any more or different information than
specialists currently have today.\324\ In the Hybrid Market, the
Specialist Algorithm would be required to function according to new
NYSE rules and take predetermined actions before an order arrives at
the Display Book system. To do this effectively, the Specialist
Algorithm would need to take into account the size and price of an
incoming order to determine the appropriate algorithmic action.\325\
According to the Exchange, specialists' algorithmic trading would be
strictly controlled and limited to relatively few circumstances as
detailed in NYSE Rule 104. The Exchange represents that the
requirements detailed in NYSE Rule 104(b)-(h) for algorithmic trading
would be enforced systematically, and, in some ways, would be more
restrictive than current auction market rules.\326\
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\324\ In response to commenters that argued that specialists
would have an informational advantage over other market participants
due to their ability to see floor broker agency interest files, the
Exchange clarified that specialists would only be able to view the
total aggregated floor broker agency interest at each price, except
for any interest a broker has elected not to have disclosed to the
specialist. The Exchange argued that specialists need to know the
amount of buy and sell interest at each price to fulfill their
obligation to maintain a fair and orderly market and to determine
appropriate prices in manual trading situations, such as after a
quote is gapped or when a LRP has been reached. The Exchange
maintains that specialists would thus not be given an advantage over
other market participants, as commenters may believe (See ICI Letter
II). Moreover, the Exchange emphasized that a broker can elect to
exclude its agency interest from the aggregate disclosed to the
specialist without jeopardizing such interest from participating in
automatic executions.
\325\ For example, to fulfill their obligations, specialists
today have knowledge of incoming orders, as well as CAP and stop
orders. See Response to Comments, supra note 14.
\326\ See also note infra and accompanying text.
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For example, to ensure that an algorithmically-generated message to
trade with the Exchange published quotation (i.e., to hit a bid or take
an offer) does not have an advantage--since the specialist's system
would be aware of an incoming order that would change the BBO before
such new bid or offer is publicly disseminated--the processing of the
specialist's algorithmically-generated message would be delayed so as
to give all market participants a comparable opportunity to trade with
such bid or offer. This would be accomplished by delaying processing of
the algorithmically-generated message for a period based upon the
average transit time from the system to the Display Book system.
According to the Exchange, the delay parameter would be adjusted
periodically to account for changes to the average transit time
resulting from capacity and other upgrades to Exchange systems.
In addition, per proposed NYSE Rule 104(b)(ii), neither the
specialist on the floor nor the messages generated by the Algorithms
would have the ability to affect the order in which algorithmically-
generated messages and incoming orders are processed by the Display
Book system. In correcting one commenter's impression that orders would
have to go through the
[[Page 16375]]
specialist's trading system before they are sent to the book for
processing,\327\ the Exchange clarified that an incoming order would
not be delayed in its arrival at, or processing by, the Display Book. A
copy of the order would go to the specialist's system, and the actual
order would continue on its path to the Display Book for processing.
---------------------------------------------------------------------------
\327\ See, e.g., SIA Letter III.
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With regard to commenters' recommendation that the Exchange
aggressively monitor the Specialist Algorithm to preclude unlawful
trading activity, the Exchange pointed out that algorithmically-
generated messages would provide improved audit trail data for NYSE
Regulation, since detailed information regarding such messages and the
systems within which they operate would be captured systematically. In
addition, the rules would require specialists to produce information
and documentation regarding their systems that should assist NYSE's
oversight of specialists' algorithmic trading.\328\ To ensure that the
specialists' ability to trade algorithmically is consistent with the
expectations of market participants, the Exchange also plans to
establish a committee composed of representatives of the various
Exchange constituencies that would review the functioning of the Hybrid
Market based upon experience and data, including specialist trading
data.\329\
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\328\ For example, proposed Exchange Rule 104(f)(ii) requires
that specialists notify the Exchange in writing within such time as
the Exchange shall designate, whenever an algorithm is not operating
and the time, cause, and duration of such non-operation.
\329\ One commenter viewed this aspect of the proposal as a
``positive step.'' See SIA Letter III.
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2. Specialists' Ability To Systematically Price Improve Incoming Orders
Commenters objected to the specialists' ability, on behalf of their
dealer accounts, to provide price improvement electronically to all or
part of a marketable incoming order.\330\ These commenters believed
that the specialists' ability to ``see'' information before others and
price improve is fundamentally unfair to other market participants and
a disincentive to displaying limit orders.\331\ One of these commenters
claimed that the algorithmic price improvement functionality would
provide the specialist with a unique proprietary trading opportunity
and would be inconsistent with the specialist's negative
obligation.\332\ This commenter also believed the requirement that the
specialist be represented in the quote for a minimum of 1000 shares to
price improve would be ineffective, and suggested that the Exchange
restrict the specialist to providing algorithmic price improvement only
when the incoming order would otherwise trade against the specialist's
bid or offer.\333\ In addition, two commenters urged the Exchange to
provide floor brokers with the functionality to provide price
improvement electronically in the current proposal, rather than in a
later filing, to promptly level the playing field between specialists
and investors.\334\
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\330\ See, e.g., IBAC Letters I and II, ICI Letter III,
Rutherfurd Letters I, III, and V, and Vanguard Letter.
\331\ See, e.g., IBAC Letter I, ICI Letters II and III (claiming
that their members are much more likely not to post orders on the
Exchange due to the ability of specialist to electronically interact
with orders through this mechanism), Rutherfurd Letters I, III, and
V (asserting that the specialist algorithmic price improvement to
incoming Auto Ex Orders that would otherwise be automatically
executed against the contra-side bid or offer has no net public
benefit and discourages the placement of public limit orders on
Book), and Vanguard Letter (arguing that if the specialist is
willing to provide liquidity at a price that is better than the BBO,
then the specialist should be required to display that liquidity).
\332\ See Rutherfurd Letter V (stating that NYSE's approach
transforms the specialist from the trader of last resort to the only
one who can trade in the first place).
\333\ See Rutherfurd Letter V.
\334\ See IBAC Letters I and II (urging the Commission to not
approve the Hybrid Market proposal until this functionality is
provided to floor brokers) and ICI Letter III.
---------------------------------------------------------------------------
The Exchange represented that throughout the process of formulating
rules governing specialist-provided price improvement, the Exchange has
sought to balance the benefit this would provide to incoming customer
orders with the interests of customers who have displayed orders at
prices inferior (albeit by as little as one cent) to that at which the
specialist would be willing to trade, or who would like a similar
opportunity to trade with incoming orders. Although comments have
criticized the algorithmic price improvement of one cent as ``penny-
jumping,'' \335\ the Exchange believes that the ability of the
specialist to provide price improvement of one cent when the quotation
spread is two cents provides a meaningful benefit to the incoming
order, and is consistent with Federal securities laws and Exchange
rules, which permit any market participant to bid, offer, or trade one
cent (i.e., the minimum variation) better than an existing bid or
offer.
---------------------------------------------------------------------------
\335\ See, e.g., Rutherfurd Letter III.
---------------------------------------------------------------------------
In response to comments that other market participants should also
have the ability to systematically price improve or trade with incoming
orders, the Exchange indicated that it is in the process of developing
the means by which floor brokers would have the ability to do this
through a discretionary price capability. In addition, the Exchange
proposes to automatically convert CAP-DI orders that are able to trade
along with the specialist at the improved price, so that these orders
can participate in that execution. The Exchange believes that the
opportunity for price improvement is an important factor in market
quality and a hallmark of the Exchange, and thus seeks to preserve this
important feature in the Hybrid Market.
E. Auction Limit and Auction Market Orders
Under NYSE's proposal, AL and AM orders would automate the
opportunity for investors to seek potential price improvement of a
penny or better. The Exchange describes AL and AM orders as market and
marketable limit orders that would be exposed to the auction and
electronic market and would have the possibility of price improvement.
These orders would automatically execute if: (1) The order is not
executed within 15 seconds; or (2) a quoting or trading action triggers
automatic execution before the 15-second period times out.
After the First Notice, a few commenters had specific questions
regarding how AL and AM orders would be processed and handled.\336\
These commenters requested clarification and examples relating to the
execution of these orders and how they would interact with existing
order types, the time priority of these orders when an incoming order
triggers their execution, and which participants could trade with these
orders. After the Second and Third Notices, another commenter, who
supported the current NYSE methodology of price improvement resulting
from order competition in the auction market, asserted that the
proposed 15-second exposure procedure for price improvement of AL and
AM orders would likely result in less price improvement, a risk of
price disimprovement, and a greater prospect of orders not even being
executed.\337\
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\336\ See BSE Letter, IBG Letter I, SIA Letter I, and STANY
Letter.
\337\ See Rutherfurd Letters I, III (stating that, given the
prospect of inferior pricing, NYSE's proposal effectively gives the
specialist an illegal ``not held'' order, and renders it virtually
impossible for broker-dealers with ``best execution''
responsibilities to seek price improvement on the Exchange), and V
(stating that AL and AM orders can be executed at worse prices
because later arriving orders could exhaust contra-side liquidity, a
result unknown in today's physical auction).
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In addressing the need for more details, NYSE provided an extensive
[[Page 16376]]
discussion in the Second Notice on AL and AM orders, including how they
would be electronically executed when they arrive at the Display Book
if the Exchange quotation is at the minimum variation, or routed away
to another market center if that market center is publishing the
national best bid (offer) and it causes a minimum variation with the
Exchange's best offer (bid). The Exchange also clarified that if AL and
AM orders are not automatically executed or routed away upon entry,
they would be quoted at a price to attract liquidity (a penny better
than the Exchange best bid or offer, as applicable) while retaining
their limit price. Furthermore, the Exchange clarified in the Second
Notice the three events that would cause automatic execution of an AL
or AM order before 15 seconds has elapsed,\338\ and also provided
detailed examples of how AL and AM orders would function in the Hybrid
Market.
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\338\ The three events are: (i) The arrival of a subsequent
order at a better price on the same side of the market as an AL or
AM order; (ii) the execution of an order on the same side of the
market as an AL or AM order that exhausts some or all of the
displayed contra-side volume available in the Exchange quotation;
and (iii) the cancellation of some or all of the displayed contra-
side volume, or the improvement of the displayed contra-side price,
creating a minimum variation market or allowing execution of the AL
or AM order with price improvement. See proposed NYSE Rule 123F.
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IV. Discussion
After careful review, the Commission finds that the proposed rule
change, as amended, is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities exchange and, in particular, with the requirements of
section 6(b) of the Act.\339\ Specifically, the Commission finds that
approval of the proposed rule change, as amended, is consistent with
section 6(b)(5) of the Act \340\ in that the proposal is 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 Commission also finds that the proposed rule change is
consistent with section 6(b)(8) of the Act,\341\ which prohibits an
exchange's rules from imposing a burden on competition that is not
necessary or appropriate in furtherance of the Act. The Commission
believes that the proposed rule change, as amended, is also consistent
with section 11A(a)(1)(C) of the Act,\342\ in which Congress found that
it is in the public interest and appropriate for the protection of
investors and the maintenance of fair and orderly markets to assure:
(1) Economically efficient execution of securities transactions; (2)
fair competition among brokers and dealers and among exchange markets,
and between exchange markets, and markets other than exchange markets;
(3) the availability to brokers, dealers, and investors of information
with respect to quotations and transactions in securities; (4) the
practicability of brokers executing investors' orders in the best
market; and (5) an opportunity for investors' orders to be executed
without the participation of a dealer.
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\339\ 15 U.S.C. 78f(b). In approving this proposal, the
Commission has considered the proposed rules' impact on efficiency,
competition, and capital formation. 15 U.S.C. 78c(f).
\340\ 15 U.S.C. 78f(b)(5).
\341\ 15 U.S.C. 78f(b)(8).
\342\ 15 U.S.C. 78k-1(a)(1)(C).
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The adoption of Hybrid Market proposal may fundamentally change the
Exchange's current market structure from a floor-based auction market
with an emphasis on human contact, to a predominantly electronic market
with limited human intervention. Today, the vast majority of orders
sent to NYSE for execution are handled manually by NYSE floor members--
specialists and floor brokers. Specialists represent orders that are
electronically submitted to the Exchange via DOT or left with them for
representation by floor brokers. Floor brokers receive their own
customers' orders at their booths on the floor that are delivered
electronically or by telephone. These floor members represent each
order individually in the market, ascertaining the current market by
seeking contra-side liquidity.
Trading on NYSE may be considerably different once the Hybrid
Market proposal is implemented. Orders that currently are represented
individually are more likely to be executed automatically without human
intervention.\343\ While NYSE has proposed to move to a more automated
model, it also seeks to retain substantive roles for its floor members.
Specialists will be permitted to perform many of their obligations to
maintain a fair and orderly market electronically, while floor brokers
will be able to represent their customer orders electronically. To
create the Hybrid Market, the Exchange has proposed significant changes
to its rules and systems to alter the way specialists, floor brokers,
and customers would participate and interact.
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\343\ Several commenters generally supported NYSE's move to a
more automated trading model. See, e.g., Ameritrade Letter, IBG
Letters I and II, ICI Letters I, II, and III, SIA Letters I, II, and
III, STANY Letter, Telic Letter, and Vanguard Letter.
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As discussed more fully below, the Commission finds that the Hybrid
Market proposal, by allowing greater electronic access to liquidity on
NYSE, should help perfect the mechanism of a free and open market. The
Hybrid Market proposal should provide investors with a more efficient
mechanism to have their orders executed on the Exchange. The Commission
also finds that the Hybrid Market should facilitate securities
transactions by providing investors with faster access to the trading
interest reflected in NYSE's published quotation, as well as interest
away from the Exchange BBO.\344\ Finally, the Commission finds that the
Hybrid Market could enhance the opportunity for a customer's order to
be executed without dealer participation, consistent with the goals of
the Act.
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\344\ The Commission notes that, while it believes the proposed
rule change, as amended, is consistent with the requirements of the
Act, the Commission makes no determination whether the Hybrid Market
would satisfy the ``automated trading center'' definition in Rule
600(b)(4) of Regulation NMS. See Securities Exchange Act Release No.
51808 (June 9, 2005), 70 FR 37496 (June 29, 2005).
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A. Increased Access to Display Book System
Under the proposal, a wide range of additional order types could be
entered into Direct+ for automatic execution. For example, all
marketable limit orders, designated market orders, designated IOC
orders (including ITS Commitments), and Intermarket Sweep orders, would
be able to receive automatic execution against interest placed in the
Display Book system. In addition, for the first time, Auto Ex Orders
would have the ability, within certain limits, to sweep interest
outside the Exchange BBO. The proposal also would eliminate the size
and the 30-second order entry restrictions that currently limit
automated access to the Exchange's quote via Direct+. The Commission
finds that the availability of automatic executions for a much wider
range of order types, the ability of Auto Ex Orders to sweep the NYSE
depth-of-book, and the elimination of the size and timing restrictions
for Auto Ex Orders, are consistent with the requirements of the Act.
Specifically, the Commission believes that providing more instantaneous
access to liquidity on the Display Book system should facilitate the
efficient execution of orders on the Exchange and potentially could
enhance the ability of executions to occur without the participation of
a dealer.
In addition to broadening the scope of automatic executions, NYSE
has proposed to limit the instances when Direct+ would not be
available.
[[Page 16377]]
Currently, under NYSE rules, Direct+ is unavailable under many
circumstances. Some of these reflect the needs of NYSE's current market
structure, which is largely a manual auction on the floor. For example,
specialists have broad discretion to disable Direct+ by publishing 100
share quotes and manually reporting floor transactions.\345\ When
Direct+ is disabled, Auto Ex Orders are directed to the specialist for
manual handling in the auction. In addition, NYSE Rule 1000 permits
Direct+ to be turned off if a block size transaction away from the NYSE
BBO is in the process of being completed on the floor.\346\ In such
instances, the specialist publishes a quote that is five cents away
from the last reported sale, and this has the effect of disabling
Direct+.\347\ Further, NYSE Rule 1000 permits Direct+ to be turned off
if the NYSE quote is not firm, the execution price would be more than
five cents away from the last reported transaction price, a better
price exists in another ITS market, or trading has been halted.\348\
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\345\ See NYSE Rule 1000(iv).
\346\ See NYSE Rule 1000(v).
\347\ In a separate proposal, the Exchange is proposing to
require specialists to publish a 100 x 100 share market quote that
reflects the last reported transaction in connection with a block
size transaction. See supra note 134.
\348\ See NYSE Rule 1000.
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Under the proposal, Direct+ would be unavailable only when: (1) The
NYSE quote is not firm; (2) trading has been halted; (3) the specialist
has gapped the quotation in accordance with Exchange procedures; (4)
trading has reached a LRP; (5) a block size transaction involving
orders in the Display Book system is being manually reported; or (6) an
Auto Ex Order is entered for a high-priced security. The Commission
believes that these proposed changes should ensure that automatic
executions are more readily available on NYSE than they are today.
Further, the Commission believes the proposal should provide
specialists with less discretion to disengage Direct+ than they have
today. This reduced specialist discretion both should help ensure that
automated executions are more widely available on NYSE and help
alleviate concerns that specialists might manipulate the automated/non-
automated status of NYSE for their own benefit. Specifically,
specialists would only be permitted in two instances to actively
disengage Direct+: (1) By gapping the NYSE quotation and (2) by
manually reporting block size transactions that involve orders on the
Display Book system. NYSE believes that the specialist, when faced with
a substantial order imbalance, may need the ability to attempt to
attract additional liquidity in a controlled environment without
automatic executions. NYSE has sought to ensure that specialists do not
frequently enter gapped quotations for the purpose of disabling Direct+
by requiring that when a specialist gaps the quote, it must follow
certain procedures and consult with floor officials.\349\ Specialists
will also be permitted to disengage Direct+ when manually reporting a
block size transaction that involves orders on the Display Book system.
The Commission believes that this limited ability to disengage Direct+
could be necessary due to the practical difficulties of integrating
orders on the Book into large transactions on the floor.
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\349\ See NYSE Information Memo 04-27. The Commission notes that
NYSE must update this information memo to reflect that automatic
executions on both sides of the market will be suspended once the
quote is gapped.
---------------------------------------------------------------------------
The Commission also believes that the other limited instances when
Direct+ will not be available are reasonable. High-priced securities
would be ineligible to participate in automatic executions because they
are thinly traded and, according to the Exchange, customers would
obtain better representation if transactions in these securities are
handled in the manual auction market. Finally, when trading is halted
or when the NYSE quotation is not firm, no execution, automatic or
manual, would be available.
The Commission notes that when Direct+ is disengaged, whether due
to an LRP or any of the other events that cause the NYSE market to
revert to a manual market, the NYSE quote would not be an ``automated
quotation,'' and thus not entitled to protection under Rule 611 of
Regulation NMS.\350\ When this occurs, NYSE also would be required to
immediately identify its quotation as a manual quotation if it is to be
considered an ``automated trading center'' for purposes of Regulation
NMS.\351\ In addition, when the NYSE quotation is not available for
automatic execution because of a LRP or gapped quotation, NYSE would
identify such quotes as non-firm. The Commission believes that these
requirements may provide an incentive to NYSE to keep the frequency and
length of the unavailability of automatic executions to a minimum.
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\350\ 17 CFR 242.611.
\351\ See 17 CFR 242.600(b)(4)(iii).
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1. Liquidity Replenishment Points
Under the proposal, when trading on the Exchange reaches a LRP,
automatic executions would be unavailable and the Hybrid Market would
temporarily revert to an auction market. NYSE has proposed two types of
LRPs: (1) The sweep LRP and (2) MLRP. As discussed in Section II(A)(5)
above, the sweep LRP price would be set at the nearest five-cent
increment outside the NYSE BBO, rounded to the next nickel. The MLRP
price would be calculated by adding the greater of $.25 or 1% of the
security's price to its lowest price within a rolling 30-second period
and subtracting that amount from the security's highest price within
the same time period. In the event that there is no transaction in a
security within the 30-second period, the MLRP would be based on the
last transaction on the Exchange.
Initially, commenters questioned the specifics of LRPs, including
whether they were too restrictive and whether they were necessary.\352\
After NYSE proposed the parameters for MLRP, one commenter questioned
whether the parameters would cause frequent suspension of Autoquote and
automatic execution.\353\ Another commenter believed that market
volatility should not be artificially limited and that LRPs are too
restrictive for active securities.\354\
---------------------------------------------------------------------------
\352\ See, e.g., Ameritrade Letter, Bear Stearns Letter, BSE
Letter, IBG Letter I, ICI Letters I and II, SIA Letter I, and STANY
Letter.
\353\ See ICI Letter II.
\354\ See Vanguard Letter.
---------------------------------------------------------------------------
According to NYSE, the LRPs are intended to moderate volatility,
which may increase when the Hybrid Market is implemented and a larger
portion of NYSE trades are executed electronically. NYSE believes that
reverting to a manual market in times of volatility will enhance the
quality of executions in its market.
As noted above, the Commission believes that the increased
availability of automated executions should facilitate the efficient
execution of orders on the Exchange and enhance the opportunity for
executions to occur without the participation of a dealer. NYSE
believes, however, that precluding automatic executions under certain
circumstances--such as where market volatility has triggered an LRP--
will provide its customers with better executions by fully utilizing
the expertise of its floor members. In the Commission's view, this type
of hybrid market model is consistent with the requirements of the Act,
and, as such, is within the realm of judgments generally left to the
discretion of individual markets. Creating a new market model also has
the potential to foster intermarket competition. Accordingly, the
Commission finds that NYSE's use of LRPs in the context of its Hybrid
[[Page 16378]]
Market is consistent with the requirements of the Act.
B. Autoquote
NYSE has proposed to disengage its Autoquote system in three
specified instances. Specifically, Autoquote would not be available
when the specialist gaps the quote, when the specialist is manually
reporting a block size transaction that includes orders in the Display
Book system, or when an LRP has been reached. The Commission believes
that it is consistent with the requirements of the Act to disengage
Autoquote for limited periods to accommodate these specific activities
in the auction market. For example, in the circumstances when the quote
is gapped or an LRP is reached, the Commission believes that Autoquote
may be disengaged to permit the specialist to more effectively fulfill
its obligation to maintain a fair and orderly market by controlling the
NYSE quote during limited periods of significant market activity.
Accordingly, the Commission finds that the proposed provisions relating
to Autoquote are consistent with requirements of the Act.\355\
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\355\ The Commission notes that the display of customer limit
orders is governed by the Limit Order Display Rule, 17 CFR 242.604,
and that even if Autoquote is disengaged, specialists may be
required to display such orders in compliance with this rule. The
Exchange represented that it would notify specialists after an LRP
has disengaged Autoquote to alert specialists of their obligations
under the Limit Order Display Rule.
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C. Liquidity Available for Automatic Execution
As discussed in Section II(A) above, NYSE proposes to allow its
floor members to post liquidity in the Display Book system
electronically, so that it is available for automatic executions.
Specifically, NYSE proposes to create two new files within the Display
Book system--the specialist interest file and the floor broker agency
interest file. Specialists and floor brokers would be allowed to place
liquidity within these new files in the Display Book system at the
Exchange BBO or outside the Exchange BBO. The liquidity within these
interest files would not be disseminated, unless it is priced at the
Exchange BBO.\356\
---------------------------------------------------------------------------
\356\ Specialists could elect to disseminate their interest via
NYSE OpenBook. The specialist would be able to view aggregate floor
broker interest at each price level, unless the floor broker elects
to exclude its interest from the specialist's view.
---------------------------------------------------------------------------
In addition, specialists and floor brokers could enter reserve size
at the Exchange BBO. This interest would not be disseminated and would
trade after all displayed interest at the BBO has been filled.
Specialists would be required to display at least 2,000 shares at the
BBO to enter reserve size, and floor brokers would be required to
display 1,000 shares. The Display Book system will automatically
replenish specialist interest files and floor broker agency interest
files to the minimum displayed amounts, unless there is insufficient
reserve size to display the minimums. In such cases, the entire amount
of reserve will be added to the displayed size.
The proposed specialist interest file and proposed floor broker
agency interest file generated several comments. Generally, commenters
raised several broad issues related to the ability of specialists to
see interest in the floor broker agency interest files, the lack of
display of both reserve interest and floor broker agency interest away
from the BBO, and NYSE's requirement that floor brokers remain in the
``Crowd'' when utilizing the floor broker interest file.\357\
Specifically, a number of commenters questioned the lack of
transparency of the floor broker agency interest file, given that floor
broker interest would not be publicly disseminated unless it were at
the NYSE BBO.\358\ These commenters argued that the floor broker agency
interest file, if not displayed, should not be entitled to trade on
parity with displayed orders on the Book.\359\
---------------------------------------------------------------------------
\357\ As discussed further below, the specialist interest file
and the floor broker agency interest file generated comments
regarding the priority and parity rules that would be implemented
for these files.
\358\ See, e.g., Bloomberg Letters I and II, ICI Letters I, II,
and III, Rutherfurd Letters I, II, III, and V, SIA Letter I, and
STANY Letter. See also Vanguard Letter.
\359\ For a complete description of the parity issues, see infra
Section IV(D).
---------------------------------------------------------------------------
The Commission finds that NYSE's proposal to allow floor brokers
and specialists to electronically participate in the Hybrid Market is
consistent with the requirements of the Act. This capability could
increase the liquidity available for automatic executions on NYSE.
Moreover, including the interest of these floor members and their
customers in the Hybrid Market electronically could improve the prices
at which Auto Ex Orders that sweep the Display Book system may execute.
In addition, the proposal should allow customers of floor brokers to
more effectively participate in an electronic trading environment.
The Commission also finds that making floor broker agency interest
information available to specialists is consistent with the
requirements of the Act. In the Hybrid Market, specialists would
continue to have the obligation to conduct the auction on the floor.
Thus, to ensure that all interest is represented in an auction, the
Commission believes that a specialist would need full information about
the liquidity available and the prices at which such liquidity is
available. The availability of this information also may assist
specialists in maintaining a fair and orderly market under NYSE Rule
104 and Rule 11b-1 under the Act. Further, floor brokers that do not
want specialists to have information about their interest have the
discretion to exclude their interest from the aggregate information
available to specialists if they believe that doing so is in the best
interest of their customers. The Commission also notes that Specialist
Algorithms would not be able to view or make quoting or trading
decisions based on interest in the floor broker agency file that is not
publicly available.\360\
---------------------------------------------------------------------------
\360\ See proposed NYSE Rule 104(c)(ii).
---------------------------------------------------------------------------
The Commission further finds that the floor broker reserve function
is consistent with the requirements of the Act as it could provide
floor brokers with greater flexibility in handling and working large
customer orders. In particular, the reserve function could prove useful
to institutions that wish to minimize the market impact of their large
orders. Furthermore, allowing floor brokers to place interest in
reserve could increase participation on NYSE, which might enhance the
depth and liquidity of NYSE's market. The Commission also believes that
it is consistent with the requirements of the Act to allow specialists
to place reserve interest in the Display Book system as it too could
increase the liquidity available for execution at the Exchange BBO.
Two commenters suggested that NYSE allow investors to place
reserve, or undisplayed, interest in the Display Book system.\361\ One
of these commenters argued that depriving investors of this ability
would be inconsistent with the principles set forth in section 11A of
the Act.\362\ The Commission believes that the decision to limit the
availability of reserve orders to specialists and floor brokers, under
the conditions proposed by NYSE, is within the realm of judgments
generally left to the discretion of an individual market and is
consistent with the requirements of the Act. In addition, this aspect
of the Hybrid Market is similar to how the NYSE market operates today,
as investors today must use a floor member to represent their
undisplayed interest on the Exchange.
---------------------------------------------------------------------------
\361\ See ICI Letters I and II and Vanguard Letter.
\362\ See Vanguard Letter.
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[[Page 16379]]
The Commission notes that two features of NYSE's proposal to allow
undisplayed reserve interest should help ensure that market
participants continue to have an incentive to display quotes or orders
on NYSE: (1) Specialists and floor brokers must display a minimum
number of shares at the BBO to have undisplayed reserve interest; and
(2) displayed interest will have priority over all undisplayed reserve
interest. The Commission believes that, taken together, these
requirements could promote additional depth at the Exchange BBO, while
preserving incentives for investors to display limit orders.
Accordingly, the Commission finds that NYSE's proposal to allow floor
brokers and specialists to have undisplayed reserve in the Display Book
system is consistent with the requirements of the Act.
NYSE also proposes to require floor brokers to be in the ``Crowd''
when the floor broker maintains interest in the floor broker agency
interest file. NYSE defines a ``Crowd'' as any five contiguous panels
at any one trading post. It would be a violation of Exchange Rules for
a floor broker to leave the Crowd without canceling its interest in the
file,\363\ but if this occurs, the floor broker nevertheless would be
held to any resulting executions. One commenter believed that limiting
the Crowd to five contiguous panels is arbitrary and unnecessarily
restrictive.\364\
---------------------------------------------------------------------------
\363\ The floor brokers would be permitted to leave the Crowd to
recharge its handheld device. See proposed NYSE Rule 70.20(f).
\364\ See Invictus Letter.
---------------------------------------------------------------------------
The Commission believes that the requirement that a floor broker be
present while representing orders in the Display Book system is within
the realm of judgments generally left to the discretion of an
individual market and is consistent with the requirements of the Act.
NYSE has proposed to create a Hybrid Market that combines a manual
auction market on the floor with an electronic market. The Commission
notes that NYSE currently requires floor brokers to be present in the
Crowd to represent their customer orders in the auction market.\365\
NYSE stated that it believes five contiguous panels is the appropriate
range of proximity to enable floor brokers to electronically
participate in the Hybrid Market and, at the same time, physically
participate in the auction component of the Hybrid Market. Under these
circumstances, the Commission believes that it is reasonable for NYSE
to require floor brokers to be available to actively represent their
customers, even when their customers' interest is in the Display Book
system, by requiring floor brokers to be present in the Crowd.
---------------------------------------------------------------------------
\365\ See, e.g., NYSE Rule 117.10.
---------------------------------------------------------------------------
D. Automatic Executions
Under the proposal, Auto Ex Orders would execute against interest
in the Display Book system, including the Book, floor broker agency
interest files, and specialist interest files. Auto Ex Orders would
first execute against interest at the Exchange BBO. Once interest at
the Exchange BBO is exhausted, an Auto Ex Order would trade with
interest outside the Exchange BBO, automatically sweeping the Display
Book system, until it is: (1) Executed; (2) its limit price, if any, is
reached; or (3) a LRP is reached, whichever occurs first. During a
sweep, the residual would trade at the clean-up price.
The Commission notes that the ability to sweep the NYSE Display
Book system is a significant expansion of the availability of automatic
executions on the Exchange. Currently, Auto Ex Orders that are for a
size greater than the Exchange BBO trade automatically with the BBO,
and then the residual is routed to the specialist for manual handling.
The Commission believes that the ability to automatically execute
against the depth of interest on the NYSE Display Book system should
enhance the speed of executions and facilitate more efficient
transactions on the Exchange.
Several commenters raised concerns about the rules NYSE proposed
governing how automatic executions would occur against interest in the
Display Book system. In particular, commenters raised concerns about
how the rules of priority, parity, and precedence would apply with
regard to interest in the Display Book system.\366\
---------------------------------------------------------------------------
\366\ See, e.g., Bloomberg Letters I and II, IBAC Letters I and
II, IBG Letter I, ICI Letters I, II, and III, Rutherfurd Letters I,
II, III, IV, V, VI, VII, VIII, IX, and X, SIA Letter I, STANY
Letter, and Vanguard Letter.
---------------------------------------------------------------------------
Currently, executions on the Exchange are governed by NYSE Rules
72, 104, and 108. When more than one market participant is bidding or
offering the best price, these rules detail which participant(s) have
the right to fill the order--either entirely, or a certain percentage
of it--before anyone else. As a general rule, the first person to quote
the price at which the security is ultimately traded is entitled to
``priority''--the right to fill the order before anyone else.\367\
``Parity,'' on the other hand, means that none of the market
participants competing to fill the order has rights over any other
based on quoting the best price first.\368\ Generally, in a situation
of this kind, participation in the order must be divided pro rata among
the crowd participants who simultaneously bid to fill the order at the
best price. To create incentives for market participants to provide
liquidity, current Exchange rules may permit certain participants to
trade ahead of others who are on parity if they are quoting in size.
(This is known as ``precedence based on size.'')\369\
---------------------------------------------------------------------------
\367\ See NYSE Rule 72(a).
\368\ See NYSE Rule 72(e).
\369\ See NYSE Rule 72(c) and (d).
---------------------------------------------------------------------------
Specialists are subject to additional restrictions on their ability
to trade for their own accounts, given their special position in the
marketplace. Specifically, specialists, as agents for orders on the
Book, are required to yield to orders on the Book.\370\ Today,
specialists also are limited, pursuant to NYSE Rules 104 and 108, when
trading for their own accounts along with orders represented by floor
brokers. NYSE Rules 72 and 104 provide that when a specialist is
decreasing or liquidating its position, the specialist is entitled to
parity unless requested by a floor broker, on behalf of its customer,
to yield. NYSE Rule 108 provides that a specialist is not entitled to
parity when increasing or establishing its position, but, according to
NYSE, it has interpreted this rule as permitting the specialist to
trade on parity when increasing its position, so long as the floor
broker consents.\371\
---------------------------------------------------------------------------
\370\ See NYSE Rule 92.
\371\ See supra note 101.
---------------------------------------------------------------------------
NYSE proposes certain changes to its rules of priority, parity, and
precedence. For example, NYSE proposes that the interest in the floor
broker agency interest file and specialist interest file trade on
parity once all interest in the Book has been satisfied, with neither
entitled to priority. To accomplish this, NYSE would prohibit a floor
broker from placing any interest in its agency interest file that would
restrict the ability of the specialist to trade on parity. In other
words, specialists would be entitled to trade on parity with orders
represented by floor brokers in the floor broker agency interest file,
and floor brokers would not be able to object to such specialist
trading.\372\ The Exchange also proposes to eliminate the regulatory
distinction, in this context, between situations where the specialist
is increasing or decreasing its position.
---------------------------------------------------------------------------
\372\ If the floor broker does not want the specialist to trade
on parity with its customer, it could place its customer's order on
the Book.
---------------------------------------------------------------------------
In addition, NYSE proposes to permit the floor broker agency
interest file to trade on parity with orders in the Book
[[Page 16380]]
to the extent that neither is entitled to priority. At the BBO, floor
broker agency interest that is displayed would trade on parity with
interest in the Book. During sweeps, floor broker agency interest that
is designated as eligible for display if the price moves to the BBO
would be permitted to trade on parity with the Book. Floor broker
agency interest that would not be displayed even if at the BBO (i.e.,
reserve interest) would not be entitled to trade on parity with the
Book during a sweep at the clean-up price.
These proposed changes generated several comments. For example,
three commenters believed that NYSE should not allow specialists to
trade on parity with the floor broker agency interest file when
specialists are increasing or establishing their position.\373\ One
commenter argued that allowing specialists to trade on parity with the
floor broker agency interest file would be inconsistent with the
specialists' negative obligation, as well as section 11A of the Act,
which encourages order interaction without the participation of a
dealer.\374\ Other commenters raised concerns about the ability of
undisplayed floor broker interest outside the BBO to trade on parity
during sweeps with displayed orders on the Book.\375\ For example, some
commenters argued that permitting floor brokers to conceal their
interest from other market participants, while allowing this
undisplayed interest to trade on parity with displayed interest, would
provide a disincentive for investors to place limit orders on the Book,
since investors would not be rewarded for taking the risk to display
their orders.\376\
---------------------------------------------------------------------------
\373\ See IBAC Letters I and II, ICI Letter III and Rutherfurd
Letters III, IV, V, VI, VII, VIII, IX, and X.
\374\ See Rutherfurd Letters III, IV, V, VI, VII, VIII, IX, and
X. See also IBAC Letter I.
\375\ See, e.g., Bloomberg Letters I and II, ICI Letters I, II,
and III, Rutherfurd Letters I, II, III, and V, SIA Letter I, STANY
Letter, and Vanguard Letter.
\376\ See, e.g., ICI Letters II and III, Rutherfurd Letters II
and V, STANY Letter, and Vanguard Letter.
---------------------------------------------------------------------------
The Commission's standard for reviewing trading rules filed by
exchanges is based on whether the rules are consistent with the
requirements of the Act, such as provisions that require that market
participants be treated fairly and provisions that limit the role of
specialists.\377\ The Commission also reviews trading rules to see if
the rules discriminate in favor of some members over others, or in
favor of members over public customers.\378\ Trading rules also must
promote fair and orderly markets, as well as the specified goals of the
national market system.\379\
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\377\ See, e.g., 15 U.S.C. 78f(b)(5) and 15 U.S.C. 78k.
\378\ 15 U.S.C. 78f(b)(5).
\379\ 15 U.S.C. 78f(b)(5) and 15 U.S.C. 78k-1.
---------------------------------------------------------------------------
The Commission finds that NYSE's proposal to permit specialists to
trade on parity with the floor broker agency interest after interest on
the Book has been exhausted is consistent with the requirements of the
Act. The Commission notes that specialists will continue to be
restricted in their ability to trade pursuant to section 11(b) and Rule
11b-1 of the Act,\380\ and NYSE Rule 104. The Commission expects and
the Exchange represented that it expects the Specialist Algorithms to
be programmed and operated in a manner to ensure that specialist
proprietary trading is conducted consistent with section 11(b) of the
Act,\381\ Rule 11b-1, and NYSE Rule 104.
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\380\ 17 CFR 240.11b-1(a)(2). In light of these changes, the
Commission expects the Exchange to update its surveillance
procedures and the specialist firms to update their compliance
programs to ensure that specialist trading is conducted in a manner
that is consistent with the requirements of the Act and NYSE rules.
\381\ 15 U.S.C. 78k(b).
---------------------------------------------------------------------------
In accordance with SEC Rule 11b-1, NYSE Rule 104 restricts the
specialist's ability to trade for its own account. SEC Rule 11b-1
provides that exchanges may permit members to register as specialists
so long as their rules include, among other things, ``provisions
restricting [the specialist's] dealings so far as practicable to those
reasonably necessary to permit [it] to maintain a fair and orderly
market * * *'' NYSE Rule 104 specifically prohibits a specialist from
dealing in its own account ``unless such dealings are reasonably
necessary to permit such specialist to maintain a fair and orderly
market * * *'' Currently, the specialist makes the determination as to
whether its proprietary transactions are reasonably necessary based on
the anticipated needs of the market and the conditions of the market at
the time the transaction is effected. As proposed, the specialist may
not have access to all of the information that it has today regarding
the condition of the market at the time of sale. Specifically, the
specialist may not, and the Specialist Algorithm will not, have access
to information regarding floor broker reserve at the BBO or floor
broker agency interest outside of the BBO. Accordingly, the Commission
must consider the application of the restrictions in SEC Rule 11b-1 and
NYSE Rule 104 to the specialist's proprietary trading in the Hybrid
Market.
In the Hybrid Market, specialists will remain obligated to
determine whether their proprietary trades are reasonably necessary to
maintain a fair and orderly market. The specialist will be expected to
actively monitor, both personally and through the Specialist Algorithm,
whether the interest placed in the specialist interest file remains
appropriate in light of current market conditions and the specialist's
obligations under NYSE Rule 104, and to make appropriate adjustments.
Nonetheless, the Commission recognizes that the role of the specialist
in the more automated Hybrid Market will be somewhat different from its
traditional role on the Exchange floor. Specifically, the specialist
will participate in automatic executions that occur against proprietary
interest previously placed in the specialist interest file. The
Commission also recognizes that, in the Hybrid Market, the specialist
will not individually handle each trade that occurs on the Exchange,
and may not necessarily know of--personally or algorithmically--other
trading interest available in the market prior to an execution for its
proprietary account. The specialist may not, and the Specialist
Algorithm will not, know whether there is floor broker reserve interest
available at the BBO, or floor broker agency interest available outside
the BBO. Accordingly, the specialist must make decisions whether to add
orders to the specialist interest file without knowing the full extent
of other trading interest available in the market, and consequently may
trade on parity with other available floor broker interest.
As noted above, the Exchange believes that providing specialists
parity with floor broker agency interest will incent specialists to
participate in the price discovery process at the point of sale and
thus dampen volatility and lower execution costs for investors. The
Exchange also believes that withholding information about floor broker
reserve interest at the BBO, and floor broker agency interest outside
the BBO, from the Specialist Algorithm--and in some cases from the
specialist himself--will allow floor brokers to more effectively
represent their customer orders, and thus further incent liquidity and
dampen price volatility in the Hybrid Market.
Although the Commission recognizes that these features may inhibit
somewhat the ability of specialists to assess the condition of the
market to comply with their ongoing negative obligations under SEC Rule
11b-1 and NYSE Rule 104, the potential benefits these features may
bring to the quality of the Hybrid Market justify the risks of
[[Page 16381]]
unnecessary specialist trading. The specialist must design its
Specialist Algorithm to support a fair and orderly market, which
includes varying its position in light of the anticipated needs of the
market. The specialist also must adjust the operation of the Specialist
Algorithm to the extent it becomes aware of changes in the market that
would render its operation inconsistent with its obligation. However,
the Commission recognizes that the specialist may, and the Specialist
Algorithm will, have less than full information about the floor broker
interest. So long as the specialist has programmed the Specialist
Algorithm, taking into account and including as inputs all relevant
factors available to the Specialist Algorithm, in a manner designed to
support a fair and orderly market, and the specialist has made
adjustments to the operation of the Specialist Algorithm based on its
knowledge of market information, the Commission believes the specialist
could trade on parity with floor broker interest consistent with its
obligations under SEC Rule 11b-1 and NYSE Rule 104 in the Hybrid
Market.\382\
---------------------------------------------------------------------------
\382\ NYSE has represented that prior to the rollout of the
third phase of the Hybrid Market, it will develop guidance to
clarify how it expects specialists to comply with the NYSE Rule 104
in the Hybrid Market. Telephone call between Catherine R. Kinney,
President and Co-Chief Operating Officer, NYSE Group, Inc., and
Richard G. Ketchum, Chief Regulatory Officer, NYSE Regulation, Inc.,
and Kelly M. Riley, Assistant Director, Division, SEC, on March 22,
2006. See also Amendment No. 8. The Commission believes that
specific guidance is necessary to help assure that specialists can
effectively program the algorithms to trade in compliance with the
negative obligation.
---------------------------------------------------------------------------
In addition, the Commission finds that NYSE's proposal to permit
interest in the floor broker agency interest files to trade on parity
with orders in the Book, subject to certain limitations, is consistent
with the requirements of the Act. NYSE appears to have sought to
balance the incentives for placing interest in the Book against the
ability of floor brokers to effectively represent their customers. The
proposal limits the ability of interests in the floor broker agency
interest files outside the BBO to trade on parity with orders in the
Book by requiring floor brokers to designate the amount of interest
that would be displayed if the price becomes the Exchange BBO, and
permitting only that amount to trade on parity. The Commission believes
that providing floor brokers with this additional incentive to place
liquidity in the Display Book system could allow them to more
effectively represent their customer orders, without materially
reducing the incentives to display liquidity on the Book.
The Commission believes that exchanges have a degree of
flexibility, in their judgment, to determine the methods of non-
discretionary order interaction on their markets so long as the
requirements of the Act are met. Accordingly, the Commission believes
that NYSE's proposed changes to its rules of priority, parity and
precedence are consistent with the requirements of the Act.
E. Role of Specialist in the Hybrid Market
To preserve a meaningful role for the specialist, NYSE has proposed
to permit specialists to participate electronically in the Hybrid
Market and replicate certain existing specialist privileges in an
electronic manner. For example, NYSE has proposed to provide
specialists with access to certain information about incoming orders
before they are processed by the Display Book system.\383\ This
information would be transmitted to the specialist via the API. Based
on this and other information, specialists would use the Specialist
Algorithms to generate quoting or trading messages, which would be
transmitted to the Display Book system via the API. The Specialist
Algorithm would be able to make limited quoting and trading decisions
in response to incoming orders, such as to provide price improvement,
improve the Exchange BBO, or supply size to fill the incoming order at
the Exchange BBO.
---------------------------------------------------------------------------
\383\ See supra note 167.
---------------------------------------------------------------------------
The proposal to create Specialist Algorithms generated several
comments. Five commenters believed that it would be unfair for the
Specialist Algorithms to view information prior to other market
participants and for the specialist to act on that information.\384\
These commenters believed that other market participants should be
given the same opportunity.\385\ For instance, one commenter viewed as
one-sided NYSE's proposal to provide specialists with the ability to
algorithmically trade with incoming orders while providing no similar
tool for floor brokers, and believed this would thwart, rather than
foster, fair competition.\386\ Another commenter was concerned that the
information barriers within a specialist firm could be breached,
resulting in the dissemination of non-public information outside the
Exchange, including upstairs traders or other business units affiliated
with the specialist firm.\387\ This commenter believed that the
Exchange should affirmatively state a prohibition against such sharing
of information.
---------------------------------------------------------------------------
\384\ See IBAC Letter I, ICI Letters I, II, and III, Rutherfurd
Letters I, III, and V, SIA Letters I and III, and Vanguard Letter.
See also IBAC Letter II.
\385\ See id.
\386\ See IBAC Letters I and II. See also ICI Letter III.
\387\ See Invictus Letter.
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Specialists will continue to be required to perform their
obligations to maintain a fair and orderly market.\388\ For example,
pursuant to NYSE Rule 104, specialists will continue to be required to
trade for their own account when there is a lack of price continuity,
depth, or a disparity between supply and demand. In addition,
specialists will continue to oversee the auction market and play an
active role when large transactions are routed to the NYSE floor for
execution. To enable specialists to effectively perform these
functions, NYSE has proposed to replicate some of the existing
specialist privileges--including an informational advantage--in an
electronic manner. As discussed below, the Commission finds that NYSE
has sufficiently limited the specialists' informational advantage so
that, in light of the specialists' ongoing duties and obligations to
the market, the proposal is consistent with the requirements of the
Act.
---------------------------------------------------------------------------
\388\ See also Section IV(D), supra, for a discussion on the
application of SEC Rule 11b-1 and NYSE Rule 104 in the Hybrid
Market.
---------------------------------------------------------------------------
1. Price Improvement
Under the proposal, the specialist could program its algorithm to
offer price improvement to incoming orders under certain circumstances.
The amount of price improvement would vary, depending on the spread.
For example, price improvement must be at least three cents when the
spread is more than five cents, at least two cents when the spread is
three cents to five cents, and one cent when the spread is two cents.
To offer electronic price improvement, the specialist must be
represented in the bid or offer in a meaningful amount, which NYSE
would define as a minimum of 1,000 shares for the most 100 active
stocks on the Exchange and 500 shares for all other stocks on the
Exchange.\389\
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\389\ The Exchange would determine the 100 most active stocks
based on the average daily volume and would provide notice to its
members on a quarterly basis, or more frequently as the Exchange
from time to time shall determine. See proposed NYSE Rule
104(e)(ii).
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Commenters objected to the ability of a specialist to provide price
improvement electronically to all or part
[[Page 16382]]
of a marketable incoming order.\390\ One commenter believed that the
specialist's ability to provide algorithmic price improvement would not
be as fair of a process as price improvement resulting from genuine
order competition in the auction market which can be verified by other
market participants at the point of sale.\391\ Two commenters insisted
that the Exchange supplement its proposal to grant floor brokers with a
similar ability to provide electronic price improvement to orders.\392\
Another commenter believed that if the specialist is willing to improve
the NYSE BBO, the specialist should display that price in its
quote.\393\
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\390\ See, e.g., IBAC Letters I and II, ICI Letter III,
Rutherfurd Letters I, III, and V, and Vanguard Letter.
\391\ See Rutherfurd Letter III.
\392\ See IBAC Letters I and II and ICI Letter III.
\393\ See Vanguard Letter.
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The Commission believes that the ability of specialists to offer
price improvement to incoming orders is consistent with the
requirements of the Act. The Commission notes that NYSE specialists
today are permitted to provide price improvement to incoming orders in
the auction market. With this proposal, NYSE is providing specialists
with the ability to continue to offer price improvement in an
electronic environment, but only if the specialists satisfy certain
conditions. As noted above, specialists would be required to be
meaningfully represented in the BBO and to provide a minimum amount of
price improvement. The Commission also notes that Specialist Algorithms
could only offer price improvement to incoming marketable orders;
incoming orders that would improve the Exchange BBO would be quoted as
the new BBO. The Commission believes that permitting specialists to
algorithmically price improve marketable orders by certain minimum
amounts could increase the quality of its electronic market, and that
the condition that specialists be meaningfully represented in the bid
or offer might enhance depth and liquidity at the NYSE BBO.
2. Ability To Hit Bids or Take Offers
In addition to offering price improvement to incoming marketable
orders, Specialist Algorithms could also generate trading messages that
would trade with the Exchange BBO. The Commission notes that NYSE has
proposed to implement safeguards that prohibit the Specialist
Algorithms from obtaining a time advantage over the public, by delaying
the processing of algorithmic messages to trade with the Exchange BBO.
The Commission believes that the capability of the Specialist
Algorithms to hit bids or take offers is designed to assure specialists
are on a level playing field with other market participants with
respect to their ability to interact with the Exchange BBO, and is
consistent with the requirements of the Act. Further, the Commission
notes that capability of the Specialist Algorithms to hit bids or take
offers must be consistent with their obligations under NYSE Rule 104
and Rule 11b-1 under the Act.
3. NYSE Rule 92
NYSE Rule 92 reflects the fundamental tenet of agency law that an
agent must place its customer's interest ahead of its own proprietary
interest. In essence, Rule 92 prohibits an NYSE member from buying or
selling for its own account an Exchange-listed security when it knows
that it is holding a customer order that is executable at the same or
better price. NYSE has proposed to clarify when the Specialist
Algorithms would be deemed to have knowledge of an incoming order.
Specifically, NYSE has proposed that the Specialist Algorithm would not
be deemed to have knowledge of an incoming order, for purposes of Rule
92, if the Specialist Algorithm is designed and operated in a manner
that prevents its handling of an incoming order from being affected by
the receipt of subsequent orders in the same security. NYSE believes
that this amendment is necessary because there could be situations
where the Specialist Algorithms generate a quoting or trading message,
and before the Display Book system can process the message, the
Specialist Algorithms receive and process information about a
subsequent incoming order that is at the same or better price. The
Commission believes that the proposed amendment to Rule 92 is
consistent with the requirements of the Act, and should maintain the
same level of protection for customer orders in an electronic
environment as exists today in a manual environment.
4. Communicating With the Specialist Algorithm
NYSE proposes to allow specialists to interact with the Specialist
Algorithms through a wired or wireless device that has been registered
with NYSE, such as a computer terminal or laptop, to activate or
deactivate a particular algorithm or adjust its parameters. NYSE also
proposes that specialist firms be required to create and maintain
records of all messages generated by the firms' wired or wireless
devices. The Commission believes that providing specialists with this
functionality would enhance their ability to function in an electronic
environment, and is consistent with the requirements of the Act. In
this regard, the Commission expects the Exchange to implement adequate
surveillance procedures and to engage in ongoing monitoring of the
wired and wireless devices to ensure that they are being used in a
manner consistent with the NYSE's rules, and the securities laws and
rules. NYSE is also requiring that specialists have an independent
third party auditor review on an annual basis the Specialist Algorithms
to ensure that they operate in accordance with all SEC and Exchange
rules, policies, and procedures. The Commission notes that the Exchange
has the responsibility under the Act to enforce compliance with the
Federal securities law and NYSE rules.\394\ The Commission expects NYSE
to review any reports, notes, analysis, documents and similar types of
materials from such independent auditing as part of the Exchange's
surveillance procedures.
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\394\ See also note and Sections 6(b)(1) of the Act, 15 U.S.C.
78f(b)(1), and 19(g)(1) of the Act, 15 U.S.C. 78s(g)(1).
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F. Changes to the Auction Market and New Order Types
As part of the Hybrid Market, the Exchange has also proposed to
modify its auction market. Specifically, the Exchange is proposing a
new order type--the AL order--and changes to the way market orders (AM
orders) are handled on the floor to accommodate investors who wish to
have their orders exposed for price improvement. Under the proposal, AL
orders and AM orders would be automatically executed when the Exchange
quotation is at the minimum variation of one cent. Otherwise, these
orders would be placed in the Display Book system for an opportunity to
receive a better price than the Exchange BBO. If an AL order or an AM
order has not been executed after 15 seconds, it would be automatically
executed at the prevailing bid or offer, provided that automatic
executions are available. In addition, certain events could cause an AL
order or an AM order to automatically execute prior to the 15-second
period.
NYSE's proposal to adopt the AL order and the AM order would offer
customers the option to seek price improvement for their orders in a
more rapidly-moving Hybrid Market. The Commission believes that these
features could improve execution quality for those customers who do not
seek an immediate execution, and generally increase the depth and
liquidity of NYSE's market. The Commission
[[Page 16383]]
believes the decision by NYSE to provide investors with the ability to
place AL and AM orders is within its discretion and consistent with the
requirements of the Act.
G. Intermarket Sweep Order
To implement the requirements of Rule 600(b)(30) of Regulation
NMS,\395\ the Exchange proposes to amend NYSE Rule 13 to adopt a new
order type--an Intermarket Sweep order. As proposed, an Intermarket
Sweep order would be a limit order designated for automatic execution
in a particular security that meets the following requirements: (1) It
is identified as an intermarket sweep in the manner prescribed by the
Exchange; and (2) simultaneously with the routing of the Intermarket
Sweep order to the Exchange, one or more additional limit orders, as
necessary, are routed to execute against the full displayed size of any
protected bids (offers) in the case of a limit order to sell (buy),
with a price that is superior to the limit price of the limit order
identified as an Intermarket Sweep order. These additional routed
orders must be identified as Intermarket Sweep orders. An Intermarket
Sweep order would be immediately and automatically executed against the
displayed bid (offer) up to its full size in accordance with and to the
extent provided by NYSE Rules 1000 through 1004, and would then sweep
the Display Book system, as provided in NYSE Rule 1000(d)(iii), with
the portion not so executed to be immediately and automatically
cancelled. The Commission believes that NYSE's proposed definition of
Intermarket Sweep order is designed, among other things, to meet the
requirements of Regulation NMS,\396\ and to perfect the mechanism of a
free and open market and a national market system and to protect
investors and the public interest, and thus, is consistent with the
requirements of the Act.
---------------------------------------------------------------------------
\395\ 17 CFR 242.600(b)(30).
\396\ An Intermarket Sweep order would allow market participants
to simultaneously route orders to multiple markets at multiple price
points. An Intermarket Sweep order is defined in Regulation NMS as
``a limit order for an NMS stock that meets the following
requirements: (i) When routed to a trading center, the limit order
is identified as an intermarket sweep order; and (ii) simultaneously
with the routing of the limit order identified as an intermarket
sweep order, one or more additional limit orders, as necessary, are
routed to execute against the full displayed size of any protected
bid, in the case of a limit order to sell, or the full displayed
size of any protected offer, in the case of a limit order to buy,
for the NMS stock with a price that is superior to the limit price
of the limit order identified as an intermarket sweep order. These
additional routed orders also must be marked as intermarket sweep
orders.'' See id.
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H. Implementation Plan
NYSE proposed to implement the Hybrid Market in four stages over a
period of months, to allow its members to familiarize themselves with
these functionalities and to perform tests on its systems. As noted
above, the Pilot implemented testing of the initial stage of the Hybrid
Market on a temporary basis. The Commission believes that the staggered
implementation would allow a gradual transition from the current
auction market model to the Hybrid Market.\397\ Further, the Commission
believes that the implementation plan would provide NYSE the
opportunity to test the changes to its systems. The Commission believes
that the proposed implementation plan is consistent with the
requirements of the Act. Due to the phased implementation of the Hybrid
Market, NYSE represented that it will provide Information Memoranda to
its members and update its online rulebook and Web site accordingly
during each phase. The Commission believes that the Information
Memoranda and web site updates should provide NYSE members with
reasonable notice of and clarification on which rules or portions
thereof will be effective during a particular implementation phase of
the Hybrid Market.
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\397\ If there is any delay in the implementation plan, the
Commission expects the Exchange to consider whether additional rule
changes would need to be filed with the Commission.
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I. Interpretive Issues
The Exchange has requested that the Commission extend its previous
approval of certain interpretations of NYSE rules as they relate to
automatic executions that occur with specialists pursuant to NYSE Rule
1001(a)(iv).\398\ Specifically, pursuant to NYSE Rule 1001(a)(iv),
specialists are required to take the contra side of an automatic
execution against the published quotation, even if the specialist's
interest was not part of such quotations. This requirement to take the
contra side of certain automatic executions may be inconsistent with
other NYSE rules or may lead to additional obligations by the
specialist. Accordingly, NYSE requested and the Commission approved the
following interpretations.
---------------------------------------------------------------------------
\398\ See note supra.
---------------------------------------------------------------------------
1. NYSE Rule 123A.40. The specialist would not be required to fill
any stop orders elected by the execution of an Auto Ex Order at the
price of the electing sale in any instance where the specialist was
required by NYSE Rule 1001(a)(iv) to take the contra side of the
automatic execution.
2. NYSE Rule 91. Because the specialist does not accept an Auto Ex
Order for execution or act as agent for such order, the transaction
confirmation requirements for NYSE Rule 91 would not apply in any
instance where the specialist is the contra party to an automatic
execution.
3. NYSE Rule 104. NYSE Rule 104 contains the specialist's
affirmative and negative obligations, and restricts the specialist's
ability to purchase stock on direct plus ticks or see on direct minus
ticks. The Exchange proposed that any instance in which the specialist
is effecting a direct tick transaction only because he or she has been
required to assume the contra side of an automatic execution pursuant
to NYSE Rule 1001(a)(iv) shall be deemed a ``neutral'' transaction for
purposes of NYSE Rule 104 and shall be deemed not a violation of the
rule. According to the Exchange, it believes this interpretation was
appropriate because the specialist is not setting the price, but is
simply being required to trade at a price set by other market
participants.
The Commission finds that these interpretations are consistent with
the requirements of the Act because they would allow the specialist to
provide liquidity in certain situations without triggering other rules
or obligations. As noted above, the Commission previously approved
these interpretations in the approval of Direct+.\399\ The Commission
believes that they should promote just and equitable principles of
trade and protect investors and the public interest because they should
assist in the execution of Auto Ex Orders.
---------------------------------------------------------------------------
\399\ See note 203 supra.
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V. Accelerated Approval of Amendment Nos. 6, 7, and 8
As set forth below, the Commission finds good cause to approve
Amendment Nos. 6, 7, and 8 to the proposed rule change, as amended,
prior to the thirtieth day after the amendments are published for
comment in the Federal Register pursuant to section 19(b)(2) of the
Act.
In Amendment No. 6, NYSE proposes to amend the rules that would
allow specialists to provide price improvement to incoming orders.
Specifically, NYSE proposed to reinstate the requirement that the
specialist be represented in the bid (offer) in order to provide price
improvement.\400\ In
[[Page 16384]]
Amendment No. 6, NYSE proposed to require specialists to be represented
in the bid (offer) in a ``meaningful amount,'' which it proposes to
define as a minimum of 1,000 shares for most securities. The Commission
notes that NYSE proposes to further amend this provision in Amendment
No. 8, as described below. Finally, the Exchange amended Rule 104 to
state that specialists may only provide price improvement to incoming
orders that are marketable.
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\400\ In the Second Notice, NYSE proposed to require specialists
to be represented in the bid (offer) by the lesser of 10,000 shares
or twenty percent of the size of the market on the side which the
transaction would take place. In the Third Notice, NYSE proposed to
eliminate this requirement to be represented in the bid (offer).
---------------------------------------------------------------------------
The Commission finds good cause to accelerate approval of these
changes prior to the thirtieth day after publication in the Federal
Register. The Commission finds that prohibiting specialists from
providing price improvement to non-marketable orders should provide
investors with more current information regarding the prices at which
other investors are willing to trade.
In Amendment No. 6, NYSE also proposes to limit the ability of
interest in the floor broker agency interest file to trade on parity
with orders on the Book outside of the Exchange BBO. Specifically,
floor brokers would be required to designate the size that it would
display should a price outside of the BBO move to the BBO. The size
designated for display would be permitted to trade on parity with
orders on the Book during a sweep at the clean-up price. The size
designated to be placed in reserve (i.e., remain undisplayed) would
yield to displayed interest.
The Commission finds good cause to accelerate approval of this
change prior to the thirtieth day after publication in the Federal
Register because the proposed change limits the ability of undisplayed
interest to trade with displayed interest, which should enhance the
execution of orders displayed on the Book, and may provide incentives
to floor brokers to increase the size of interest eligible for display.
In Amendment No. 7, NYSE proposes to modify to its proposed changes
to its Rule 92. Specifically, NYSE proposes to define when a specialist
has knowledge for purposes of the rule in the context of the Specialist
Algorithm. Specifically, a specialist would not be deemed to have
knowledge of an order that is received while the Specialist Algorithm
is transmitting a quoting or trading message based on the knowledge of
an earlier order, if the Specialist Algorithm is designed and operated
in a manner that prevents a quoting or trading message from being
affected by the knowledge of the later order.
The Commission finds good cause to accelerate approval of this
change prior to the thirtieth day after publication in the Federal
Register because it better defines the scope of knowledge for purposes
of the Specialist Algorithm. The Commission believes that the change is
narrowly tailored to this specific circumstance to ensure that
specialists cannot trade for their own accounts when they have
knowledge of an order.
In addition, NYSE proposes to amend its Rule 13.30 and the
definition of stop orders to reflect that elected stop orders in the
Display Book system would be eligible for automatic execution in
Direct+.\401\ This change conforms NYSE's Hybrid Market proposal to
changes proposed by NYSE in an earlier filing.\402\ Accordingly, the
Commission finds good cause to accelerate approval of this change
because it updates NYSE's proposal to make it consistent with
previously filed rule changes. Finally, NYSE proposes to amend its rule
text to correct typographical errors, reflect other rule changes that
have been approved by the Commission, and further clarify its rules.
For example, NYSE modified its definition of All or None Order in its
Rule 13 to reflect current NYSE rule text, amended other definitions to
reflect new citations to Regulation NMS, and amended NYSE Rule 60(e) to
clarify that Autoquote will automatically update the NYSE BBO to
reflect floor broker agency interest and specialist interest as well as
non-marketable limit orders. The Commission finds good cause to
accelerate approval of these changes prior to the thirtieth day after
publication in the Federal Register because they better clarify the
NYSE's rules, which should assist members' ability to comply with their
requirements, and assist investors in understanding their application
and scope.
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\401\ The Commission notes that NYSE proposed further changes to
these rules and NYSE Rule 76 regarding stop orders in Amendment No.
8.
\402\ See Securities Exchange Act Release No. 52362 (August 30,
2005), 70 FR 53701 (September 9, 2005).
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Finally, in Amendment No. 8, NYSE proposes to: (1) Amend proposed
NYSE Rules 13 and 124 to specify that a round lot portion of a PRL
order is an Auto Ex Order and that the odd lot portion of a PRL order
would be executed in the Odd Lot Execution System at the same price as
the round lot portion of the PRL; (2) amend proposed NYSE Rule 13 to
reflect that stop orders and stop limit orders may still be represented
manually by a floor broker in the Crowd; (3) amend the definition of
IOC order in proposed NYSE Rule 13 to: (a) Propose an IOC order that is
designed to be in compliance with Regulation NMS; (b) specify that NYSE
IOC orders would be eligible to be routed away during a sweep; and (c)
eliminate the previously proposed changes to the treatment of ITS
Commitments; \403\ (4) amend the definition of Intermarket Sweep order
in proposed NYSE Rule 13 to permit such order to sweep the Display Book
system and then immediately cancel any portion remaining unexecuted;
(5) amend proposed NYSE Rule 36 to state that a specialist may only use
a wired or wireless device that has been registered with the Exchange
to communicate with the Specialist Algorithms and provide that
specialist firms must create and maintain records of all messages
generated by the Specialist Algorithm; (6) amend proposed NYSE Rule 60
to: (a) Set forth the instances during which Autoquote will update the
quote even if automatic executions are not available; (b) set forth the
instances during which Autoquote will update the quote when Autoquote
and automatic execution are suspended and disseminate a 100 share quote
in certain situations; and (c) propose to use an indicator when the
NYSE quote is not available for automatic execution due to a gapped
quotation or LRP to signify that the NYSE quote is not firm; (7) amend
proposed NYSE Rule 70.20 to: (a) Permit a floor broker to leave the
Crowd without canceling its floor broker agency interest file to
recharge its handheld device and (b) specify the procedures for
entering interest in the floor broker agency interest file before the
open; (8) amend proposed NYSE Rule 72 to specify the priority and
parity rules for instances when there are shares remaining after a
sweep that triggers an LRP; (9) amend NYSE Rule 76 to reflect that it
would not apply to elected stop or stop limit orders other than those
manually represented in the Crowd by a floor broker; (10) amend
proposed NYSE Rule 104 to: (a) Permit specialists to manually layer
proprietary interest in the specialist interest file; (b) permit
specialists to enter certain quoting messages when automatic executions
and Autoquote are suspended; (c) amend the definition of ``meaningful
amount'' for purposes of determining when a specialist could provide
price improvement; and (d) require specialists to hire independent
auditors to review their algorithms on an annual basis; (11) amend
proposed NYSE Rule 123A.30 to: (a) Provide
[[Page 16385]]
systematic conversion of CAP-DI orders on the same side as a specialist
when the specialist is bidding (offering) or trading and an automatic
execution occurs against the specialist's proprietary interest and (b)
clarify the execution of contra-side elected and converted CAP-DI
orders; (12) amend proposed NYSE Rule 123F to codify that NYSE may
execute an AL order or AM order at a price that matches a better away
market; (13) amend proposed NYSE Rule 1000 to: (a) Clarify that
automatic executions will resume in the same manner as Autoquote; (b)
prohibit short sale orders, except those for Regulation SHO pilot
securities, from sweeping the Display Book system; (c) eliminate the
provision that would have suspended the operation of Direct+ when an
away market disseminates a better quote; (d) eliminate the proposal
that would have permitted automatic executions to continue while the
specialist reports a block trade until the quote decremented to 100
shares; (e) specify the process for determining when a high-priced
security would be eligible for automatic executions; (f) specify that
automatic executions would be suspended on one side of the market when
a bid (offer) is outside the MLRP; (g) specify that any shares
remaining after an execution in IOC orders, NYSE IOC orders, or
Intermarket Sweep orders would be cancelled after sweeping the Display
Book system; and (h) clarify that auto ex limit orders, except IOC
orders, that are not able to be immediately executed due to a
suspension of Direct+ would be placed in the Book; and (14) amend Rule
1001.
---------------------------------------------------------------------------
\403\ See also note 22 supra.
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The Commission finds good cause to accelerate approval of these
changes prior to the thirtieth day after publication in the Federal
Register for the reasons discussed below. The Commission notes that
many of the changes proposed in Amendment No. 8 were previously
disclosed in earlier amendments and notices and the Pilot. The
Exchange, in Amendment No. 8, merely proposes to codify these
requirements in its rules, which the Commission believes should ensure
that market participants are fully apprised on how the Hybrid Market
would operate and ensure that NYSE rules are complete. Specifically,
NYSE proposes the following changes, which were published in one of the
three Hybrid Market notices or the Pilot.
1. NYSE proposes to amend proposed NYSE Rules 13 and 124 to reflect
the execution of PRL orders, which was discussed in both the Second and
Third Notices. In the Second Notice, NYSE proposed to amend NYSE Rule
124 to reflect that the round lot portion of a PRL order would be
automatically executed in Direct+. In Amendment No. 8, NYSE proposes to
make a conforming change to NYSE Rule 13. In the Third Notice, NYSE
represented that the odd lot portions of PRL orders would be executed
in the Odd-Lot Execution System. In Amendment No. 8, NYSE proposes to
reflect this language in its Rule 124 and to state that the odd lot
portion of a PRL would be executed at the same price as the round lot
portion.
2. NYSE proposes to amend its Rules 60(e)(iv)(a) and 1000(c) to
specify that when the NYSE bid (offer) is outside the MLRP range and
such MLRP has not yet been reached, automatic executions on that side
of the market would not be available but Autoquote would remain active.
NYSE discussed this aspect of the Hybrid Market in its Third Notice.
3. NYSE proposes to add language to its Rule 1000(b) to provide
that automatic executions would resume in the same manner as Autoquote
as set forth in proposed NYSE Rule 60(e). This process was discussed in
the Second Notice.
4. NYSE proposes to specify in its Rule 70.20(j) that a floor
broker may enter interest in its floor broker agency interest file
prior to the open regardless of its location on the floor. The floor
broker, however, must be in the Crowd at the open in order to
participate. NYSE discussed this provision in the Third Notice.
5. NYSE proposes to amend its Rule 123F to codify that NYSE may
execute an AL order or AM order at a price that matches a better away
market. NYSE originally proposed this function in the Third Notice.
6. NYSE proposes to amend NYSE Rule 1000 to provide that short sale
orders must comply with Commission Rule 10a-1 and Exchange Rule 440B,
which would prohibit short sale orders, other than orders for those
securities included in the Regulation SHO pilot, from sweeping the
Display Book system. The NYSE proposed this restriction in the Second
Notice.
7. Proposed NYSE Rule 13--Stop and Stop Limit Orders. In Amendment
No. 8, NYSE proposes to permit floor brokers to continue to represent
stop and stop limit orders in the Crowd. NYSE originally proposed this
change in the Pilot. The Commission finds good cause to accelerate
approval of this change because it could provide investors with an
additional means to have their orders represented on NYSE and is
consistent with NYSE's current rule.
8. NYSE proposes to amend its Rule 104 to allow specialists to
manually place interest in the specialist interest file to ensure that
the specialist would be able to place its interest in the Display Book
system if its algorithm is not operating. NYSE originally proposed this
provision in the Pilot. The Commission finds good cause to accelerate
approval of this change because it should ensure that specialists can
continue to participate in the Hybrid Market and fulfill their
obligations to maintain a fair and orderly market.
9. NYSE proposes to amend NYSE Rule 76 to provide that its
requirements would not apply to elected stop or stop limit orders other
than those represented in the Crowd. NYSE originally proposed this
change in the Pilot. The Commission finds good cause to accelerate
approval of this change because it reflects the change NYSE proposes
with regard to the automatic execution of elected stop and stop limit
orders in the Display Book system.
The Commission also finds good cause to accelerate approval of the
other changes proposed in Amendment No. 8 for the reasons discussed
below.
10. Proposed NYSE Rule 13. Definition of IOC. In Amendment No. 8,
NYSE proposes to amend its definition of IOC order. As originally
proposed, NYSE defined two types of IOC orders--one that would sweep
the Display Book system after trading with interest at the BBO and
could be routed to away markets if such away market is displaying a
better price (this order would now be called a NYSE IOC order), and ITS
Commitments that would only trade with interest displayed at the BBO.
In Amendment No. 8, NYSE proposes to remove its proposed changes
relating to ITS Commitments because its current rule needs to remain in
effect in order to comply with the provisions of the ITS Plan.\404\
NYSE also proposes to allow another type of IOC order to be entered on
the Exchange for purposes of Regulation NMS. This type of IOC order
would be permitted to sweep the Display Book system but would not be
routed to away markets if such away market displays a price better than
the NYSE BBO or sweep clean up price. In such circumstances, the IOC
order (or residual if a portion is executed at the NYSE BBO) would be
cancelled. The Commission finds good cause to accelerate approval of
this change because it would provide investors with a means to
immediately access NYSE liquidity without relying on NYSE to access
away markets' liquidity, and is
[[Page 16386]]
designed to be consistent with Regulation NMS.
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\404\ See also note 22 supra.
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11. Proposed NYSE Rule 13. Definition of Intermarket Sweep Order.
In Amendment No. 8, NYSE proposes to amend its definition of
Intermarket Sweep Order to provide that this type of order may sweep
the Display Book system but would not be routed to away markets that
display a better quote. In such circumstances, the Intermarket Sweep
would be cancelled. The Commission finds good cause to accelerate
approval of this change because it is designed to be consistent with
Regulation NMS.
12. Proposed NYSE Rule 36. In Amendment No. 8, NYSE proposes to
amend its Rule 36 relating to the means by which specialists on the
floor can communicate with their Specialist Algorithms. NYSE had
originally proposed language to amend its Rule 36 in the Third Notice.
In Amendment No. 8, NYSE limits the types of communications that may be
transmitted over a wired or wireless device and limits where the
communications can be sent to ensure that these communications are
consistent with NYSE's current telephone policy. The Commission finds
good cause to accelerate approval of this change because it allows NYSE
to control the ability of specialists on the floor to communicate off
the floor. NYSE also proposes that specialist firms create and maintain
records of all messages generated by the firms' wired or wireless
devices. The Commission finds good cause to accelerate approval of this
requirement because it codifies in the rules the specialist firms'
recordkeeping obligations to comply with Exchange and SEC rules.
13. Proposed NYSE Rule 60. In Amendment No. 8, the NYSE proposes
several changes. First, NYSE proposes to identify quotations that are
disseminated when automatic executions and Autoquote are suspended by a
LRP or gapped quotation as non-firm. The Commission finds good cause to
accelerate approval of this change because it will provide investors
with more accurate information about the state of the NYSE quotation.
Next, NYSE proposes to update the quote in high-priced securities even
though automatic executions are not available. First, NYSE would keep
Autoquote active when an order or a cancellation of an order arrives
that would not result in a locked or crossed market in a high-priced
security or a manual execution takes place in such security. Second, if
there is a cancellation of the Exchange best bid (offer) in a high-
priced security when the market in such security is internally locked
or crossed, and autoquoting of the next best bid (offer) would create a
locked or crossed market on the Exchange, NYSE would automatically
generate a quote of 100 shares at the bid (offer) price that existed at
the time of the cancellation. The Commission finds good cause to
accelerate approval of this change because it would provide investors
with additional quotation data in high-priced securities. Finally, the
Exchange proposes to update its quote in the following situations even
though Autoquote is suspended due to an LRP or a gapped quotation, and
automatic executions are not available: (1) If part of the existing
Exchange best bid (offer) cancels, the Exchange would use Autoquote to
update its quote to reflect the remaining volume; (2) if the entire
existing Exchange best bid (offer) cancels, the Exchange would
automatically generate a quote of 100 shares at the bid (offer) price
that existed at the time of the cancellation; or (3) if there is a
cancellation of the Exchange best bid (offer) when the market is
internally locked or crossed, and autoquoting of the next best bid
(offer) would create a locked or crossed market on the Exchange, NYSE
would automatically generate a quote of 100 shares at the bid (offer)
price that existed at the time of the cancellation. The Commission
finds good cause to accelerate approval of this change because it would
provide investors with additional quotation data during the time when
Autoquote and automatic executions are otherwise suspended and would
alert investors that a previously disseminated quotation had been
cancelled.
14. Proposed NYSE Rule 70.20. NYSE proposes to permit floor brokers
to leave the Crowd for short periods of time to recharge their handheld
devices. The Commission finds good cause to accelerate approval of this
change because it reflects a reasonable accommodation to allow floor
brokers to ensure that their equipment is operable while permitting
them to continue to represent their customers.
15. Proposed NYSE Rule 72. In Amendment No. 8, NYSE proposes to
specify the priority and parity of residual shares when a LRP has been
triggered. The Commission finds good cause to accelerate approval of
this change because it provides specificity to the execution of orders
during these limited situations and is generally consistent with the
Exchange's current rules.
16. Proposed NYSE Rule 104. In Amendment No. 8, NYSE proposes to
make several changes to its Rule 104. First, NYSE proposes to amend
what it would consider to be a ``meaningful amount'' of shares that a
specialist must be represented in the BBO for purposes to determining
when a specialist can provide price improvement to an incoming order.
Specifically, NYSE proposes to define a ``meaningful amount'' as at
least 1,000 shares for the 100 most active securities on the Exchange,
based on the average daily volume, and at least 500 shares for all
other securities. NYSE would disseminate, at least quarterly, the list
of the 100 most active securities. In Amendment No. 8, NYSE proposes to
set the minimum number of shares for all securities rather than its
previous proposal, which was not specific as to all securities. The
Commission believes that having the minimums set forth in the rule for
all securities should ensure that specialists can comply with the
rule's requirements and ensure that all market participants are aware
of the instances when a specialist would be allowed to price improve
incoming marketable orders. Accordingly, the Commission finds good
cause to accelerate approval of this change. Second, NYSE proposes to
permit specialists to enter certain quoting messages when automatic
executions and Autoquote are suspended. Specifically, specialists would
be permitted to enter quotes that are outside of the Exchange's BBO,
and manually enter quotes at prices that are within a previously-
established locking or crossing quotation. The Commission finds good
cause to accelerate approval of this change because it could enable
specialists to add liquidity in preparation for the after-market and
assist specialists in satisfying their obligation to make markets with
appropriate depth and price continuity. Finally, NYSE proposes to
require specialists to hire independent third party auditors to review
their algorithms on an annual basis to ensure that the algorithms are
operating in accordance with Federal securities laws and NYSE rules.
The Commission finds good cause to accelerate approval of this change
because it could assist specialists and the Exchange in monitoring the
operation of the Specialist Algorithms.\405\
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\405\ See Section IV(E)(4), supra.
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17. Proposed NYSE 123A.30. In Amendment No. 8, NYSE proposes to
provide for the systematic conversion of marketable CAP-DI orders on
the same side as a specialist when a specialist quotes or trades and an
automatic execution occurs against the specialist's
[[Page 16387]]
proprietary interest. The Commission finds good cause to accelerate
approval of this change because it should ensure the proper execution
of CAP-DI orders when the specialist is trading. In addition, NYSE
added language to its rule to specify the manner of execution of
contra-side elected and converted CAP-DI orders when an automatic
execution occurs against the Exchange BBO and when an Auto Ex Order
sweeps the Display Book system. The Commission finds good cause to
accelerate approval of this change because it clarifies in the NYSE
rules how executions of contra-side CAP-DI orders occur.
18. Proposed NYSE Rule 1000. In Amendment No. 8, NYSE proposes to
make several changes to its Rule 1000. First, NYSE proposes to
eliminate the provision that would have suspended automatic executions
when another market disseminated a better quotation. The Commission
finds good cause to accelerate approval of this change because this
provision was inconsistent with NYSE's proposal to immediately route
orders to markets that display quotes better than NYSE's displayed
quote. Second, NYSE is eliminating its proposal to allow automatic
executions to continue while the specialist manually reports a block
trade that involves orders on the Display Book system until the NYSE
quote decremented to 100 shares. NYSE proposes to suspend automatic
executions as soon as the reporting of the block transaction begins.
The Commission finds good cause to accelerate approval of this change
because when the specialist manually reports a block trade that
involves orders on the Display Book system, the NYSE quotation is not
updated to reflect new quotations, orders, or cancellations. Since the
NYSE quote that is disseminated when a block trade that involves orders
on the Display Book system is manually reported may not reflect the
current state of the market, the Commission believes it is appropriate
in that situation for the Exchange to discontinue automatic executions.
Third, NYSE proposes to amend the process for determining when a high-
priced security would be eligible for automatic execution.
Specifically, NYSE proposes to look at the closing price of a security
(or if the security did not trade during the day, then the closing
bid), and if the closing price/closing bid is $300.00 or more, then
automatic executions would not be available on the next trading day on
either side of the market. The Commission finds good cause to
accelerate approval of this change because it better defines the
process by which NYSE would determine the availability of automatic
executions for high-priced securities. Fourth, NYSE proposes to specify
in its rule that any shares remaining after the execution of an IOC,
NYSE IOC or Intermarket Sweep order would be cancelled. The Commission
finds good cause to accelerate approval of this change because it
codifies the handling of these types of orders in the NYSE rules.
Fifth, NYSE proposes to amend NYSE Rule 1000 to clarify that certain
Auto Ex Orders that are not able to be automatically executed due to
the suspension of automatic executions would be placed on the Book. The
Commission finds good cause to accelerate approval of this change
because it provides specificity in NYSE rules regarding how orders
would be handled.
19. Proposed NYSE Rule 1001. In Amendment No. 8, NYSE proposes to
eliminate language that it had originally proposed in its Rule 1001(iv)
to clarify instead in NYSE Rule 70.20(f) that the floor broker would be
held to all executions involving its agency interest files, including
interest that the floor broker does not cancel when leaving the Crowd.
The Commission finds good cause to accelerate approval of this change
because floor brokers would be responsible for executions against
interest in their files and would be responsible for ensuring that
their files reflect accurate information. Accordingly, there is no need
for the additional language originally proposed by NYSE to Rule
1001(iv).
VI. Solicitation of Comments on Amendment Nos. 6, 7, and 8
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 6, 7, and 8, including whether such
amendments are 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-2004-05 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-2004-05. 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. Copies of such
filing also will be available for inspection and copying at the
principal office of the Exchange. 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-2004-05 and should be submitted on or before April
21, 2006.
VII. Conclusion
For the foregoing reasons, the Commission finds that the proposed
rule change, as amended, is consistent with the Act and the rules and
regulations thereunder applicable to a national securities exchange,
and, in particular, with sections 6(b)(5) of the Act \406\ and 6(b)(8)
of the Act.\407\
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\406\ 15 U.S.C. 78f(b)(5).
\407\ 15 U.S.C. 78f(b)(8).
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It Is Therefore Ordered, pursuant to section 19(b)(2) of the
Act,\408\ that the proposed rule change (SR-NYSE-2004-05) and Amendment
Nos. 1, 2, 3, and 5 are approved, and that Amendment Nos. 6, 7, and 8
thereto are approved on an accelerated basis.
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\408\ 15 U.S.C. 78s(b)(2).
By the Commission.
Nancy M. Morris,
Secretary.
[FR Doc. 06-3012 Filed 3-30-06; 8:45 am]
BILLING CODE 8010-01-P