[Federal Register Volume 60, Number 194 (Friday, October 6, 1995)] [Notices] [Pages 52436-52438] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 95-24908] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-36324; File No. SR-CSE-95-07] Self-Regulatory Organizations; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change by the Cincinnati Stock Exchange, Inc., Relating to the Preferencing of Public Agency Market and Marketable Limit Orders by Approved Dealers and Other Proprietary Members September 29, 1995. I. Introduction Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that on September 22, 1995, the Cincinnati Stock Exchange, Inc. (``CSE'' or ``Exchange'') filed with the Securities and Exchange Commission (``Commission'') the proposed rule change, and on September 28, 1995, Amendment No. 1 thereto,\3\ as described in Items II and III below, which Items have been prepared by the self-regulatory organization. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. \1\ 15 U.S.C. 78s(b)(1) (1988). \2\ 17 CFR 240.19b-4 (1994). \3\ See letter from Robert Ackerman, Vice President, CSE, to Sharon Lawson, Senior Special Counsel, SEC, dated September 28, 1995. Amendment No. 1 amended the request for an extension through June 28, 1996, to an extension through March 29, 1996. --------------------------------------------------------------------------- II. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change The CSE hereby proposes to extend the CSE's pilot program regarding preferencing until March 29, 1996. The pilot was initially approved by the Commission on February 7, 1991, and is currently extended until October 2, 1995. III. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the self-regulatory organization included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The self-regulatory organization has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The purpose of the rule filing is to extend the existing pilot program of the Exchange relating to the preferencing of public agency market and marketable limit orders by approved dealers and other proprietary members. The Commission originally approved the pilot on February 7, 1991.\4\ The Commission has subsequently extended the pilot several times.\5\ The Exchange now seeks an extension of the program until March 29, 1996. \4\ See Securities Exchange Act Release No. 28866 (February 7, 1991), 56 FR 5854 (February 13, 1991). \5\ See Securities Exchange Act Release Nos. 29524 (August 5, 1991), 56 FR 38160 (August 5, 1991); 30353 (February 7, 1992), 57 FR 5918 (February 18, 1992); 31011 (Aug. 7, 1992), 57 FR 38704 (August 26, 1992); 32280 (May 7, 1993), 58 FR 28422 (May 13, 1993); 33975 (April 28, 1994), 59 FR 23243 (May 5, 1994); 34493 (August 5, 1994), 59 FR 41531 (August 12, 1994); 35717 (May 15, 1995), 60 FR 26909 (May 19, 1995). --------------------------------------------------------------------------- 2. Statutory Basis The exchange believes that the proposed rule change is consistent with Section 6(b) of the Act in general and furthers the objectives of Section 6(b)(5) in particular in that it will promote just and equitable principles of trade and remove impediments to and perfect the mechanisms of a free and open market and a national market system. B. Self-Regulatory Organization's Statement on Burden on Competition The CSE does not believe that the proposed rule change will impose any inappropriate burden on competition. C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others The CSE informed the other Intermarket Trading System (``ITS'') participants of its intention to file this proposal to extend the preferencing pilot through March 29, 1996. The CSE previously solicited comments from other participants on its request for permanent approval.\6\ The proposed extension would continue the program under the same terms and conditions as the existing pilot that was previously commented upon. \6\ See infra note 14. --------------------------------------------------------------------------- IV. Solicitation of Comments Interested persons are invited to submit written data, views and arguments concerning the foregoing. Persons making written submissions [[Page 52437]] should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street NW., Washington, D.C. 20549. 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. Sec. 552, will be available for inspection and copying at the Commission's Public Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of such filing will also be available for inspection and copying at the principal office of the CSE. All submissions should refer to File No. SR-CSE-95-07 and should be submitted by [insert date 21 days from date of publication]. V. Commission's Findings and Order Granting Accelerated Approval of Proposed Rule Change A. Description The CSE is an electronic exchange that uses multiple competing dealers rather than a single specialist. CSE members transmit orders, make markets, and receive executions and reports through remote terminals or computer interfaces from around the country. The preferencing program permits CSE dealers to retain and execute their internal order flow at the prevailing ITS best bid or offer (``ITS/ BBO''), provided that there are no public agency limit orders on the CSE's National Securities Trading System (``NSTS'') limit order book at that price or better. To this end, the preferencing program permits CSE dealers to internalize order flow by eliminating price and time priority between CSE dealers, thereby enabling preferencing dealers to interact with public market and marketable limit orders they represent as agent Specifically, the preferencing program gives preferencing dealers priority over same-priced (or superior-priced) professional agency or principal orders entered prior in time when interacting with a public order it represents as agent.\7\ The dealer may interact with such orders either by (1) taking the contra-side position on the trade as principal (``paired order trade''), or (2) crossing the order with another customer order it represents as agent (``agency cross'').\8\ \7\ See CSE Rule 11.9(u). \8\ The majority of agency crosses are the result of a limit order resident in the dealer's proprietary system at the ITS/BBO, which is matched with an incoming contra-side market order. For example, it the market is 20 bid--20\1/8\ asked, and a dealer has a limit order to buy at 20, an incoming market sell order will be matched with that limit order because the dealer may not trade for its own account ahead of its own customer limit order. See CSE Rule 12.6(b). --------------------------------------------------------------------------- By way of example, if dealer A on the CSE is quoting at the ITS/ BBO, dealer B can still internalize its order flow (even if he is not quoting at the ITS/BBO so long as dealer B executes the order at the ITS/BBO (or better) and there is no contra-side public agency order in NSTS at that price. If there is a public agency limit order in NSTS with priority, however, NSTS will automatically break the cross and match the incoming public agency order with the public limit order on the CSE book. The system rejects the CSE dealer's principal side of the attempted cross or, in the case of an attempted public agency cross, rejects the agency order required to yield priority to the order that was on the NSTS book. In approving the initial preferencing program pilot, and subsequent extensions and expansions, the Commission imposed certain limitations and requirements on its operation. These conditions limit the number of issues in which a preferencing dealer may be registered to 350; require the Exchange to provide certain information to the Commission; prohibit preferenced trading for index arbitrage purposes when certain ``circuit breakers'' are in effect;\9\ and prohibit a dealer from making cash payments for order flow that it preferences to itself. \9\ Specifically, the index arbitrage restriction permits preferencing dealers to preference their customer order flow that is related to index arbitrage only on plus or zero plus ticks when the Dow Jones Industrial Average (``DJIA'') declines by fifty points or more from the previous day's closing value. See Securities Exchange Act Release No. 28866, supra note 4. --------------------------------------------------------------------------- The CSE proposes to extend the preferencing program pilot through March 29, 1996. B. Discussion After considering carefully the data and comments received on the CSE's preferencing program, the Commission finds that the CSE's proposal to extend its preferencing pilot program to March 29, 1996, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange. Specifically, the Commission finds that the proposed rule change is consistent with Section 6(b)(5) of the Act,\10\ which requires that the rules of an exchange be designed to promote just and equitable principles of trade, prevent fraudulent and manipulative acts, remove impediments to and perfect the mechanism of a free and open market and a national market system (``NMS''), and in general, to protect investors and the public interest. \10\ 15 U.S.C. Sec. 78f(b)(5) (1988). --------------------------------------------------------------------------- In its August 1994 order extending the preferencing program,\11\ the commission expressed concerns regarding what impact preferencing might have on the quality of the CSE market and the national market system. The Commission enumerated six reporting requirements to be submitted quarterly in order to facilitate evaluation of the CSE's preferencing program. In addition, the Commission required the CSE to submit an analysis detailing how the preferencing program has affected the quality of the CSE's market, including its effect on quote competition, market transparency, depth and liquidity, and improved quotations.\12\ Specifically, the Commission instructed the CSE to analyze the effects of the preferencing program on the quality of market making by CSE preferencing dealers, and demonstrate that the preferencing program has resulted in added depth and liquidity to its market and improved quotations. The CSE subsequently filed interim reports with the Commission and submitted its pilot analysis.\13\ \11\ See Securities Exchange Act Release No. 34493, supra note 5. \12\ See id. \13\ See letters from David Colker, Executive Vice President and Chief Operating Officer, CSE, to Arthur Levitt, Chairman, SEC, dated January 18, 1995 (``January Report''), and to Jonathan Katz, SEC, dated June 14, 1995 (``June Report'') (available to the public in File No. SR-CSE-95-03). --------------------------------------------------------------------------- The data provided by the CSE attempts to prove that the Exchange's preferencing dealers add to the national market system because, among other things, (1) the average spread of CSE quotes in issues that have only preferencing dealers is \1/4\ point, which is narrower than any other regional exchange for these securities; (2) preferencing dealers are responsible for generating 4% of all quotes that establish a new ITS/BBO, more than twice the percentage of CSE's market share in NYSE- listed stocks; (3) preferencing dealers account for 46% of all ITS inbound orders in those issues that have both preferencing dealers and non-preferencing dealers; and (4) preferencing dealers execute approximately 62% of their orders between the ITS/BBO when the spread is greater the \1/8\ point. The Commission received several comment letters on the CSE proposal to adopt permanently the preferencing [[Page 52438]] pilot, many of which challenged the CSE's statistics.\14\ Some of the commenters proffered statistics to support their contention that the CSE merely serves as a means for firms to internalize order flow. Among other things, commenters alleged that (1) over 94% of preferencing dealers' executions are paired order trades; (2) only 4.8% of CSE trades can be characterized as trades between CSE dealers; and (3) CSE quotes are inaccessible to other ITS participants. \14\ The Commission received negative comment letters from, among others, the New York Stock Exchange, American Stock Exchange, and Boston Stock Exchange. These and other correspondence received regarding the CSE's request for permanent approval of the pilot program are available to the public in File No. SR-CSE-95-03. --------------------------------------------------------------------------- The Commission has examined the data provided by the CSE and commenters and believes it would be useful to analyze additional data before making a definitive determination on the pilot. To allow further evaluation of the market structure implications of permanently approving the CSE's preferencing program, the Commission requests that the CSE continue to submit the quarterly reports described in the Commission's previous orders approving extensions of the pilot. The Commission also will collect relevant data on its own to evaluate the pilot. More importantly, the Commission is interested in exploring whether broader market structure initiatives can address the commenters' concerns regarding order interaction and the effects of preferencing on the NMS in general, and on order execution quality in particular. In this regard, the Commission recently proposed rules that attempt to address, among other things, the order interaction and best execution issues presented by preferencing of order flow.\15\ Extension of the CSE pilot will allow the Commission an opportunity to study the implications of the proposals for the CSE's preferencing pilot during the pendency of the rulemaking process. \15\ See Securities Exchange Act Release No. 36310 (September 29, 1995). --------------------------------------------------------------------------- The Commission finds good cause for approving the proposed rule change, as amended, prior to the thirtieth day after the date of publication of notice of filing thereof in the Federal Register. The Commission believes that accelerated approval of the proposal is appropriate in order to avoid an interruption to the existing pilot while the Commission continues to collect data and consider broader market structure rules to address internalization. VI. Conclusion It Is Therefore Ordered, pursuant to Section 19(b)(2)\16\ that the proposed rule change, as amended, is hereby approved on an accelerated basis, and the preferencing pilot is extended through March 29, 1996. \16\ 15 U.S.C. Sec. 78s(b)(2) (1988). --------------------------------------------------------------------------- By the Commission. Jonathan G. Katz, Secretary. [FR Doc. 95-24908 Filed 10-5-95; 8:45 am] BILLING CODE 8010-01-M