May 10, 2000
Jonathan G. Katz
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0601
Re: Commission File No. 4-430
Dear Mr. Katz:
This is in response to the Commission's order, dated April 13, 2000 ("Order"), staying the deadlines for decimal pricing implementation and requesting comments on two alternative decimal implementation proposals.1
Following are the Exchange's responses to questions posed in the Order.
Is it feasible to begin Dual Pricing by September 4, 2000? If it is feasible, should trading in all exchange-listed securities be in nickel or penny increments? If it is not feasible to begin Dual Pricing by September 4, 2000, why not?
As previously stated in my March 20, 2000 letter to Chairman Levitt, the Philadelphia Stock Exchange ("Exchange" or "PHLX") has been preparing for a phased-in approach to decimal trading, as recommended by the Securities Industry Association ("SIA"), and therefore would be able to trade listed equities (and options on those equities) in decimals and trade options on Nasdaq securities in fractions.2
The Exchange strongly believes that a Dual Pricing approach, as defined in the Order (the trading of exchange-listed stocks in decimals and Nasdaq stocks in fractions across all markets and without a controlled phase-in period), should not be implemented on September 4, 2000. Phlx believes that this approach would likely lead to investor confusion, require additional financial expenditure by the Exchange, increase the chance of errors and rejected orders, overwhelm the options consolidated quote and trade reporting systems, and generally undermine the confidence of the investing public in our financial institutions. The Exchange is also of the view that Dual Pricing could severely impair the capacity of the industry to identify and correct any problems. For example, one of the first industry-wide actions when converting to decimals would be for the exchanges and their member firms to convert all open orders over a weekend and compare the results. Any problems would have to be addressed and corrected on the trading day following the conversion, and, with the onslaught of decimal trading in listed options across all markets, could cause a market stoppage while exchanges and firms go through the process of correcting problems.
A further Exchange concern is that commencing decimal pricing for all listed securities at the same time, without a phase-in and evaluation period, could overwhelm the ability of the Options Price Reporting Association's ("OPRA") system to handle the increase in message traffic caused by decimal trading. The Securities Industry Automation Corporation ("SIAC"), the entity through which all options messages are routed on behalf of OPRA, has indicated that its capacity through the year 2001 is 12,000 Messages Per Second ("MPS"). On the other hand, the SRI Consulting ("SRI") presentation regarding mitigating options message traffic that was given to the Commission on December 14, 1999 projected that, if equities and options on those equities trade in penny increments, by the end of the year 2000, options messages will increase to 24,000 MPS, and by the end of year 2001, they will increase to 38,000 MPS.
SRI has proposed several alternatives that could reduce options message traffic, although to date, none have been implemented on an industry-wide basis. The Exchange has taken the lead in employing one of the primary mitigation strategies that SRI identified: de-listing of inactive issues. From July 1999 through February 2000, the Exchange has de-listed more issues than any other options exchange over the same time period. The Exchange is concerned that, if mitigation strategies are not effectively employed by the options industry, and the SRI projections prove to be accurate, the introduction on September 4 of decimal pricing in all listed securities could result in severe queuing of options quotes, with the public receiving stale, and largely ineffectual, quotes. The problem will likely be exacerbated with the addition of Nasdaq issues in 2001.
What, if any, systems changes or other steps would be necessary to implement Dual Pricing by this September 4, 2000 deadline? What types of changes would need to be made to the systems of securities firms, investment companies, and vendors? What would be the impact on system capacity? In light of your answers to the foregoing questions, what changes would need to be made to the current decimals testing schedule?
The Exchange has designed its systems to allow an equity issue or an option issue to quote and trade in either fractions or in decimals on any particular day. No further system changes would be required to support exchange-listed issues trading in decimals and Nasdaq issues trading in fractions.
However, the Exchange cannot support exchange-listed issues quoting and trading in decimals on the listed exchanges while the same issues quote and trade in fractions on the Nasdaq. Such quoting and trading would require the Exchange to make extensive and costly changes to all order, quote, trade, and back office processing systems and to extend testing for Nasdaq issues. Moreover, as discussed above, the Exchange believes that OPRA would not be able to accommodate the increase in message volume that simultaneous trading would cause.
Is the risk of customer confusion because of Dual Pricing significant, and if so, how should it be addressed?
The risk of investor confusion from a bifurcated market under the Dual Pricing approach is significant, and, the Exchange believes, inevitable. This risk could be substantially diminished by implementing a structured, phased-in Decimals Pilot program.
If commenters believe that implementing Dual Pricing by September 4, 2000 is not feasible, what date(s) is (are) feasible to implement Dual Pricing?
The Exchange does not believe that the Dual Pricing approach discussed in the Order is feasible, or should be implemented, and urges the Commission to implement the Decimals Pilot proposal.
The Exchange believes, however, that a Dual Pricing alternative, with a controlled, phased-in initial period, could be implemented by September 2000.
In addition, if commenters believe that implementing Dual Pricing by September 4, 2000 is not feasible, is the alternative Decimals Pilot proposal feasible or preferable? If commenters believe that the Decimals Pilot is feasible, what, if any, systems changes or other steps would be necessary to facilitate this schedule? In particular, what changes would need to be made to the current decimals testing schedule? What type of changes would need to be made to the systems of securities firms, investment companies, and vendors? What would be the impact on systems capacity? Is there a risk of customer confusion, and if so, how should it be addressed?
The Exchange believes that the Decimals Pilot program described in the Order is feasible, and clearly preferable, to Dual Pricing. A Decimals Pilot plan where the industry would begin trading a limited number of equities and the options on them in decimals, and would evaluate the impact of such trading before fully converting to decimals, is the safest and fairest way for the industry to commence decimal pricing.
Moreover, a limited-issue pilot program would allow the securities industry to measure its operational readiness, allow for systematic evaluation and adjustment, and would diminish the risk to the markets and to investors. A limited-issue pilot would likewise permit the discovery of new trading patterns and trends (e.g., short sales, arbitrage trading), and would allow the exchanges and the Commission to take prudent steps to address them. The Exchange does not foresee the need for significant system changes under the Decimals Pilot approach, but believes that additional testing may be necessary prior to full Nasdaq implementation.
The Exchange believes that the risk of investor confusion would be minimized under the limited-issue Decimals Pilot approach, particularly if the conversion process, and how investors could address problems arising out of the process, is explained to investors before the conversion takes place.
If commenters believe that the Decimals Pilot is not feasible, what alternative would expedite the implementation of decimal pricing in Exchange-listed and Nasdaq securities? Commenters should include a discussion of the systems changes and testing schedules that would be for alternative, including implementation date(s).
Commenters are requested to offer specific views on the optimal schedule for implementing decimal pricing in options based on exchange-listed and Nasdaq stocks subject to decimal pricing.
The Exchange believes that decimal trading ideally should begin after the industry has successfully executed extended-point-to-point testing of exchange-listed and Nasdaq-listed equities and options, and Nasdaq can implement decimal pricing in exchange-listed securities and Nasdaq securities. An optimal schedule would therefore be a pilot program starting at the end of February 2001 (the date Nasdaq indicated that it would be ready for trading in decimals), and, assuming that the pilot is successful and the industry has the capacity to process the increased message traffic, full decimal pricing by the end of March 2001. The Exchange would not require any systems changes under this scenario, but would extend its testing schedule through August 2,000 for exchange-listed issues and through February 2001 for Nasdaq issues.
The Exchange remains committed to carry out the goal of the Commission to implement decimalization in a timely and responsible fashion.
Meyer S. Frucher
Chairman and Chief Executive Officer
Philadelphia Stock Exchange, Inc.
1 Release No. 34-42685/April 13, 2000, File No. 4-430.
2 See letter dated March 20, 2000 from Meyer S. Frucher, Chairman and Chief Executive Officer of the Philadelphia Stock Exchange, Inc., to Arthur Levitt, Chairman of the Securities and Exchange Commission.