September 22, 2000
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Attention: Jonathan G. Katz, Secretary
Re: SEC File No. S7-16-00
Dear Mr. Katz:
Philadelphia Stock Exchange, Inc. ("Phlx" or "Exchange") appreciates the opportunity to comment on the Proposed Rule concerning Disclosure of Order Routing and Execution Practices, published for comment in Securities Exchange Act Release No. 43084 (July 28, 2000).
The Exchange has significant reservations with Proposed Rule 11Ac1-5, the Order Execution Rule ("Rule"). To date, the Commission has regulated the securities markets based on the model of the public investor as customer to his or her broker. Specifically, the public investor looks toward the broker to represent his or her interest in the marketplace. This Rule would erode that model by providing public investors with only partial, uninterpreted information and then encouraging them to substitute their judgment for their brokers' judgment in order routing decisions.
First, the Exchange believes that our members are best equipped to inform us of their informational needs in achieving the goals of their customers. With this Rule, the Commission steps in between the Exchange and its members and mandates the type and form of information that public investors will have available to them. In most cases, public investors do not have the access to the information or the experience to interpret the information which would allow them to comprehensively judge their brokers' order routing practices. It is possible, if not likely, that public investors, with access to the information proposed in this Rule, would presume that this information encompasses the entire standard (or the appropriate standard) by which to evaluate their brokers' order routing practices. This misconception would be enhanced by the imprimatur of authority it would surely carry, if mandated by the Commission. Customers are done a disservice if they can not have their brokers tailor the information they receive to their needs and then are mislead by incomplete or extraneous information. Therefore, the Exchange believes that it is imperative to continue to allow our members to drive the disclosure of information to their customers. In that way, the free flow of information which supports innovation and new areas of service will not be stagnated by regulatory mandates which could present an incomplete view of the situation.
One example of how the information mandated by the proposed Rule relates to exchange automated execution systems. Most exchanges employ automated execution systems which accept orders under a specified number of shares and automatically execute some of those orders depending on the parameters of the given system. Exchanges may, by SRO rulemaking, accept and execute different size orders in these systems than may be accepted and executed on other exchanges with automatic execution systems. The size categories proposed in the Rule do not correspond to the order acceptance limits or the automatic execution limits of the Exchange's PACE system1. Therefore, at best, these arbitrary size categories will not give the public investor a true picture of the executions available on the Phlx. At worst, it could encourage the Phlx to conform PACE to the arbitrary reporting categories created by regulatory mandate instead of by the ever-changing demands of the marketplace. This scenario would likely be played out at other exchanges, therefore stagnating competition and innovation in the area of automatic execution systems.
Second, with this Rule, the Commission would allow the public investor to view only a portion of the information that is needed by a broker in deciding where to route an order. The statistical measures proposed in the Rule do not, by themselves, provide a complete picture of the range of services that the Exchange offers to its members. National securities exchanges compete for order flow on the entire range of services they provide to their members, price and speed of execution being two of those factors. Other services that our members demand include responsiveness of the customer service personnel who administer our electric order routing and execution system, the quality and responsiveness of our automation staff who design, create and maintain the trading systems that the members propose through their representatives on our Board and Exchange committees, and the quality and effectiveness of our surveillance personnel and systems.
While these services and others are demanded by our members as they attempt to live up to their responsibilities to their customers, they can not be quantified and compared to each venue by reducing them to a number. The decision on where to route an order, therefore, requires the reasoned and attentive judgment of brokers who have access to a wide range of information and experience to interpret that information. Therefore, with this Rule, the Commission makes an unsupportable assumption that public investors with partial information can make better decisions about order routing than their brokers who have access to other, important information which affects the broker's decision to route an order.
In addition, for this Rule to have any potential benefit to the public investor, significant, on-going education would be needed. Public investors would need a context to interpret the numbers generated by this Rule. They would need assistance in determining what categories of information apply to them and their orders. They would need education in the other, non-quantifiable measures that go into the order routing decision. The logistics of providing this education would burden both the exchanges and the brokers. Exchanges would be placed in the awkward situation of dealing directly with their members' customer. Brokers would be required to educate their customers to evaluate order routing decisions on their own.
While customer education is a laudable goal, this Rule could actually hinder that education as brokers would need to expend resources educating customers about the report proposed in this Rule, even when this report would contain information that is not applicable to that particular customer's needs or demand. Again, brokers are in the best situation to discover customer needs for information and education. They must either meet their customers needs or watch them leave for their competition. Therefore, brokers are in the best position to tailor customer education and demand appropriate information from exchanges to support that education. In addition to increased demands on our members for interpretations of this report, the Exchange anticipates an influx of inquiries from public investors who want explanations about these reports.
The costs of implementation and maintenance of this proposed Rule, in terms of dollars and personnel, would vastly outweigh the benefits. The Exchange estimates that the cost of creating the reporting system, as well as creating the interfaces with our members to meet their requirements under the Rule would be at least $500,000 and require between six months and one year to fully implement. In addition, the implementation of this Rule would come during a period that requires exchanges to expend significant time and resources on other industry mandates, such as decimalization and "T+1" settlement. This would place unwarranted strain on those resources which are being marshaled to meet those other important goals.
Should the Commission decide to go forward with this Rule, the Exchange suggests the following modifications to meet some of the concerns raised above. First, the categories proposed in the Rule do not take into account various factors which influence the numbers reported in significant respects. For example, the Exchange does not believe that internalization of order flow will be adequately accounted for by the Rule and thus would distort the numbers that would be reported. As mentioned above, different parameters on different automatic order routing and execution systems will cause the report to give an inaccurate picture of orders sizes that fall between the order sizes mandated in the Rule. For example a 500 share order might receive automatic execution with price improvement where a 1500 share order might not, but the proposed categories lump these orders together and thus do not accurately represent execution quality of either size order with the proposed category at `500 to 1999 shares'. Therefore, the Exchange would recommend excluding or separating internalized orders from these reports and allowing market centers to choose the size of reporting share categories.
Additionally, the Exchange recommends a clarification of the cancellation category. Cancels take place for many reasons, some generated by the customer and some by other market events. A single category would not portray an accurate picture to the public investor. Therefore, if the Commission chooses to retain this category, the Exchange recommend excluding or delineating cancels that occur outside of the control of the Exchange.
Finally, the Exchange requests clarity on the definition of the term time of order receipt at Proposed Rule 11Ac1-5(a)(20) when referring to orders that are received by floor brokers on exchanges. Specifically, with respect to reporting by exchanges, would the time of order receipt be the time that the floor broker receives an order or would it be the time the specialist receives the order. This difference will have a significant effect on execution time numbers as reported by exchanges. The Exchange recommends clarifying this definition to state that orders are received by the exchange when they are received by the specialist on the exchange floor. This would prevent the execution time report from including the performance of floor brokers, which are chosen or employed by the routing broker and focus the report on the exchange specialist which seems to be a truer measure of the order execution quality at a given market center.
In closing, the Exchange respectfully suggests that the Commission explore other means of strengthening the relationship between brokers and their customers. The Exchange believes that proposed Rule would, in the end, do a disservice to those very customers the Commission is attempting to benefit. The Exchange continues to provide its members with order execution information and listens to their needs in this area through its Board and committee structure. The Exchange continues to believe that our members are best equipped to discover and meet the needs of their customers. This proposed Rule is inconsistent with that belief. Yet, if the Commission moves ahead with this proposed Rule, the Exchange respectfully suggests that the Commission consider the Exchange's technical recommendations above which the Exchange believes would strengthen the proposed Rule. The Exchange appreciates this opportunity to make its views known to Commission and its staff.
Lanny A. Schwartz
Executive Vice President
1 PACE stands for Philadelphia Stock Exchange Automated Communication and Execution System. PACE is Phlx's automated equity delivery and order execution system.