|MORGAN STANLEY & CO.
NEW YORK, NEW YORK 10036
|January 29, 1999|
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-6009
Attention: Mr. Jonathan G. Katz, Secretary
Re: Proposed Rule 10b-18 Amendment (File No. S7-27-98)
Ladies and Gentlemen:
Morgan Stanley & Co. Incorporated is pleased to submit this letter to supplement the comment letter we filed on December 10, 1998 in response to the request of the Securities and Exchange Commission (the "Commission") for comments on Release No. 34-40617 (the "Release"). We are proposing an amendment to Rule 10b-18 ("Rule 10b-18" or the "Rule") under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that would provide a general safe harbor for order imbalance LOC Orders. The proposal described in the Release would amend Rule 10b-18 to exempt from the Rule's time of purchase limitations purchases or bids made by issuers or affiliated purchasers following a market-wide trading suspension (as defined in proposed Rule 10b-18(a)(15)).
We believe the goals of the Commission's proposal would be further advanced by an additional safe harbor for issuer and affiliated purchaser repurchases not limited to days on which market-wide trading suspensions occur. Our proposal would amend Rule 10b-18 to permit issuers and their affiliated purchasers to place limited types of orders after a sell "imbalance" publication up to the amount of the imbalance. This narrow expansion would provide liquidity and market stability during periods where the market itself might not otherwise provide sufficient demand to meet selling activity and, in a manner similar to the Commission's proposed relief during market-wide trading suspensions, ease the financial pressures on stock specialists and market-makers.
One mechanism that could effectively achieve these goals without undermining the Rule's objectives is to permit limit-on-close ("LOC") or similar orders by issuers and their affiliated purchasers ("Issuer LOC Orders") after a sell "imbalance" publication up to the amount of the imbalance. The NYSE has established procedures regarding the placement and priority of LOC and market-on-close ("MOC") orders.(1) An LOC order is one that is entered for potential execution at the closing price if the closing price is at or better than the limit specified. Under the NYSE Rules, LOC orders are prioritized on the specialist's book by the time of entry and go behind all other orders on the specialist's book at that price. LOC orders with prices that are better than the closing price are guaranteed an execution, unless there is a trading halt in the security. LOC orders at the closing price are executed in order of time priority with respect to other LOC orders, but are not guaranteed an execution. See NYSE Information Memo No. 95-23 (June 9, 1995). LOC and MOC orders are irrevocable once placed and may not be canceled or reduced in size, except in the case of legitimate error or to comply with the provisions of NYSE Rule 80A (which would tend not to affect issuers).
Currently, the NYSE requires that LOC and MOC orders generally be placed before 3:40 p.m., unless the MOC or LOC order is entered to offset a published imbalance. At 3:40 p.m., the specialist for the security determines the quantity of orders to buy and sell a particular stock. If either buy or sell orders outnumber the other by at least 50,000 shares, the Exchange announces the discrepancy in an "imbalance" publication. An additional imbalance publication is made available at 3:50 p.m. These publications are meant to attract the buy or sell orders needed to correct the trade imbalance. MOC and LOC orders may be entered after 3:40 p.m. only to offset a published imbalance, subject to certain restrictions on expiration days.(2) These procedures are designed to alleviate volatility and correct trade imbalances at the close by providing timely market information to attract contra-side interest.(3) All MOC orders must be executed prior to any LOC orders.
The proposed addition to the Rule 10b-18 safe harbor would apply only to Issuer LOC Orders with a limit price that complies with current Rule 10b-18(b)(3) price of purchase rules at the time the Issuer LOC Order is entered. We contemplate that the timing and price levels would work as follows. Assume that the NYSE Specialist publishes a sell imbalance of 50,000 shares promptly after 3:40. Assume that the published bid price and the last independent sale price for the issuer's stock at 3:40 on the NYSE is $50. Under our proposal, the issuer may place an Issuer LOC Order at 3:45 with the specialist to purchase no more than 50,000 shares at a price not exceeding $50. Assume that, at the close, an order imbalance of 4,000 shares still exists after all MOC and other customer orders have been filled. Assume that the stock closed at a price of $49 1/2. The issuer's order could be partially filled (i.e. up to the amount of the remaining imbalance) but would be filled at $49 1/2. To the extent that the price of the issuer stock closed above $50, the Issuer LOC Order would not be filled, even if an imbalance remained.
Because the market price may move subsequent to entry of an Issuer LOC Order, it is possible that the Issuer LOC Order might be executed on a plus tick. However, because the order is irrevocable, may only be entered upon published imbalances, receives lowest order fill priority and would be in compliance with the price limits when entered, we do not believe that the order price could be used in a manipulative manner. Similarly, since the Issuer LOC Order would be required to be within the price limitations when placed, our proposal is consistent with the policy behind the Rule 10b-18 price limitations to prevent issuers from using repurchase programs to establish an artificially high market price for their stock.
Under our proposal, the Rule 10b-18 volume limitations would not apply to Issuer LOC Orders, although issuers would be limited to purchases up to the amount of the imbalance. Since Issuer LOC Orders would have the lowest priority and could only be filled up to the amount of the imbalance, an additional volume restriction should not be necessary to prevent manipulation of the market. The orders would be required to comply with the single broker rule of current Rule 10b-18(b)(1). Finally, the limited nature of the order as well as the fact that it would be entered with a specialist, should be viewed as consistent with the manner of purchase rules set forth in Rules 10b-18(b)(1) and (2).
We believe that this expansion of the safe harbor would promote the Commission's objectives underlying the current LOC/MOC procedures by helping correct trade imbalances and ease volatility at the close -- essentially permitting the issuer and its affiliated purchasers to provide additional liquidity. We believe the foregoing constraints placed on Issuer LOC orders, along with the placement and priority rules relating to MOC and LOC orders, substantially reduce the risk that an issuer or affiliated purchaser could use the additional safe harbor for manipulative purposes.
We believe this proposal would help achieve the Commission's laudable objectives of enhancing market efficiency, providing market liquidity and alleviating volatility at the close without creating a potential for abuse or manipulation of the market. These changes are consistent with the Commission's stated goal of exempting issuer repurchase activity "where the likelihood of manipulative abuse is not sufficient to justify imposing the restrictions of [a] ... rule." See Exchange Act Release No 6248 (Fed. Sec. L. Rep., Oct. 17, 1980) ¶ 82,669 at 83,672 (commenting on proposed Rule 13e-2, the precursor of Rule 10b-18).(4) Our proposed addition to Rule 10b-18 would allow issuers and their affiliated purchasers to provide liquidity in the face of order imbalances that occur from time to time which are outside their control. Adopting our proposal would benefit both issuers and their investors.
would welcome the opportunity to meet with the Staff of the Division of
Market Regulation to discuss this LOC proposal.
* * * * *
commend the Commission's initiative in improving the effectiveness of Rule
10b-18 and are pleased to have this opportunity to suggest an additional
general safe harbor for order imbalance LOC orders. Please feel free to
call the undersigned if you would like to discuss these views or if we
can be of any further assistance.
Ivan K. Freeman
&nbs p; &n bsp; &nbs p; &n bsp; &nbs p; Managing Director
cc: The Honorable Arthur Levitt, Chairman
The Honorable Norman S. Johnson
The Honorable Isaac C. Hunt, Jr.
The Honorable Paul R. Carey
The Honorable Laura S. Unger
Richard R. Lindsey, Director, Division of Market Regulation
Robert L.D. Colby, Deputy Director, Division of Market Regulation
Larry E. Bergmann, Associate Director, Division of Market Regulation
Catherine McGuire, Associate Director and Chief Counsel, Division of Market Regulation
Nancy J. Sanow, Senior Special Counsel, Division of Market Regulation
James A. Brigagliano, Assistant Director, Division of Market Regulation
Denise Landers, Attorney, Division of Market Regulation
Jerome Roche, Attorney, Division of Market Regulation
1. See NYSE Information Memo No. 98-20 (June 22, 1998). The American Stock Exchange's procedures for processing orders at the close of the market substantially conform to the NYSE procedures. See Exchange Act Release No. 40123 (June 24, 1998) (approving revision to the American Stock Exchange's policy for entry of MOC and LOC orders). We contemplate that our proposed rule could be extended to apply to Nasdaq and similar markets upon their adoption of rules for publication of market imbalances as well as acceptance of orders that operate like LOC orders (i.e., orders that are irrevocable, do not take priority over other customer orders and are given with particular price and quantity limits).
2. Op. Cite. NYSE Information Memo No. 98-20 (June 22, 1998) (prohibiting the entry of MOC or LOC orders after 3:40 p.m, on expiration days to establish or liquidate positions related to a strategy involving derivative instruments, even if such orders might offset published imbalances).
3. See Exchange Act Release No. 40094 (June 22, 1998) (approving revision to the NYSE's policy for entry of MOC and LOC orders).
4. We note that, in Exchange Act Release No. 6248 (Fed. Sec. L. Rep., Oct 17, 1980) ¶ 82,669 at 83,686 n.55, the Commission criticized a broader but somewhat similar proposal made by a commentator to proposed Rule 13e-2 (the precursor to Rule 10b-18) that would have exempted execution by a specialist of limit orders placed by the issuer during the last hour prior to market close or at the opening of trading. We believe that our more limited approach differs in important respects from the previous proposal.
Under our proposal, since Issuer LOC Orders will have lowest priority and may be executed only up to the amount of an imbalance, the market would have the opportunity to correct imbalances in the ordinary course and only rely upon issuer purchases as a last resort (i.e., after filling all other orders). We believe our proposal addresses the issues raised by the Commission in connection with the previous proposal, while at the same time satisfying the stated goals (i.e., of providing for additional liquidity and market stability) that underlie the Commission's proposed exemption for issuer and affiliated person purchases during the last half hour of trading after a market-wide trading suspension.