May 4, 1998
Jonathan Katz, Secretary
Securities and Exchange Commission
450 Fifth Street NW
Washington, DC 20549
Re: Release 34-39718; File No. SR-NASD-98-17
Dear Secretary Katz,
American Century Investment Management, the investment manager for the American Century family of mutual funds, welcomes the opportunity to comment on proposed changes to the NASD markets with respect to the Consolidated Limit Order Book (CLOB) and sponsored institutional access as outlined in Release 34-39718; File No. SR-NASD-98-17.
American Century is extremely supportive of the NASD proposal to provide a CLOB with sponsored institutional access and Intermarket Trading System (ITS) linkages. For the first time, the retail, institutional, and broker dealer participants will see a fair representation of orders in this marketplace. This transparency will benefit the retail investor by providing a ready avenue for the posting of limit orders and the immediate execution of orders submitted against a posted bid or offer. Institutions will be able to access the same limit order book for order placement and execution combined with transparency at multiple price levels known as "depth of book". Multi-level price transparency will assist the broker dealer community in pricing principal bids and offers.
The Intermarket Trading System (ITS) and the NASD Central Limit Order Book (CLOB)
The CLOB proposal is inadequate without a basic architecture that mandates the interface between the CLOB and ITS. Recent S.E.C. releases refer to many Electronic Communication Networks (ECN's) establishing themselves as separate "exchange-like" entities. The CLOB for the first time provides an opportunity to centralize all institutional, retail, and market maker order flow. But if there is no robust interaction between the CLOB and other "ECN exchanges" many advantages are lost. The S.E.C. order handling rules of 1997 did much to enforce better price discovery mechanisms for over-the-counter stocks. But it fell short in facilitating better avenues by which these newly transparent orders could interact with one another. The N.A.S.D. has now offered the solution; we must be careful this opportunity is not lost. Price protection, not price improvement, via ITS must be part of any CLOB if we are to trade in a world of multiple exchanges.
In a larger context, American Century has proposed "fortifying" ITS with the National Market System (NMS) as originally proposed by the 1975 Exchange Act whenever the opportunity presented itself. "A patchwork of complicated alterations to outdated, antiquated market definitions and structure should be completely reexamined. Technology has rendered obsolete many accepted market terms and structures. The Commission should reexamine ways to enhance current intermarket quote linkage through the Intermarket Trading System...." The proprietary nature of orders within ECN's, third market firms, or blind matches serves only to fragment markets and prevent the true level playing field that would be afforded through a strong, automated ITS-based execution facility. A robust ITS linkage with the CLOB and both traditional and the newly envisioned ECN exchanges serves to protect retail and institutional investors while maintaining the transparency so essential to a multi-dealerr market.
Dynamic depth of book, decimalization and increments
American Century believes that current technology provides the ability to maintain a real time, dynamic depth of book for the CLOB, and opposes the NASD proposal that depth of book be available only upon request. Instinet has been providing depth of book in both listed and over the counter stocks for many years, so it is difficult to understand why the NASD cannot provide similar technology.
There has been much discussion within the industry concerning the move to decimals and meaningful price increments greater than one cent. American Century believes that a dynamic depth of book removes the need for any artificial constraints upon order incrementation. Although small orders may easily "front run" larger institutional orders on the book by one cent, a screen that displays orders of size at multiple price levels will provide the transparency necessary for all participants to execute trades. Stocks are frequently quoted in increments of 1/64 (.0156 cents) in various ECN's, but depth of book provided on these ECN's provides liquidity at multiple price levels.
24 Hour Access
American Century believes that the CLOB should be available around the clock. Trading activity outside of normal market hours will continue to increase. There is no need for the NASD to cede this order flow to other markets or proprietary third parties that do not enjoy the transparency the CLOB will. U.S. Exchanges must be competitive to attract listings and order flow. The Deutsche Bourse, for example, maintains an electronic order book that allows five and one half hours of trading beyond normal market hours each day. Many major institutional investors, both within the United States and abroad, now maintain 24 hour coverage of global equity markets, and the trend is growing. The CLOB potentially provides both the infrastructure and compliance mechanisms for efficient markets; as such, it should be available to market participants whenever and from wherever they wish to trade.
Delays in execution, cancellations, and the option
American Century strongly opposes any artificial constraints placed upon order execution or cancellation in the CLOB and NASD quote. Orders placed into the NASD quote should be available for immediate execution and cancellation. Any constraints placed upon the availability of these orders, whether they be in the CLOB or a market maker quote, grant a free option to the floor crowds who may be acting as agent or as principal or with full "discretion".
Market makers must not be awarded a "free look" at any incoming orders before making the decision to execute. American Century has numerous examples of members of the floor community at the New York Stock Exchange getting just such an option when a DOT order arrives at the specialist post. The specialist announces the incoming DOT order to the crowd under the auspices of providing "price improvement" and provides any participant standing in the crowd with the option of hitting/taking the posted bid or offering before the DOT order can be executed against the posted market. The NASD has the opportunity to establish a price discovery mechanism that provides immediacy of execution and a level playing field for market makers, retail and institutional investors. Delays in execution of seventeen seconds, thirty-two or any other window will allow a market maker to decide if it is in his or his firm's collective economic self interest before he/she executes that order. Such a deelay impedes competition by corrupting the price and time prioritization of an electronic execution platform.
Any delay in order cancellation poses risks to all investors. With the explosion of electronic trading in recent years trillions of dollars in equity transactions are being entered into markets electronically. Institutions may enter baskets of trades in multiple securities totaling several billion dollars at any one time, while individual investors are entering orders via the internet or dedicated phone lines to their brokers that are much smaller in absolute size but represents just as significant a financial stake. American Century has electronic linkages in place that will cancel an order posted on an ECN if that order does not exist on our mainframe database before an equity trader on our desk could physically recognize and cancel that order. Why would we want to take a step back and wait for 10 seconds? When an order is entered in error, the opportunity to cancel that order immediately must be available. In an era where many order handling systems can create orders and route them in fractioons of a second, a ten second delay for order cancellation becomes an immensely valuable free option for market makers and other participants.
Institutional sponsored access and primary market makers
It is imperative that the NASD provide economic incentives that support NASD broker dealer activity and the liquidity that comes from that within the framework of the CLOB. Revenue opportunities that encourage market makers to sponsor stocks, both large and small, and regional diversity will prevent the abandonment of lower capitalization stocks by the broker dealer community and the diminished liquidity that would ensue. Market makers who make active markets in less liquid stocks bear an economic cost for providing this liquidity; as such, they should be allowed to participate in the good times when the liquidity is present by sponsoring institutional access and earning a portion of the revenues such access provides.
That said, access to the CLOB and NASD montage must be available to institutions and there should be choices. A successful market provides choices to ensure competition. These choices must include an anonymous execution only vehicle (an ECN would be an example) and sponsored access via a simple NASD connection that will allow the institution to make pricing decisions while simultaneously designating a broker dealer who is a primary market maker in that security. This will ensure anonymity and liquidity. The anonymity and technological advantage an ECN provides to institutions is good for markets, consolidates volume and enhances liquidity. ECN's that provide these services should also participate in the primary market maker standards with the opportunity to earn revenues from that participation.
Sponsored institutional access to the NASD should be through open architecture that allows the institutional participant several options for order entry. To encourage use of the system we suggest a front end application that permits a participant to enter orders through one direct connection to the NASD that provides opportunities to select any number of sponsoring broker dealers and access the book electronically in anonymity. Further, the architecture should support electronic linkages by institutions who have developed their own, proprietary order entry and management systems via one direct connection that provides the same multiple broker sponsoring opportunities. Institutions should also have the capability to enter orders into the CLOB with the "reserve quantity" features that virtually all ECN's now provide.
American Century strongly suggests that connectivity and communication between the NASD, the broker dealer, ECN, and institutional communities be F.I.X. (Financial Information Exchange) compliant. The broker dealer and institutional community have worked to develop a communication protocol that provides a standardization of communication. It is in the NASD's best interest to "leverage" this work and enable new systems to speak the language most of the institutional community now speaks.
Liquidity fees should be paid by "liquidity takers", those who hit bids or take offerings posted in the quote. Those who provide liquidity by posting bids/offers in the national market system should be rewarded for providing this market service and should face no transactional charges.
Several market making firms have complained to AC about the unequal execution obligations of ECN's and market makers. In essence, market makers are required to execute trades against their posted bid/offer, while ECN's are able to refuse access to their posted bid/offer (even when it is the best price available) if the liquidity provider does not pay them an access fee. This inconsistency within the NASD quote severely damages the quest for best price and encourages fragmentation. If we cannot get to an ECN through the NASD link, we either have to "pay up" or establish a relationship with that ECN. A liquidity fee will alleviate this inequity by providing consistent and fair pricing for all participants.
American Century appreciates the opportunity to comment on these exciting developments in U.S. equity markets and would be prepared to discuss these subjects further at your convenience.
Manager, Equity Trading
American Century Investments