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U.S. Securities and Exchange Commission

Supplementary News Material:
Market Structure Initiatives in the Options Markets

Fact Sheet

The Commission today approved two related initiatives designed to better ensure that customersí orders for exchange-traded options receive best execution. The recent expansion of multiply-traded options, in conjunction with a lack of effective access across the options markets, has significantly increased the likelihood that a customer order may be executed at a price that is inferior to a price available on another market. This is known as an "intermarket trade-through." Intermarket trade-throughs are estimated to occur in as many as 5% of all options trades.

To address the problem, the Commission has for several years encouraged the options exchanges to develop a linkage voluntarily. In October 1999, the Commission issued an Order directing the options exchanges to act jointly to file a linkage plan. In response, the Commission received three linkage plans -- one from the American Stock Exchange, Chicago Board Options Exchange, and International Securities Exchange, and one each from the Philadelphia Stock Exchange and the Pacific Exchange -- that the Commission published for comment last March.

Although the proposed plans offer significant advantages, there are concerns that a single, mandated linkage may fail to adapt over time to changes in the markets and potentially impede the entry of new participants using different business models. Moreover, there may be a number of ways in which technology can be relied upon to decrease the likelihood of intermarket trade-throughs. This was the basis for the Commissionís proposal today -- a flexible, market-based approach to reduce intermarket trade-throughs without mandating the means to achieve this goal.

  • Approval of Linkage Plan. First, the Commission approved the linkage plan proposed by the Amex, CBOE, and ISE but did not order the options exchanges to participate in it.
  • Proposed Trade-Through Disclosure Rule. Second, to enable customers to better assess the quality of the executions that they receive, the Commission has proposed to require a broker-dealer to disclose to its customer when the customerís order for an exchange-traded option was executed at a price inferior to the best-published quote. The proposal would not prohibit trade-throughs. It would, however, ensure that the decision not to pursue publicly displayed superior prices is rooted in the interests of customers. Furthermore, a broker-dealer would not have to make this disclosure if it effects the transaction on an options market that participates in a linkage plan approved by the Commission that contains provisions reasonably designed to limit trade-throughs.
  • Proposed Amendment to the Firm Quote Rule. Finally, the Commission has proposed requiring options marketsí quotes to be firm up to their published quotation size. This proposal would ensure that when access methods are developed, these quotes would in fact be honored when orders are routed to them from other markets.

Public Disclosure of Order Routing Practices and Execution Quality in the Equities Markets

The Commission is proposing for public comment two new rules that would require greater public disclosure by brokers and equity market centers concerning their order routing practices and execution quality. In todayís markets, many different market centers compete for order flow in the same security. The decision of where to route orders therefore is critically important. Currently, investors have few tools to evaluate the extent to which their orders receive the best execution available. As a result, it may be difficult for brokers and market centers to compete on the basis of execution quality.

Advancing technology now offers new alternatives for making available to the public valuable information concerning where orders are routed and the quality of executions in these markets. By providing this valuable market information to investors and others, the rules proposed today are intended to energize competitive forces that will produce fairer and more efficient markets.

  • Under proposed Rule 11Ac1-5, equity market centers (primarily exchange specialists, OTC market makers, and ECNs) would be required to make available to the public, in electronic form, monthly reports that include uniform statistical measures of execution quality on a stock-by-stock basis. These measures include price improvement and disimprovement, speed of execution, and limit order fill rates
  • Under proposed Rule 11Ac1-6, brokers that route orders on behalf of customers would be required to make publicly available, primarily by posting on a free Internet web site, quarterly reports that describe their order routing practices. Among other things, the reports would disclose the percentage of customer orders routed to different market centers for execution. In addition, the reports would disclose any material relationship between the broker and the market center, such as an internalization or payment for order flow arrangement.

Once the market center and broker information is made available to the public, all interested persons, including the financial press, independent analysts, consultants, and others, will be able to analyze the information, particularly the extensive execution quality data, and prepare comparisons between markets and brokers.

At this time, the Commission is not taking action on the price/time priority alternatives described in its February 2000 Fragmentation Release. The Commission, however, will continue to analyze the potential for internalization and payment for order flow arrangements to interfere with order interaction and discourage the display of aggressively-priced quotations, particularly in light of the unanimous concerns expressed by investors responding to the Release.

To more fully evaluate these concerns, the Commissionís Office of Economic Analysis currently is conducting an in-depth study of trading in Nasdaq equities and NYSE equities. The study is using order information on Nasdaq trading that has not previously been available. The Commission intends to use the results of this study, as well as its experience with changing market conditions, to determine whether further steps are needed to address internalization and payment for order flow.

Todayís release also discusses and requests comment on other actions that could strengthen competition in our markets. Among these are:

  • Safeguarding the competitive price-setting mechanism of limit orders. The display of limit orders in the quote is a valuable contributor to price competition in both listed and Nasdaq securities.

    While trading in decimals may result in narrower spreads and lower costs for retail investors, there is also the potential that decimal pricing may put displayed limit orders at a disadvantage. This is because if market participants are able to trade with market orders for only a penny better than a displayed limit order, they can "step ahead" of limit orders at minimal cost. If such trading patterns become common, investors may lose confidence in the effectiveness of using limit orders, fewer limit orders may be placed, and a powerful agent of price competition may be lost.

    The Commission intends to carefully consider, and discuss with the SROs, whether market participants with access to market orders should be limited from stepping ahead of limit orders by some increment greater than a penny.

  • Including ECN prices in the consolidated quote for listed securities. The Commission is committed to resolving, with the SROs and the ECNs, issues that hinder inclusion of ECN prices in the consolidated quote for listed securities. One of the most important issues that must be addressed is the treatment of access fees charged by ECNs to their subscribers and others.
  • The possibility of a trade-through disclosure rule for the equities markets. The Commission asks for comment on whether a rule similar to the one separately proposed today for the options markets would be appropriate in the equities markets. Any such rule would supplement -- but not replace -- the broker-dealerís duty to obtain best execution for its customer orders.

Finally, questions have been raised about the fees charged for market information and the current methods of consolidating quotes from different markets. The Commission agrees that these issues warrant further consideration. As such, the Commission is establishing a formal Advisory Committee on Market Information to provide advice on issues related to consolidating data in the equities and options markets. The committee will consider, among other things, alternative models for disseminating and consolidating information from multiple markets, and appropriate governance structures for joint market information.


Public comments on the proposed disclosure rules and the Commissionís discussion of further action to strengthen competition should be submitted within 45 days after the releaseís publication in the Federal Register.


Modified: 07/25/2000