Junius W. Peake
Monfort Distinguished Professor of Finance
University of Northern Colorado
Greeley CO 80639-0001
Tel: 970-351-2737 Fax: 970-351-1062
Home page: http://www.coba.unco.edu/bafn/fac/peake/peake.htm
July 14, 1997
Jonathan G. Katz, Secretary
United States Securities & Exchange Commission
450 Fifth Street, N.W.
Washington DC 20549
Also via e-mail to: firstname.lastname@example.org
File No. S7-16-97
Release No. 34-38672
Concept Release on regulation of exchanges
and other markets
Dear Mr. Katz:
This letter contains my initial comments on the above-captioned Release. While I have responded to each of the more than 200 questions posed by Commission staff members, it is awkward to comment in detail on a document which almost completely misses the mark in its regulatory approach. I want the Commission to know why I have come to that opinion.
"...the lesson is...that consumers and merchants, not governments, will ultimately determine what new products are successful in the marketplace. Government action can retard progress, but almost certainly cannot ensure it."
The Future of Money in the Information Age
Although Chairman Greenspans quotation above relates to a different system, it appears spot on as a reminder to the Commission that micromanaging the design and operation of a national market system for securities is far better left to the innovative and entrepreneurial activities of the private sector than to government bureaucrats, even those whose training is in the law, rather than in information systems.
While the Commission repeatedly asserts it has not micromanaged the development of the national market system, the evidence to the contrary is overwhelming. Since 1975, when the legislation was enacted (Section 11A of the Securities Exchange Act is annexed as Appendix "A"), there have been many iterations orchestrated by the Commission in an attempt to achieve a national market system, so far all unsuccessful. The millions upon millions of words written by the Commission in 22 years worth of national market system-related Releases do not support its assertions that what is being proposed is merely a framework for a national market system, rather than micromanagement.
I would remind the Commission of what my colleagues, Professor Morris Mendelson, R.T. Williams, Jr., and I wrote when we presented a plan for the design of a national market system (The Peake-Mendelson-Williams National Book System: An Electronically-Assisted Auction Market) to the Commissions congressionally-mandated National Market Advisory Board on April 30, 1976:
"Any attempt to obtain a system such as we present (a decimalized, price-time priority auction execution system with competitive market makers and total order interaction), in stages, must result in a sequence of fully-developed systems, each operating only long enough to permit the next step to be constructed before being discarded."
A review of the past 22 years worth of effort and rule writing would, it seems to me, have validated our prediction, although I would argue that no system yet in operation over that period of time has met the definition of "fully-developed." The Commission has not yet discovered that the only solution to their national market system dilemma will be to opt for a price-time priority auction trading system. The establishmentold-line stock exchanges, the NASD and market maker trade associationshave been doing their best since Section 11A became law to prevent the creation of the best system for investors and issuers (for whose ultimate benefit, after all, equity markets are supposed to exist). However, the only way to achieve the congressional intent of Section 11A is to centralize all bids and offers for each security. The only possible way a different system can meet congressional objectives is if the law is amended, which, of course, is always an option.
Congress was farsighted when it realized that the use of new technologies in the trading process would most probably require amendment to the legislation some later date. They included that possibility in the law in plain language. Following the articulation of the congressional findings which were the predicate for the rationale of a national market system, and setting forth the general characteristics of that national market system, Congress drafted a contingency plan, as follows:
"... The Commission is directed, therefore, having due regard for the public interest, the protection of investors, and the maintenance of fair and orderly markets, to use its authority under this title to facilitate the establishment of a national market system for securities (which may include subsystems for particular types of securities with unique trading characteristics) in accordance with the findings and to carry out the objectives set forth in paragraph (1) of this subsection.
"The Commission, by rule, shall designate the securities or classes of securities qualified for trading in the national market system from among securities other than exempted securities. (Securities or classes of securities so designated hereinafter in this section referred to as qualified securities.)
"(3) The Commission is authorized in furtherance of the directive in paragraph (2) of this subsection -
"(A) to create one or more advisory committees pursuant to the Federal Advisory Committee Act (which shall be in addition to the National Market Advisory Board established pursuant to subsection (d) of this section) and to employ one or more outside experts;
"(B) by order, to authorize or require self-regulatory organizations to act jointly with respect to matters as to which they share authority under this title in planning, developing, operating, or regulating a national market system (or a subsystem thereof) or one or more facilities thereof; and
"(C) to conduct studies and make recommendations to the Congress from time to time as to the possible need for modifications of the scheme of self-regulation provided for in this title so as to adapt it to a national market system." 1
For the past 22 years the Commission has been attempting to meet the congressional mandate to "facilitate" the establishment of a national market system, albeit (as the Commission itself acknowledges in the Release) with far less than great success. For example, in the Concept Release, the Commission repeatedly suggests its regulatory record from 1975 to present has been inadequate, and frequently off target. In the Table of Contents at the end of page 2 and continuing at the top of page 3 of the downloaded version of the Release from the Commissions Web site, it states:
"B. Market Regulation
1. The Current Regulatory Approach Applies Inappropriate Regulation to Alternative Trading Systems
2. The Current Approach Impedes Effective Regulation
a. Market Access and Fairness
b. Market Transparency and Coordination
c. Market Surveillance
d. Market Stability and Systemic Risks"
Further, on page 8 of the Release (all page numbers referred to in this Comment Letter are based on the downloaded Internet version of the Release), it states:
"At the same time, alternative trading systems are not fully integrated into the national market system. As a result, activity on alternative trading systems is not fully disclosed to, or accessible by, public investors. The trading activity on these systems may not be adequately surveilled for market manipulation and fraud. Moreover, these trading systems have no obligation to provide investors a fair opportunity to participate in their systems or to treat their participants fairly, nor do they have an obligation to ensure that they have sufficient capacity to handle trading demand. These concerns together with the increasingly important role of alternative trading systems, call into question the fairness of current regulatory requirements, the effectiveness of existing NMS mechanisms, and the quality of public secondary markets."
And again, on page 37, it states:
"Recent evidence suggests that the failure of the current regulatory approach to fully coordinate trading on alternative trading systems into national market systems mechanisms has impaired the quality and pricing efficiency of secondary equity markets, particularly in light of the explosive growth in trading volume on such alternative trading systems. Although these systems are available to some institutions, orders on these systems frequently are not available to the general investing public. The ability of market makers and specialists to display different and potentially superior prices on these alternative trading systems than those displayed to the general public created, in the past, the potential for a two-tiered market."
It would seem appropriate from these statements which admit that the present regulatory approach has not succeeded, the Commission should look to the operative language of Section 11A of the relevant legislation, which instructs the SEC:
"... to conduct studies and make recommendations to the Congress from time to time as to the possible need for modifications of the scheme of self-regulation provided for in this title so as to adapt it to a national market system."
Surprisingly, nowhere in the Release does the Commission cite this statutory language, nor does it suggest these are actions the SEC should take.
To be sure, the Commission did make the following point on page 11:
"As an initial matter, the Commission is soliciting comment on whether the current statutory and regulatory framework remains appropriate in light of the myriad new means of trading securities made possible by emerging and evolving technologies."
Unfortunately the Commission failed to ask what should have been the threshold question: "Why has the Commission found it impossible during the past 22 years to meet the congressional mandate requiring them to facilitate the establishment of a national market system?" Instead, almost the entire 230-page Release (156 pages in distributed form) is spent constructing hypothetical questions on new regulatory approaches which would require complex Commission rulemaking to attempt to convert the obsolescent language of the Act to fit into a modern trading system, despite the clear charge by the Congress for the Commission to go back to the Congress when necessary to recommend changes in the laws.
I recognize that for the Commission to ask the Congress to reopen the national market system legislation would be like opening Pandoras box. Every vested interest, led by the stock exchanges and the NASD, will immediately ask for new legislation to protect their self-interests as they perceive them. As usual, they will argue that their own best interests are congruent with the public interest. Whether that may be true is, to say the least, very doubtful. However, our political process is designed to let the participants fight ideas out in the arena of public opinion, and whatever legislation, if any, results from such a battle will be a law, passed by Congress and signed by the President (or with an overridden presidential veto).
US and international investors can have a better system in which to buy and sell securities. The main reason they do not have one today is because of the deference given by the Commission to the self-interest of the powerful group of intermediaries, led by the New York Stock Exchange. If an intelligent Martian were to arrive on Earth today and be required to set up and operate our secondary equity trading system by reading the rules of the Commission, it would certainly be nonplused, to say the least, by the millions of words of arcane legal language.
The Commissions proposals will make their already complicated rulebook even more so, and motivates this commentator to suggest that an entire rethinking by the Commission of the past 22 years be undertaken. It would seem preferable to follow the accounting principle of ridding an organization of obsolete facilities ("sunk costs"), and replacing them with new facilities. In the present instance, the "sunk costs" represent unworkable rules. Most of these rules, written within the framework of present legislation, should be scrapped in favor of a simpler, more modern statutory and regulatory scheme.
This comment letter proposes a simpler solution, and also responds succinctly to the plethora of questions posed in the Release.
The economic function of a secondary market for equities is straightforward: to provide a system which allows shareholders to maximize the value of their holdings by enabling them to find the counterparty willing to pay the best discovered price, and to do so in a system which is low-cost, efficient and secure.
The stated policy of the United States is to provide investors with a market system that is "fair and open." The Congress further articulated that technology affords better ways to meet this objective. The core of the problem to be solved is lodged in the term "best execution." There is widespread agreement that this term lacks substantive definition. For example, the June 16, 1997 majority opinion of the United States Court of Appeals for the Third Circuit, Kenneth E. Newton, et al. v Merrill Lynch, et al. (96-5045), pointed out the vagueness of the concept of "best execution" when it upheld the lower courts opinion (at page 5) with the following words: The district court granted summary judgment to the defendants...because the duty of best execution is ill-defined..."
The Commission has spent more than two decades attempting to link marketplaces (stock exchange floors and over-the-counter trading facilities), rather than markets (bids and offers), in an attempt to create a national market system. As a result, American equity markets have become increasingly fragmented, with ever smaller percentages of the total number of bids and offers able to interact. If many of the possible regulatory changes, under consideration as "questions" in the Concept Release, are implemented, fragmentation would be greatly exacerbated. Even now, major firms such as Goldman Sachs and Bear Stearns are developing their own ECN internalized trade matching systems.
Buyers and sellers want only one thing in a trade execution: best net price after deducting (if a sale) or adding (if a purchase) all costs. There is a difference between "working" an order, in which the judgment and skill of the person or firm entrusted with achieving the overall best net price is crucial, and making certain that the very best possible price per execution is guaranteed.
Sometimes an entire security position can be traded as a single transaction. At other times, multiple trade executions are required. The important thing to be remembered is that each trade execution should be made in a system which guarantee that the best possible price for both buyer and seller has been achieved at that moment in time. That is the essence of the national market system mandated by the Congress in Section 11A of the Exchange Act in 1975. That is the objective the Commission should have "facilitated," but so far has not accomplished. This is the real definition of "best execution."
The Commission has equated multiple execution of a series of trades in one security for a single account with the execution of a single transaction. During the debate lead up to the congressional language of "the practicability of brokers executing investors' orders in the best market," the testimony was focused on the execution of each single transaction, not the completion of a large order in multiple transactions. What the Congress wanted was a system that assured that the execution of every trade would in and of itself be best execution by dint of the fact that there was no better bid or offer for either buyer or seller available anywhere in the national market system at the moment of the trade, and that the first bid or offer at a price would have priority over subsequently-entered bids and offers at the same price.
Let me make an analogy: Every attorney is required to practice his or her profession under the same set of rules, known as laws and opinions. However, each attorney attempts to exercise his/her duty in the best interests of the client. The approach of each attorney to the same case are frequently different. "Best execution," in my analogy, would mean that there is but one set of laws to be followed. However, the execution of a clients order (case) would be handled differently in an attempt to gain the best result for the client. Some lawyers, like some brokers, are better than others. The result of one brokers multiple execution of a clients large order may result in a different outcome than if the same order had been given to another broker. The same is true for lawyers. Give one lawyer a case, and the client may win it. Give the same case to another lawyer, and the client may lose it. The case is the same; the law is the same; the relevant opinions cited should be the same. Only the decision may be different. The skill of the attorney in serving his/her clients best interests is paramount. However, if the end result is not the same, neither attorney may be charged with having failed his or her duty for "best legal practice." Different overall results do not necessarily mean negligence. But if an attorney misses a legal deadline, (s)he has committed malpractice. Today, however, a broker has no precise "deadline." There is precise definition of "best execution" because the Commission has made it too vague and broad. But if every bid and offer in a national market qualified security were required to be able to interact at a moment in time, then our Nation would have a system with a precise, achievable definition.
If that analogy doesnt do the job, lets try another: When making a long distance conference telephone callsay, among people in Washington, Fairbanks, Alaska, Tokyo and Londoneach party uses a different local telephone company. The connections are made by the automated routing algorithms of the various long distance carriers employed in making that telephone call. But ultimately, the connections reach the various parties involved, although none knows or cares which companies have been used, or what the particular routing has been.
Likewise, in a national market system (or, better yet, an international market system), each potential buyer and seller wants to be readily able to reach and trade with the counterparty with the best contra bid or offer. Neither buyer nor seller can know who that ideal counterparty can be unless (s)he is able to enter a bid or offer that can interact with all potential counterparties. No buyer or seller wants his/her bid or offer exposed only to a subset of all the potential counterparties. If interaction with a subset should occur, there can be no assurance that the execution of that bid or offer (or the execution of a portion of that bid or offer) has ever met the mandate of "best execution" as it should in a national market system. Where a trade takes place is irrelevant to an investor; it is the total cost or net proceeds of each executionthe amount realizedwhich is the important thing.
Under the present market structure, there is no assurance that a bid or offer will have the opportunity to interact with (or even be exposed to) the best possible contra bid or offer. An investors bid entered through the Boston Stock Exchange, for example, has no opportunity to interact and execute directly with another investors offer entered through the Cincinnati Stock Exchange, or through an ECN.
While the argument is loudly made that the investor who is buying may receive the same price at the Boston Stock Exchange or elsewhere, the fact is that the selling investor who has indicated a willingness to sell at the same price through the Cincinnati Stock Exchange may not receive an execution, although the very existence of that investors offer may well have been the sole reason a specialist on the Boston Stock Exchange agreed to match the price.
While that may be considered "price improvement" for the buyer, the fact that no trade took place for the selling investor provides conclusive evidence that there was neither "price improvement," nor "best execution," since there was no trade. And it takes both a buyer and a seller to complete a trade. No matter how the arguments may be twisted or framed, there is ultimately only one way to assure the desired result: require all bids and offers for each security (deemed to be a qualified "national market security") outstanding at the same moment in time to trade in a system in which buyer and seller are able to meet directly (without the participation of a dealer) and for best bid, first entered to have the opportunity to meet the best offer, first entered. Any system which does not permit all bids and offers to interact cannot result in the national market system envisioned by Congress. This has been clearly shown by the 22-year- long failure of the Commission to solve the problem absent the only rule which will guarantee the proper result: price-time priority for each trade execution (and the implementation of which would obviate the need for almost all other rules, including many of the ones the Commission is contemplating in the Concept Release).
Today there are many market centerssome considered stock exchanges by the Commission, and others electronic communications networks ("ECNs")which trade the same securities at the same time. Each investors order is entered by its agent broker-dealer into one of these systems, either directly, or via an entry point. However, since there is no national market system, no order is guaranteed interaction with all potential contra orders.
The Commission has written and rewritten the markets structural rules so often since 1975 thatlike the Internal Revenue Codenobody can keep up with them. For the first few years, the Commission took a laissez-faire attitude toward the national market system, and allowed the New York Stock Exchange to take the lead in specifying a system which, while it had a few electronic bells and whistles for show, missed the entire point of the congressional intent.
The staff of the Commission bought the notion of allowing the NYSEs majority-owned subsidiary, the Securities Industry Automation Corporation ("SIAC")badly misnamed, as it wasto have exclusive control over what was grandly called the "essential elements" of the national market system: the Consolidated Quotations System ("CQS"), the Intermarket Trading System ("ITS"), and the Consolidated Tape Association ("CTA").
These three "systems" were not systems, nor were they integrated. They kept separate the very elements which automation for the first time in history enabled integration into a seamless unit, and as a result, they made certain the national market system as envisioned by Congress would be thwarted. For the Commission to award what it considered to be the core elements of a national market system to a single entity owned by the largest stock exchange was the antithesis of what the Congress sought when it called for the forces of competition to create the national market system.
Next, the Commission started to tinker with a badly-flawed system. Sometimes, when "tinkering" didnt work well, they used the regulatory equivalent of a sledge hammer. Most of the modifications ordered by the Commission have either not worked well, or created new problems, which, in turn have had to be "fixed." In truth, very few "fixes" have cured the original problem they were designed to cure, and none has so far created the national market system. The myriad of potential new regulations posed as "questions" in the subject Release will also fail to create the national market system.
As further evidence that the national market system does not exist even today, it is educational to note that the national market systems "laundry list" of structural problems hasnt changed much since the early 1970s: fragmentation; internalization; preferencing; lack of "best execution"; trade-throughs; crossed and locked markets; lack of precise audit trails; late and missing trade reports; inadequate and expensive regulatory oversight; congressional grumblings; investor discontent; complicated and expensive trading systems: the list goes on almost endlessly.
How should financial markets be regulated? Should regulation set the rules which define fairness, system integrity, disclosure and efficiency, and let the competitors which provide trading services fight out the best way to provide those services subject to meeting the rules? Or should the Commission continue to micromanage every minute detail of each market center, attempting to equate "fairness" with one competitor or another gaining or losing market share? The latter approach hasnt worked for more than two decades; isnt it time to try the first?
Unfortunately, the Commission doesnt see it this way. Chairman Levitt, at the open meeting of the Commission on May 23, 1997, at which the Concept Release was issued, made the following assertion:
"As regulators, we face an important choice. We can take a piecemeal approach and hope that we can accommodate technology simply by tinkering with the current regulatory scheme.
"Or we can look for ways to create a new framework -- one that will serve our markets well into the 21st century.
"The concept release we are considering today adopts the second approach. I believe it is the right one."
Having read the Concept Release carefully, I must respectfully disagree with the Chairmans characterization. The proposals made, and the questions asked in the Release subsume a great deal of tinkering with the present regulatory structure. The way the Commission has gone about the task is somewhat like the homeowner, who, in attempting to fix a wobbly chair, shortens each leg an inch at a time, each time trying to get the chair to sit straight, until finally (s)he has cut all four legs off entirely. While the chair may no longer be wobbly, it does not serve the original purpose for which it was intended. Every bit of previous tinkering with the US market structure has unbalanced the system some more, and this Release demonstrates just how much more it now resembles more one of Rube Goldbergs crazy, worthless cartoon machines than it does a modern, efficient, low-cost, electronic trading system for equities.
In addition to simplifying the regulation of the trading system itself, self-regulation of broker-dealers should be delinked from owning and operating trading facilities. This issue has not been seriously posed in the Release. Self-regulators should not regulate market centers at all, since market centers are commercial enterprises; those should be neutrally regulated. Most importantly, market center operators should not be regulated by broker-dealers under the guise of "self-regulation," and market center operators should not regulate other market centers which compete against them.
I have made this argument for the past two decades. I also made that recommendation strongly while a member of the Board of Governors of the National Association of Securities Dealers, Inc., in the early 1970s, during the debate over the Associations potential of building and operating what would become Nasdaq. And in The National Market System, a paper given in 1977 at the University of Chicago, and later published in the Financial Analysts Journal (July-August 1978), I wrote:
"One major deterrent to progress towards an NMS (national market system) is the absence of an impartial body chartered to get the job done. While self-regulation is a good concept, multiple self-regulators spoil the broth that is the securities industry, particularly since self-regulators also operate the market centers. So long as market centers compete for order flow in the same securities, self-regulation should be separated from market center promotion."
And in a paper entitled Who Should Guard the Hen House: Regulating Market Centers, co-authored with Professor Morris Mendelson and published in the Proceedings of the International Organization of Securities Commissions ("IOSCO") at their XVI Annual Conference in Washington, DC in September 1991, we stated:
"...asking market center operators to be the custodians of the public interest by serving as self-regulators is a bit like asking your friendly neighborhood fox to safeguard the hen house: very risky."
I made the same point to the Rudman Committee during their investigation of the Nasdaq market.
The Congress itself saw the possible need for neutral regulation of the national market system. In the original legislation, they proposed that the National Market Advisory Board, created by Congress to advise the Commission on the best way to achieve a national market system, should also advise the Commission on whether there should be a "National Market Regulatory Board." There was even a great deal of specificity as to what should be considered in such a Board.
Here is the language:
"B) The 2 Advisory Board shall study the possible need for modifications of the scheme of self-regulation provided for in this title so as to adapt it to a national market system, including the need for the establishment of a new self-regulatory organization (hereinafter in this section referred to as a "National Market Regulatory Board" or "Regulatory Board") to administer the national market system. In the event the Advisory Board determines a National Market Regulatory Board should be established, it shall make recommendations as to:
(i) the point in time at which a Regulatory Board should be established;
(ii) the composition of a Regulatory Board;
(iii) the scope of the authority of a Regulatory Board;
(iv) the relationship of a Regulatory Board to the Commission and to existing self-regulatory
(v) the manner in which a Regulatory Board should be funded."
In 1976 and 1977, it was clear that the NMAB would be unable to make any rational recommendations with respect to the national market system. The NMABs very composition guaranteed that no major decisions would ever be agreed, and that it would be impossible for consensus to be reached. As a result it became self-evident that there could be no National Market Regulatory Board. The establishment had accomplished their objective: to preserve their competitive position by eliminating the possibility of meaningful reform. But perhaps today, at the cusp of the 21st Century, with more than two decades for us to review the inability of the Commission to create a national market system, it will now be possible to reorganize the regulatory structure. It would seem timely for the Commission to ask the Congress whether it should now consider the establishment of such a Board to oversee the national market system.
New technologies have forever changed the face of the information processing industry, of which the trading of financial instruments is a major part, and have also made the decades-old regulatory structure obsolescent. Regulating the modern financial services industry under the present set of laws and Commission rules has about as much chance of being successful as attempting to push a wheelbarrow full of healthy frogs down the road and arriving at your destination with all frogs still on board.
The technological changes have been so rapid, and will continue to escalate even faster in the years to come, that securities regulators will keep falling farther and farther behind, should they continue their present approach.
The changes of the last three decades in market structure have been enormous. However, much of the older infrastructure has deliberately been left almost unchanged, and the requirements set forth by the Commission to interconnect disparate technologies, rather than allowing market forces to eliminate inefficient ones through competition, will continue to exacerbate the problems.
Any data processing expert will tell you that the most expensive and complicated part of any system is to be found at the intersection of disparate technologies. In a computer system, this would be exemplified by the problems of input and output devices which must be coupled with the internal processing systems. The keyboard is the slowest and most error-prone part of a computer system. Printers are also relatively slow. The screen is faster, but still very slow in relation to the disk drive, processor or memory. Making smooth connections between components operating at very different speeds is almost impossible.
The same is true in trading systems. Interconnecting the traders on the floor of a physical stock exchange with the telecommunications lines and display devices of an electronic trading system is difficult, cumbersome, and wasteful. Yet 22 years after Congress pointed out to the world that "New data processing and communications techniques create the opportunity for more efficient and effective market operations," we still are left with much of the older technologies for tradingthe modern equivalent of horse and buggy-style trading systemsin place.
Throughout the world, the notion that trading is best done on physical stock exchange floors, manned by a finite number of individual members, is fast disappearing. Just as we are the last nation in the world to move to decimal pricinga move opposed the hardest and longest by those who operate and work on physical exchange floorsso the United States is becoming almost the "Tail-end Charlie" among developed nations in retaining physical trading floors for equity trading.
The exchanges argue that their regulatory duties are far greater than those carried by the exempt exchange (the Arizona Stock Exchange) and the proprietary trading systems, typified by Madoff, Instinet and Posit. There have also been assertions made that this latter group of market centers are "unregulated," a canard. SEC regulations govern the operations of all registered broker-dealers, as well of the Arizona Stock Exchange, an exchange exempt from but a portion of the regulations to which other exchanges are subject. The choice is whether to require all market centers to assume the burdens, duties and costs of self-regulation, or to separate self-regulation from market center operation.
The first part of the argument deals with the amount of SEC regulation which affects the traditional exchanges and the NASD. Each new regulation must be approved by the Commission prior to its implementation. This has the effect of allowing the SEC to micromanage the day-to-day systems changes of these exchanges.
However, it also provides them with immunity from suit against allegations of violations of antitrust laws. This immunity is valuable; many of the rule changes have anticompetitive implications, such as the NYSE's Rule 390, Rule 62 (present version), Rule 500, and the NASD's restrictions on the use of portions of their trading systems by investors who prove too successful in their use (see, for example, Commission releases on the SOES system).
There seems to be no question that it would be fairer to put traditional exchanges, the NASD and proprietary systems on the same footing competitively. However, the question is, "Which footing?" Should they all be required to go through SEC oversight and approval, or should they all be free to make whatever changes they desire based on their wish to gain a comparative advantage? Should they all be self-regulators, or should none self-regulate?
The Securities Exchange Act as written today is premised on having the securities industry be at least partially responsible for regulating the conduct of its professional participants.
However, the Act was written in the early 1930s, when those who wrote it could not foresee the development of the technological marvels in communication and data processing we take for granted today. The drafters of the Act could also not foresee that entrepreneurs could build trading systems which were not dependent on membership organizations to operate and which would be non-geographic and electronic.
Today the traditional exchanges perform three functions: First, they operate trading systems for the benefit of their members. Second, they offer listing to certain issuers. Finally, under SEC oversight they perform some of the prudential, operational and financial regulation of their members.
This three-part role may have been appropriate when the only trading mechanisms possible were embedded within membership organizations. Today, however, when entrepreneurs can build trading systems which are open to all who wish to use them, and where the location can be cyberspace, the requirement to perpetuate multi-faceted roles creates problems, including irreconcilable conflicts of interest. If a market center operator also has regulatory power over its members, it has the potential to hold that power over the heads of its members to prevent criticism, to retain business it would otherwise lose to competitors, or to inhibit competitors' initiatives.
For example, the NYSE enforces the capital requirements set by the Commission. It also inspects members and looks for violations of its own and SEC rules. It has the ability to expel, suspend, fine or censure member firms and their employees for violations. Given this power, it is only the very brave firm or individual who will dare to challenge policies and pronouncements made by the exchange. For example, among the many offenses which are subject to a variety of "disciplinary sanctions" which consist of: "expulsion; suspension; limitation as to activities, functions and operations, including the suspension or cancellation of a registration in, or assignment of, one or more stocks; fine; censure; suspension or bar from being associated with any member or member organization, or any other fitting sanction...", is the heinous offense of: "...acts detrimental to the interests or welfare of the Exchange..." (NYSE Rule 476(a)(7).)
Whenever there is a conflict between its self-regulatory obligations and the obligations the NYSE (or, for that matter, any other traditional exchange or the NASD) may have, there is a very heavy pressure placed on the decision makers by the membership to come down on the side of their members' economic self-interests. In fact, many of the policy makers are themselves members whose self-interest might well be compromised by making a decision which favors the public interest over their own.
We have only to read the testimony of the exchange and NASD officials at the hearings a few years ago of the Subcommittee on Telecommunications and Finance to see just how the public interest is defined by those who have parallel private interests. The claims, for example, that decimalization of price increments would be difficult and costly, give plain evidence that perceived self-interest frequently overrides public interest.
It is far preferable to separate self-regulation from market center operation. This step presumably would have to be done through legislation; the SEC does not have the authority to do this unilaterally, despite their well-known creativity in crafting rules which claim to be carrying out congressional intent.
I would recommend that all market centers be treated equally: Allow them to make whatever modifications they wish to their trading systems without prior approval of the Commission, subject to those modifications meeting objective operational standards. At the same time, however, the Congress should remove all antitrust immunity from market center operators. Congress should also require the separation of market center operations from self-regulation, and encourage combining the self-regulators into a single, effective, self-regulator.
As we head into the new millennium, the Commission should seek to be as creative and innovative as the companies and people who are redrawing the faces of financial market systems. It is time to regenerate the enthusiasm that was felt in the early 1970s, when fixed commissions were finally abolished, and Wall Street and Main street looked forward to the promises contained within the new technologies and communications systems.
Instead of continual legalistic flyspecking the hoary language of laws written long before the ideas of virtual trading systems, the Internet, and global communications were with us, the Commission should take this opportunity to revamp their regulatory structure, and ask the Congress for the assistance it so wisely offered in 1975.
The balance of this Comment Letter responds, albeit briefly, to each of the questions asked in the Release.
Responses to Questions posed by the Commission
Question 1: The Commission seeks comment on the concerns identified above and invites commenters to identify other issues raised by the current approach to regulating alternative trading systems.
The Commission makes a risky presumption when it refers to market centers other than stock exchanges as "alternative trading systems." The changes which have taken place in market structure since 1975 have been so great that it will not be long before we shall refer to stock exchanges as alternative (or, more likely, old fashioned) trading systems. The economic functions of all market centers is the same: to provide counterparty search services, to discover prices, and to report transactions according to a set of predetermined rules.
Whether a market center is organized as a cooperative, or as a corporation, its aims are the same. What has become so apparent in the past two decades is that the necessity for organizing market centers as membership organizations with large trading rooms is becoming obsolescent, and that the new technologies allow a different type of structureone which permits access to the virtual trading arena by an almost infinite number of participants worldwide.
The issue of self-regulation is separate from that of market center operation. It was merely an historical accident which combined the two legislatively after the start of the Great Depression. Now, more than six decades after the establishment of the Commission and the regulatory structure which has been created since then, it is now timein fact overduefor new legislation to address the changed face of the securities industry, just as the telecommunications industry has been reregulated after technological advances.
Question 2: Are the concerns raised in this release with regard to the operation of alternative trading systems under the current regulatory approach unique to such systems?
No, the concerns are not unique to the methods of trading. However, if the regulatory system requires members, specialists and a floor, it needs to be changed, and the sooner the better.
Question 2a. To what extent could these concerns be raised by broker-dealers that do not operate alternative trading systems, such as a broker-dealer that matches customer orders internally and routes them to an exchange for execution or a broker-dealer that arranges for other broker-dealers to route their customer orders to it for automated execution?
Given a good lawyer, concerns can be raised about almost anything. A broker-dealer which internalizes its customer orders and executes them without making sure they are exposed to possible superior counterparty prices, has been a faithless agent. A proper national market system would be constructed to assure that every order had the potential to interact with the best possible price of a counterparty.
If there is to be a change to that principle, legislation must repeal the relevant parts of Section 11A of the Securities Exchange Act.
Question 3: What regulatory approaches would best address the concerns raised by the growth of alternative trading systems and the needs of the market?
A rewrite of the sections of the 1934 Act which relates to the regulation of exchanges, securities associations, broker-dealers and information processors.
Question 3a. Is the current approach the most appropriate one?
What is the current regulatory approach? Is it to issue Releases of 230 pages which ask more than 200 questions (when you count the ones which are unnumbered), apparently drafted by every single staff member of the Division of Market Regulation?
In 1975, the Congress had the right idea: Set forth a document which had relatively few objectives, and let the potential competitors fight it out, with the Commission as the party whose task it was to clear away obstacles, and serve as arbitrator. Instead, what has happened is that the Commission, rather than clearing the way, has inserted pebbles, rocks, boulders and wallsaround which, through which, and over which participants have had to climb or clamber. The Ægean stables of regulations need to be cleaned out once and for all. That does not mean no regulation. To the contrary, proper regulation would require the building of a national market system which would, by its design, make regulation simple, less costly, as well as easily understood by all market participants, especially investors.
Question 4: What should be the objectives of market regulation?
The objective of market regulation should be to create that fair field of competition on which market participants can compete for business, and to monitor compliance with the rules which create the fair field of competition.
Question 4a. Are the goals and regulatory structure incorporated by Congress in the Exchange Act appropriate in light of technological changes?
Congress was farsighted when it added Section 11A to the Exchange Act. Its drafters would hardly recognize what has happened in the 22 years since the law was passed as a result of the tinkering by Commission attorneys and the lobbying efforts of the exchanges and the NASD. The goals were good; the methods chosen to achieve those goals have not been good.
Question 4b. Are business incentives adequate to accomplish these goals?
This question seems inappropriate. It is a "When did you stop beating your wife?" type of interrogatory. First of all, what "goals" are referred to? Next, what are "business incentives?" I do not understand the question as written, but assume it was written to elicit a "no" answer. If proper business objectives are set as goals, they are sufficient.
Question 5: Are the regulatory categories defined in the Exchange Act sufficiently flexible to accommodate changes in market structure?
Question 5a. If not, what other categories would be appropriate?
There should be four broad categories of regulated entities: (1) broker-dealers, which deal with investors as agents, which trade securities as principals, and which provide investment banking and/or securities research services; (2) market centers, which include stock exchanges, electronic trading systems, crossing systems, call market systems and any other system which allows buy and sell orders to interact; and (3) information vendors, which perform the function of sending order entry, bid-offer and trade reporting information between and among broker-dealers, market centers and the public, but do not actually execute transactions.
Question 5b. How should such categories be defined?
As simply and as clearly as possible.
Question 6: Can the Commission regulate markets effectively through standard-oriented regulation of the type described above?
Yes, if it kept simple and clear.
Question 7: How could the Commission enforce compliance with the Exchange Act under such a standard-oriented approach?
By using the powers granted it under the Securities Exchange Act.
Question 8: Is the current regulatory framework an effective form of oversight, in light of technological changes?
Question 8a. Are there other regulatory techniques that would be comparably effective?
It is difficult to think of any which would be worse.
Question 8b. If so, would the implementation of such techniques be consistent with congressional goals reflected in the Exchange Act?
No more than the present ones.
Question 9: Are there viable alternatives within the existing Exchange Act structure, other than those discussed below, that would address the concerns raised by the growth of alternative trading systems and congressional goals in adopting the Exchange Act?
Question 10: What types of alternative trading systems would it be appropriate to regulate in this manner?
What is an "alternative trading system?" All trading systems attempt to do the same thing: find counterparties, execute trades and discover prices. Stock exchanges and electronic trading systems are both "alternative" systems.
Question 11: If the Commission decided to further integrate alternative trading systems into the NMS through broker-dealer regulation, should it require alternative trading systems to submit all orders displayed in their systems into the public quotation system?
The Commission was ordered by the Congress to "facilitate the establishment of a national market system." A "national market system" would contain, display and make accessible to all investors and broker-dealers all bids and offers extant at a moment in time. Otherwise it would be a "Tantalus" system, in which some bids and offers were not reachable. The Commission should not regulate market canters as broker-dealers.
Question 11a. If not, how should the Commission ensure adequate transparency?
Since the answer to Question 11 was "Yes," this question is not applicable.
Question 12: If the Commission requires alternative trading systems to submit all orders displayed in their systems into the public quotation system, how can duplicate reporting by alternative trading systems and their participant broker-dealers be prevented?
By use of a novel idea (discussed extensively for the past 25 years) known as a "price-time priority" rule. With such a rule, there could be no duplicate quotes, executions, trade-throughs or locked and crossed markets. Such a rule would also guarantee that every trade execution was a guaranteed "best execution."
Question 13: Are there other methods for integrating all orders submitted into alternative trading systems into the public quotation system?
One term which has been used is "CLOB," standing for Composite Limit Order Book. All dealer bids and offers are the functional equivalent of an investors limit (or priced) order. If dealer bids and offers and customer bids and offers are intermingled in a price-time queue, the national market system will have been created.
Question 14: Are there any reasons that orders available in alternative trading systems should not be available to the public?
Not unless the Commission wants to make the system unfair. All market information should be made available to every market participant and at the same time.
Question 15: If the Commission requires alternative trading systems to allow non-participants to execute against orders of system participants, how should it ensure that non-participants are granted equivalent access?
Sure. Just as stock exchanges should allow non-participants (non-members) to use their facilities. Why discriminate against ECNs? Use the price-time priority rule. Then all systems would be part of the national market system and there would be no "alternative" trading systems.
Question 16: If the Commission requires alternative trading systems to allow non-participants to execute against orders of system participants, how should it determine whether the fees charged to non-participants by such systems are reasonable and do not have the effect of denying access to orders?
Let competition work it out. As long as every bid and offer has a chance to be executed against every other counterpartys order, then every system will effectively give every participant equal access at the same cost. It is questions like this which demonstrate the Commissions lack of understanding of systems design.
Question 17: Are there any reasons that non-participants should not be able to execute against orders of participants in alternative trading systems?
No good ones.
Question 18: Should the Commission require alternative trading systems to provide additional information (such as identifying counterparties) to their SRO in order to enhance the SRO's audit trail and surveillance capabilities?
Again, the concept of "alternative trading system" is anathema to this commentator. But if there were such an animal as a "neutral" SRO, the answer would be a resounding "Yes." But since SROs also operate market centers which compete against other market centers, thats not the right way to do it. On the other hand, if there were a neutral facility which focused all bids and offers for the required price-time execution priority, that entity could make the audit trail as a byproduct of its other functions. However, ITS, CQS and CTA are not neutral. All three are owned and controlled by the New York Stock Exchange, which has a majority ownership interest in SIAC.
Why should "alternative trading system" operators be forced to change their rules by disclosing the identities of counterparties? All market centers should have minimum disclosure rules which do not include the identities of those doing the trading. If any market center wishes to disclose more (an unlikely event), they should be free to do so.
Question 19: What other methods could the Commission use to enhance market surveillance of activities on alternative trading systems?
I dont see where any enhanced surveillance has been made by identifying counterparties. I presume the national market system operator(s) will know the identity of all traders, and will make that information available on a need-to-know basis to the Commission. See answer to Question 18.
Question 20: Should SROs be required to surveil trading by their members in securities that are not listed or quoted on the market operated by that SRO?
A single, neutral SRO which did not own or operate a market center would be the place to lodge surveillance. We have had (and continue to have) evidence of what happens when SROs operate market centers. It sounds like a "Yes" answer to this question will result in an overproliferation of regulators to no good purpose.
Question 21: Should alternative trading systems be required to follow guidelines regarding the capacity and integrity of their systems?
Not if set by the Commission or the existing SROs. The customers of the market centers should select the winners, in part by their capability to handle the business. Here the market should be allowed to work, so long as the rules under which the market centers operate are neutral and fair. If a market center operator doesnt provide enough capacity, it will lose business, as it should.
Question 21a. If not, how should the Commission address systemic risk concerns associated with potentially inadequate capacity of alternative trading systems, particularly those systems with significant volume?
Not applicable. See answer to Question 21.
Question 22: With what types of standards regarding computer security, capacity, and auditing of systems, should alternative trading systems be required to comply?
The standards should be set by open competition, and data and communication standards set by appropriate, technologically-qualified industry groups. Presumably, customers of these market centers would wish to make certain they were satisfied as to the quality of their vendors, and to receive assurances the systems worked as advertised. If not, competition will take care of things far better than if bureaucrats do so.
Question 23: To what extent would complying with systems guidelines similar to those implemented by exchanges and other SROs require modification to the current procedures of alternative trading systems?
It would probably be better if the exchanges had to modify their systems to meet those the Commission refers to as the "alternative trading systems." It is difficult to imagine Bernie Madoff being told to develop a SuperDot and a trading floor.
Question 23a. What costs would be associated with such modifications?
Humongous and unnecessary.
Question 23b. How much time would be required to implement the necessary modifications and systems enhancements?
Question 23c. Please provide a basis for these estimates.
Nearly a half-century of experience in dealing with the glacial pace of exchange innovation.
Question 24: Is access to alternative trading systems an important goal that the Commission should consider in regulating such systems?
When Congress mandated a national market system, they meant it. They did not intend to exclude market centers which did not then exist. The answer is a resounding "Yes!" Access to the national market system should be universal.
Question 24a. If so, are there circumstances in which alternative trading systems should be able to limit access to their systems (for example, should the Commission be concerned about access to an alternative trading system that has arranged for its quotes to be displayed as part of the public quotation system)?
The question is not whether access to market centers should be restricted by market center operators. The question is whether the bids and offers, once entered into any trading system, should be restricted from availability for viewing and execution on a price-time priority basis. All disclosed bids and offers entered into the national market system (whether dealer bids and offers or investor bids and offers) should be made available instantly to all. After all, Congress mandated that there be "availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities...", not that some participants should see bids and offers, but not all.
Question 25: If alternative trading systems were to continue to be regulated as broker-dealers and were subject to a fair access requirement, should the Commission consider denial of access claims brought by participants and non-participants in alternative trading systems?
All market centers should be regulated as market centers, not as broker-dealers. This would also include all crossing systems as well as all others.
Question 25a. If not, are there other methods that could adequately address such claims?
Question 26: Are commenters aware of any unfair denials of access by broker-dealers operating alternative trading systems, where there were no alternative trading venues available to the entities denied access?
Yes, and there has been denial of access to systems other than alternative trading systems.
Question 27: Would enhanced surveillance of alternative trading systems by their SROs raise competitive concerns that could not be addressed through separation of the market and regulatory functions of the SROs?
SROs which also operate market centers should not surveil any trading systems. If they surveil their own, they risk a major conflict of interest, such as last years Nasdaq problem, and if they surveil another market centers trading system, they have an unfair economic competitive advantage.
Question 28: If alternative trading systems continue to be regulated as broker-dealers, are there other ways to integrate the surveillance of trading on alternative trading systems?
No market center should be regulated as a broker-dealer. They should all be regulated as market centers.
Question 29: What is the feasibility of establishing an SRO solely for the purpose of surveilling the trading activities of broker-dealer operated alternative trading systems, that does not also operate a competing market?
At least with this question you are on the right track. Let me ask you one in return: What is the feasibility of establishing an SRO which has no duties other than to surveil all market centers (including stock exchanges and associations) under the ægis of the Commission? That would be the sensible solution.
Question 30: If alternative trading systems continue to be regulated as broker-dealers, how can the Commission address anticompetitive practices by such systems?
They cannot, at least not very effectively.
Question 31: Would this approach be an effective means of addressing the issues raised by the growth of alternative trading systems?
See answer to Question 29.
Question 31a. What would be the benefits of such an approach?
See answer to Question 29.
Question 31b. What would be the drawbacks of such an approach?
See answer to Question 29.
Question 32: If the Commission reinterpreted the term "exchange," are the factors described above (i.e., (1) consolidating orders of multiple parties and (2) providing a facility through which, or setting conditions under which, participants entering such orders may agree to the terms of a trade) sufficient to include the alternative trading systems described above?
Why not get rid of the term "exchange" as a legal entity. "Market center" is far more descriptive, and by using it, it gets rid of any differentiation of organizations which all have the same economic function.
Question 33: Is broadening the Commission's interpretation of "exchange" to cover diverse markets, and then exempting all but the most significant of these new exchanges from registration, the most appropriate way to address the regulatory gaps discussed above and provide the Commission with sufficient flexibility to oversee changing market structures?
If there is an easy way to do something, and a hard way, why does the Commission always seem to suggest the hard way?
Question 34: Are there any other categories of alternative trading systems that have sufficiently minimal effects on the public secondary market that they should be treated as exempted exchanges?
Here we are again! Even if a market center handles only trades for 10 users, every trade they make is just as important to their clients as any trade a market center makes for 10,000,000 investors. Regulation should be the same for all, and national market system executions should also be the same: Best bid, first entered, should always be able to find and be executed against best offer, first entered. That is the essence of the national market system Congress wanted.
Question 35: Should low impact markets be regulated as exempted exchanges, rather than as broker-dealers?
What in the world is a "low impact" market? The only "low impact" anything I am aware of is low impact aerobics! If the Commission means "low volume," my answer that all market centers should be regulated the same, still stands.
Question 36: What measure or measures should be used in determining whether a market has a low impact?
No measure. All markets have a major impact on their users.
Question 36a. What is the level above which an alternative trading system should not be considered to have a low impact on the market?
One trade a year.
Question 36b. At what level should an already registered exchange be able to deregister?
All market centers should be regulated alike. There would be no need to "deregister."
Question 37: Should an alternative trading system be considered to have a low impact on the market and be treated as an exempted exchange if it trades a significant portion of the volume of one security, even if the trading system's overall volume is low in comparison to the market as a whole?
See answer to Question 36.
Question 38: In determining whether an alternative trading system has a low impact, what factors other than volume should the Commission consider?
See answer to Question 36.
Question 38a. Should this determination be affected if the operator of an alternative trading system was the issuer of securities traded on that system?
See answer to Question 36.
Question 39: Should passive markets be regulated as exempted exchanges, rather than as broker-dealers?
Treat them all the same: as market centers!
Question 40: Are the requirements described above appropriate to ensure the integrity of secondary market oversight?
If you mean, do my answers (if implemented) solve the problem, the answer is "Yes."
Question 41: Should any other requirements be imposed upon exempted exchanges, such as requirements that an exempted exchange provide fair access or establish procedures to ensure adequate system capacity, integrity, and confidentiality?
As noted before, access to bids, offers and executions in the national market system are what is needed. If any market center operator wants to limit access on any other terms, why not?
Question 42: Should requirements vary with the type of alternative trading system (e.g., should passive systems be subject to different conditions than systems exempted on the basis of low impact)?
Question 43: Should the Commission require that securities traded on exempted exchanges be registered under Section 12 of the Exchange Act?
Not necessarily. The entire concept of "listed" and "unlisted" seems archaic these days. The national market system talks about securities with "unique" trading characteristics potentially trading in different subsystems, not "listed" and "unlisted" securities trading differently. What "unique trading characteristics" do Intel and Motorola have to differentiate them, for example? Why do they trade on different "subsystems" even though they are both qualified national market securities? I dont remember ever seeing an SEC Release that deals with this issue. Why not?
Question 43a. Should different disclosure standards be applicable to such securities if they are only traded on such exchanges?
Minimum disclosure requirements should be the same for all registered securities. Any issuer should be free to disclose more.
Question 44: Should the Commission allow institutions to be participants on registered exchanges to the same extent as registered broker-dealers?
Access to the national market system should be restricted by objective criteria which ensures fulfillment of the contract and deters market manipulation. If one market center wants to give access to institutions, why not?
Question 44a. If so, should the Commission adopt rules allowing registered exchanges to have institutional participants, or should the Commission issue exemptive orders on a case-by-case basis, upon application for relief by registered exchanges?
Why does the Commission rely so heavily on its exemptive authority? Market centers should be able to have as customers (rather than as "members") any person or institution which meets whatever objective criteria are established.
Question 45: Should the Commission allow exchanges to provide services exclusively to institutions?
If the question were rephrased as "market centers" rather than "exchanges," the answer is "Yes." Otherwise, the answer is "No."
Question 46: If the Commission allows institutions to participate in exchange trading, should the Commission view all entities that have electronic access to exchange facilities as "members" under the Exchange Act and then exempt exchanges from Section 6(c)(1)?
In my answer to Question 44a, I indicated the term "member" was inappropriate. Market centers should not be clubs. Again, market centers should be able to have as customers any person or institution which meets whatever objective criteria are established.
Question 47: Is it foreseeable that exchanges will wish to permit retail investors to be participants in their markets?
See answer to Question 46.
Question 47a. If so, should the Commission allow retail participation on registered exchanges to the same extent as registered broker-dealers?
See answer to Question 46.
Question 48: Should the Commission allow registered exchanges to provide services exclusively to retail investors?
See answer to Question 45.
Question 49: Could exchanges have various classes of participants, as long as admission criteria and means of access are applied and allocated fairly?
What a great idea! Sure!
Question 49a. Would it be in the public interest if new or existing exchanges sought to operate primarily or exclusively on a retail basis?
That would be up to the market to determine. But, as asked, it doesnt appear to be against the public interest. After all, arent retail investors also members of the public?
Question 49b. What would be the advantages and disadvantages if new or existing exchanges were to admit as participants only highly capitalized institutions or only highly capitalized institutions and broker-dealers?
Once again, it would be up to the market to determine whether it is a great idea or a dumb one. Remember, my hypothesis is that every bid and offer, whether a customers order or a dealers quote, would be accessible and visible to all market participants at the moment an execution was made. And trade executions would have a national market system-wide price-time priority sequence.
Question 50: Should non-membership exchanges (including alternative trading systems that may register as exchanges) be exempt from fair representation requirements?
So long as all market centers agree to the price-time priority rule in the national market system.
Question 51: Should all exchanges be required to comply with Section 6(b)(3) by having a board of directors that includes participant representation?
No. Some market centers may be proprietary, and some may be public companies.
Question 52: If not, are there alternative structures that would provide independent, fair representation for all of an exchange's constituencies (including the public)?
If the national market system itself is fair, and the Commissions oversight is effective, there is no need to get into that level of detail. The market will sort things out if a customer is unhappy with his or her choice of a market center.
Question 53: Would the revised interpretation of "exchange" being considered by the Commission adequately and clearly include alternative trading systems that operate open limit order execution systems (even those that also provide brokerage functions)?
As noted earlier, get rid of the term "exchange" entirely from a regulatory perspective, and call every system which sends buy and sell orders for execution a market center.
Question 54: In light of the decreasing differentiation between market maker quotes and customer orders in trading, should the Commission consider an "order" to include any firm trading interest, including both limit orders and market maker quotes?
As noted earlier, all bids and offers should be able to interact, be displayed, and treated alike.
Question 55: What should the Commission consider to be "material conditions" under which participants entering orders may agree to the terms of a trade?
If the buyer and seller agree on the execution price, and so long as the price-time priority rule is observed, those would be the "material conditions" of the trade. It goes without saying, of course, that the buyer and seller must both have been able to enter their bid and offer through registered market centers.
Question 55a. For example, should an alternative trading system be considered to be setting "material conditions" when it standardizes the material terms of instruments traded on the market, such as standardizing option terms or requiring participants that display quotes to execute orders for a minimum size or to give priority to certain types of orders?
Standardized options trade on an options exchange. Priority should be restricted to price and time.
Question 56: Is it appropriate for the Commission to consider the activities described above as broker-dealer activities?
No. These are market center activities.
Question 57: How should a revised interpretation of exchange adequately and clearly distinguish broker-dealer activities, such as block trading and internal execution systems, from market activities?
Internal crossing systems and block trades should all be executed though a price-time priority rule in the national market system. Inferior-priced and later entered orders would be deferred until the first orders at the best prices were executed.
Question 58: Are the distinctions discussed above accurate reflections of exchange and broker-dealer activities?
Please see my earlier answers on that matter.
Question 58a. Are there other factors that may better distinguish a broker-dealer from an exchange?
I go back to the definition of "market center," which includes systems that effectuate trades.
Question 59: How should a revised interpretation of the term "exchange" adequately and clearly distinguish broker-dealer activities, such as block trading and internal execution systems, from market activities?
Already asked (As Question 57) and answered.
Question 60: What factors should the Commission consider in determining whether an organization of dealers is sufficiently "organized" to require exchange registration?
If there is a trading capability between buyers and sellers, they are a "market center."
Question 61: Does the revised interpretation of "exchange" described above clearly exclude information vendors, bulletin boards, and other entities whose activities are limited to the provision of trading information?
If the function of a bulletin board is to bring buyer and seller together, it is a "market center." However, if dealers make the trade other than on the bulletin board system, whatever system they use to make the trade becomes the market center, and the price-time priority rule must be observed. If the bulletin board is used for information, rather than trade execution, the operator of the bulletin board is an information vendor, not a market center.
Question 61a. How should the Commission distinguish between information vendors, bulletin boards, and exchanges?
If a trade execution functionality exists, it is a market center. Otherwise it is an information vendor.
Question 62: If the Commission expands its interpretation of "exchange," should the Commission exempt interdealer brokers that deal only in exempted securities from the application of exchange registration and other requirements?
See answer to Question 61a.
Question 63: How could the Commission define interdealer brokers in a way that would implement congressional intent not to regulate traditional interdealer brokers as exchanges, without unintentionally exempting other alternative trading systems operated by brokers?
If there is a problem, ask Congress to help you solve it by legislation. Careful draftsmanship will solve almost anything.
Question 64: How could the Commission foster the continued trading of all securities currently traded on alternative trading systems if these systems are classified as exchanges under the interpretation described above and some of these systems are required to register as national securities exchanges?
Thats one of the reasons why I suggest that all market centers be regulated and registered alike.
Question 64a. For example, what would be the effect on alternative trading systems that wish to trade securities exempted from registration under Rule 144A if those systems are required to register as national securities exchanges?
See answer to Question 64.
Question 65: How would the requirement to have rules in place for trading unlisted securities affect the viability of alternative trading systems that are required to register as national securities exchanges?
The whole notion of listed and unlisted is obsolete. All investors should be able to trade all securities in the best possible system. Back to the notion of "market centers."
Question 66: Would the specifications in the OTC-UTP plan relating to the trading of Nasdaq/NM securities pose particular problems for systems that are required to register as national securities exchanges?
Not necessary if its done right.
Question 67: Should the Commission extend UTP to securities other than NM securities, such as Nasdaq SmallCap securities?
Sure. Trade them all the same way: price-time priority!
Question 67a. What effect would an inability to trade Nasdaq SmallCap and other non-Nasdaq/NM securities have upon alternative trading systems that are required to register as national securities exchanges?
None, if you use the concept of market centers.
Question 68: What effect would the prohibition on UTP trading of newly listed stock until the day following an initial public offering have upon systems that are required to register as national securities exchanges?
See answer to Question 67.
Question 69: How should existing exchange rules designed to limit members from effecting OTC transactions in exchange-listed stock be applied, if the Commission's interpretation of exchange were expanded to include alternative trading systems and organized dealer markets?
Dont apply them; repeal them.
Question 69. What customer protection and competitive reasons might there be to preserve these rules if alternative trading systems are classified as exchanges?
Classify "alternative trading systems" and exchanges the same: as market centers.
Question 70: What effects would linking alternative trading systems to NMS mechanisms have on those systems?
What are the "NMS mechanisms?" If they include ITS, CQS and CTA, these are all obsolescent facilities which would disappear in a proper national market system. All market centers should be part of the national market system.
Question 70a. For example, how would such linkages affect the ability of alternative trading systems to operate with trading and fee structures that differ from those of existing exchanges or to alter their structures?
Its called "competition." The low cost provider who also gives customers what they want will win.
Question 70a. To what extent could revision of the NMS plans alleviate these effects?
If its done right, the problems go away. Otherwise theyll just get more complicated.
Question 71: Are there any insurmountable technical barriers to admission of alternative trading systems into the CTA, CQS, OPRA, or OTC-UTP plans?
The only barriers are those in the governance, design and operational characteristics of those plans.
Question 72: What costs are associated with the admission of new applicants to these plans?
The plans should be scrapped and a new set of rules written.
Question 73: Are there any CTA, CQS, OPRA, or OTC-UTP plan rules that would prevent newly registered national securities exchanges from obtaining fair and equal representation on these entities?
Probably, but so far I dont have a copy of all the plans.
Question 74: What effect would the admission of newly registered national securities exchanges to the CTA, CQS, OPRA, and OTC-UTP plans have upon the governance and administration of those plans?
It would probably make those who are in the plans angry, and would make it even harder to make them work.
Question 75: Do admissions fees for new participants required by the terms of the plans present a barrier to admission to the plans?
Question 75a. Do the plans' provisions that all participants are eligible to share in the revenues generated through the sale of data affect commenters' views on this issue?
I cant speak for any commenter except me, and my answer is "no," but most probably, yes.
Question 76: What effect would the admission of new, highly automated participants have upon the operation of the ITS?
In sworn testimony before two committees of the House of Representatives in 1979, I testified: "You have asked me for my assessment of the ITS system...
"ITS is merely a teletype-like message delivery system which interconnects exchange floors and is used by specialists to lay off their excess trading positions at other exchanges. ITS creates the illusion, rather than the reality, of a modern automated system. It adds to existing costs. It replaces nothing. In short, it is not an element of a national market system."
At the same hearings, William Schreyer, then president of Merrill Lynch, also in sworn testimony, testified: "The Intermarket Trading System, or ITS, which links the New York with some regional exchanges, is a communications device, and nothing more. It is as far from the concept of an automated, efficient marketplace as a tom-tom is from a communications satellite."
Connecting ITS to modern, automated trading systems like Instinet or Optimark would be a farce.
Question 77: How would compliance with the current ITS rules and policies affect trading on alternative systems that may be regulated as exchanges?
It would cripple them.
Question 77a. How appropriate are these rules and policies for alternative trading systems?
Not appropriate at all.
Question 78: What costs would be associated with newly registered exchanges joining ITS?
Lots, and there would be a complete waste of money.
Question 78a. Would those costs represent a barrier for newly registered exchanges to join ITS?
Sure. Who wants to waste money?
Question 79: Are there any ITS plan rules or practices that would prevent newly registered national securities exchanges from obtaining fair and equal representation on the ITS?
Yes, and the Commission has already pointed some out in their letter of May 26, 1997.
Question 80: What effect would the admission of newly registered national securities exchanges to the ITS plan have upon the governance and administration of the plan?
It would make things even more complicated.
Question 81: What effect would the requirements to impose trading halts or circuit breakers in some circumstances have upon alternative trading systems if such systems were regulated as exchanges?
I have long believed that trading halts are anathema to markets. If the Commission wants to do something useful, let the price-time priority rule be implemented, and require that all bids and offers in the national market system be priced. Then if there is a problem, and the spread opens up because of a bad day, the "circuit breaker" will be the fact that consenting adults do not want to trade at the prices quoted, not because some bureaucrats have determined they shouldnt trade.
Question 82: What impact would registration of an alternative trading system as an exchange have on the institutional participants of that trading system, including registered investment companies?
See answer to Questions 44-46.
Question 83: If the Commission allows institutions to effect transactions on exchanges without the services of a broker, to what extent should an exchange's obligations to surveil its market and enforce its rules and the federal securities laws apply to such institutions?
Market centers should not surveil. An independent SRO and the Commission should surveil.
Question 84: How could an exchange adequately supervise institutions that effect transactions on an exchange without the services of a broker?
Presumably, every entity which was permitted to enter bids and offers into a national market system would be surveilled by some regulatory entity. If there were a neutral market center regulator, that regulator would surveil those participants. It is important to distinguish between surveillance of market centers and surveillance of market participants. Market centers should make certain the price-time priority rule is kept, and that the core order queuing and execution facilities operate properly according to their rules. Market Center participantsbroker-dealers and others permitted direct access to the national market centerwould be regulated by their self-regulators under the Commissions oversight.
Question 85: What, if any, accommodations should be made with respect to an exchange's surveillance, enforcement, and other SRO obligations with respect to institutions that transact business on that exchange?
See answer to Question 84.
Question 86: How could institutions that directly access exchanges be integrated into existing systems for clearance and settlement?
All institutions which are fiduciaries must use a financial institution with trust powers. Those institutions are alreadyor can easily becomemembers of clearing corporations and depositories. If electronic execution of trades becomes the norm, clearing houses may well no longer be needed, since every trade could be instantly settled with the institutional counterparty, as is done now in Switzerland.
Question 87: Under what conditions should an entity be subject to both exchange and broker-dealer regulation?
If the same entity performs the functions of a market center as well as a broker-dealer, it will need to be regulated by both regulatory organizations, just as banks which operate broker-dealer subsidiaries are today regulated by bank regulators and the Commission. I would presume that the market center operations of a broker-dealer would be contained in a separate subsidiary.
Question 88: Should a dually registered entity be required to formally separate its exchange operations from its broker-dealer operations (e.g., through use of separate subsidiaries)?
See answer to Question 87.
Question 89: Would this approach be an effective means of addressing the issues raised by the growth alternative trading systems?
As stated above, all market centers should be regulated equally.
Question 89a. What would be the benefits of such an approach?
Great and many.
Question 89a. What would be the drawbacks of such an approach?
No important ones.
Question 90: Would it be feasible for the Commission to expand the scope of rules eligible for expedited treatment pursuant to Section 19(b)(3)(A) without jeopardizing the investor protection and market integrity benefits of Commission oversight of exchange and other SRO rule changes?
Question 90a. If so, to what types of rule filings should immediate effectiveness, pursuant to Section 19(b)(3)(A), be extended?
As many as possible.
Question 91: If the Commission expands the scope of rule filings eligible for treatment under Section 19(b)(3)(A) to include, for example, certain types of new products, what conditions or representations should be required of an SRO to ensure that the proposed rule change is eligible for expedited treatment under Rule 19b-4?
I am not certain what types of "new products" the Commission refers to. If they mean new trading innovations, so long as they are not anti-competitive, go for it.
Question 92: Should the Commission exempt markets' proposals to implement new trading systems, separate from their primary trading operations, from rule filing requirements?
As noted earlier, market center regulation should be separate from conduct and capital regulation.
Question 92a. If so, should SROs be permitted to operate pilot programs under such an exemption if they trade the same securities, operate during the same hours, or utilize similar trading procedures as the SRO's main trading system?
So long as a system-wide price-time priority rule is in place.
Question 92b. Should there be a limit on the number of pilot programs an SRO can operate under an exemption at any one time?
SROs should not operate pilot programs; market centers should be able to innovate easily.
Question 92c. What other conditions should apply to such exemption?
See answer to Question 92b.
Question 93: Do differences between automated and non-automated trading require materially different types or degrees of surveillance or enforcement procedures?
Yes. Non-automated systems require much higher levels of surveillance than do properly-designed automated systems.
Question 94: Which Exchange Act requirements applicable to registered exchanges, if any, could be minimized or eliminated without jeopardizing investor protection and market integrity?
As proposed earlier, there should be the same regulation over all market centers, whether the are known as "exchanges" or otherwise.
Question 95: If an automated exchange contracts with another SRO to perform its day-to-day enforcement and disciplinary activities, should this affect the exchange's requirement to ensure fair representation of its participants and the public in its governance?
Bad idea! There should be one SRO which regulates broker-dealer activities. As far as governance goes, market centers should represent the interest of their owners. Competition, fairly conducted., will take care of the public interest, so long as they all operate under SEC rules for equal access and information.
Question 96: If an exchange contracts with another entity to perform its oversight obligations, should that exchange continue to have responsibility under the Exchange Act for ensuring that those obligations are adequately fulfilled?
See answer to Question 95.
Question 97: What costs to investors and other market participants are associated with the current regulation of alternative trading systems as broker-dealers?
Large costs. Regulation of market centers should be simplified.
Question 97a. Specifically, what costs are associated with the potential denial of access by an alternative trading system?
Legal costs, for one. Litigation in the securities industry is extremely high because of the way it has been regulated. However, if every participant who wishes to do so can have access to the national market system with a price-time priority rule, that should reduce costs substantially.
Question 98: What costs are associated with each of the alternatives for revising market regulation discussed above?
Lots of costs, most of them unnecessary. If the Commission obtains the authority from Congress to regulate all market centers alike, and to divide regulated market participants into four broad groups: market centers, broker-dealers, information communicators and post-trade processors (clearing houses and depositories), the regulatory task would be far simpler and less costly. The Commissions alternatives, as outlined in the Concept Release, would be cumbersome and add to the systems complexities.
Question 98a. For example, would either of the two principal alternatives discussed in Section IV above impose costs by limiting innovation?
See answer to Question 98.
Question 98b. Would these costs be greater than those imposed by the current regulatory approach?
Question 99: What regulatory costs can be shared by markets operating simultaneously as self-regulatory organizations, and what regulatory costs must be borne by each market individually?
As noted earlier, market center operators do not lend themselves well to being self-regulators.
Question 99a. What are the relative magnitudes of these costs (as a proportion of total costs)?
Impossible to answer given the information provided.
Question 100: Are there innovations or adjustments that can be made to market wide plans such as CQS, CTA and ITS that will lead to lower regulatory costs for exchanges under any of the alternatives for regulating domestic markets?
Not under any of the alternatives proposed. As stated earlier, all three plans are fatally flawed, since they do not create the elements of a national market system, and they are all under the operational control of the New York Stock Exchange through SIAC.
Question 101: Total regulatory costs vary with a variety of factors (e.g., volume of trade, degree of technology applied in trade). Of these factors, which are most relevant in considering the alternatives discussed above?
The more manual the trading system, the more expensive the regulatory costs. In addition, to the extent the national market system is segmented into disconnected elements (CQS, ITS and CTA being a prime example), the more costly it becomes.
Question 101a. For example, recognizing that some market mechanisms may rely on some factors more than others, to what extent are regulatory costs greater for particular mechanisms than others?
See answer to Question 101.
Question 102: What costs are associated with the responsibilities of an SRO?
A properly-designed SRO will charge for the examination of broker-dealer financial records, enforcement of ethical conduct with clients, and employee registration.
Question 102a. Will the costs to existing SROs be reduced by registering significant alternative trading systems as exchanges?
Question 103: What regulatory burdens currently inhibit innovation of trading systems?
Far too complicated rules and too much micromanagement by Commission. The Commission should set forth the general "fairness" rules, such as price-time priority, accessibility requirements, minimum price increments (pennies), and let the competitors have at it. Then such systems as Optimark could flourish with minimum intervention by government.
Question 103a. How will the alternatives discussed above change the incentives for innovation?
I believe so much time will be spent on reading the Commissions Concept Release and attempting to answer the 200-plus questions that innovation will be stifled for years to come for that reason alone. Since there will be uncertainty as to what the rules will be, people will not want to invest in new systems that may be made illegal by unknown regulations.
Question 104: Will the alternatives discussed above impose costs on systems that differ depending on the nature of the trade?
Question 104a. For example, will the proposed regulatory revisions change the costs of trades directly between customers relative to the costs of trades between a customer and a dealer?
If all trades must pass the price-time priority screening, they should all cost the same at the moment of execution.
Question 105: What regulatory approaches would best address the concerns raised by the development of automated access to foreign markets?
It would be too easy just to state "common sense." So long as the investor is affirmatively toldeither by the system and/or by his/her broker-dealerthat the trade will be made on a foreign market, not regulated by the U.S. government, that should be sufficient. For example, when leaving the "Thomas.gov" Web site on the Internet, the viewer is told of that fact when they click on a hyperlinked address outside of the Thomas system. That provides the necessary caveat emptor notification. That might be a good paradigm for the Commission.
There is no way the Commission can regulate foreign markets the same way they regulate US markets. People should assume responsibility for their own conduct.
Question 105a. Would these approaches differ if U.S. investors accessed foreign markets in ways other than those described above, such as through the Internet?
See answer to Question 105.
Question 105b. Are there any other alternative approaches that could be more appropriate?
See answer to Question 105.
Question 106: If the Commission were to rely solely on a foreign market's primary regulator, how could it address the investor protection and enforcement concerns discussed above?
By disclosure, as discussed in the answer to Question 105.
Question 107: Should the Commission require foreign markets with only limited activities in the United States to register as national securities exchanges or obtain an exemption from such registration?
These are really two separate questions. Certainly foreign market centers (which is what I believe the term "markets" refers to above) should not have to register as US market centers. If US investors are told that the Commission does not regulate foreign market centers, but instead the investors should rely on the foreign regulators or not trade on foreign market centers, that should suffice.
Question 107a. How would this affect U.S. persons trading directly on foreign markets?
See answer to Question 107.
Question 108: How can the Commission best achieve its goal of regulating the U.S. activities of foreign markets?
Its tough and getting tougher. Why not just work with the other countries and convince them of the merits of full and fair disclosure? Also, warn US investors that the SEC cannot regulate outside its borders and that if they are not prepared to have to live with that limitation, they should not invest outside the US.
Question 108a. Commenters should take into consideration that foreign markets are regulated abroad, that there is a potential for international conflicts of law, and that the Commission has jurisdictional limits. Given the difficulties of surveilling public networks such as the Internet, would an access provider approach be workable?
It might work for a short while, but the innovators will come up with something different. There is no point in conducting a stern chase; regulation will always be far behind innovation.
Question 109: What would be the best way for the Commission to regulate the limited U.S. activities of foreign markets that provide remote access to U.S. members?
See answer to Question 107.
Question 110: When should an entity be required to register with the Commission as a non-exclusive SIP under Section 11A of the Exchange Act?
With respect to information about US securities, they should be required to register; with respect to non-US securities, they should not be required to register.
Question 110a. For example, should the activities described above require registration as a SIP?
With respect to information about securities not traded on US market centers, the answer is "No."
Question 111: If the SIP approach were adopted, is it likely that U.S. members of foreign markets would wish to transmit their orders to such markets through more than one SIP registered with the Commission?
Not applicable, given my answer above.
Question 111a. If so, should all but one of those SIPs be exempt from registration?
Question 112: Under the SIP approach, should foreign markets that allow their U.S. members to transmit their orders solely through a registered SIP have a safe harbor from registration as national securities exchanges?
Question 113: What type of activities should a registered SIP be permitted to conduct on behalf of a foreign market without the SIP or the foreign market registering as an exchange?
Providing information on securities not traded on a US market center.
Question 114: What types of automated broker-dealer systems, both operational and contemplated, would be encompassed within the above description of access providers to foreign markets?
All that exist, and those that will be invented. This is really an impossible question to answer.
Question 114a. How widespread are these activities?
Question 115: Would the above description of broker-dealer access providers adequately and clearly exclude traditional brokerage activities, particularly handling the execution of customer orders on foreign markets?
As I have proposed, broker-dealer registration and regulation would be separated from market center operation and regulation.
Question 115a. If not, how should such activities be distinguished from traditional brokerage activities, particularly traditional cross-border activities?
See answer to Question 115.
Question 115b. Should U.S. broker-dealers that provide investors with access to foreign markets be subject to any additional requirements?
Yes, disclosure to clients that they are trading on markets which the US does not regulate.
Question 116: Should foreign broker-dealers that provide U.S. investors with automated access to foreign markets be required to register as broker-dealers on the basis of that activity?
If a US resident has an account with a broker-dealer, that broker-dealer should be registered.
Question 117: What types of conditions, if any, should the Commission place on access providers if it were to pursue that approach?
See answer to Question 115b.
Question 118: If the Commission decides to regulate access providers to foreign markets, what criteria should the Commission use in determining whether an exchange is a bona fide foreign market?
The broker-dealer handling the US client should have the necessary information on the bona fides of the foreign market. If the broker-dealer does not have that information, the Commission should have enforcement power over the broker-dealer.
Question 118a. Should a market be required to have at least a majority of foreign members in order to be a bona fide foreign market?
No, not necessarily. The issue should be whether the securities traded on the foreign market are not traded in the US.
Question 118b. Should the Commission exclude exchanges that provide terminals in the United States?
Question 119: Should the Commission regulate as a U.S. exchange any market that, although organized and having its principal place of business outside of the United States, is under common control with or controlled by U.S. persons, or whose decisions regarding trading rules, practices, or procedures are made by U.S. persons?
No, provided the US person is located outside the US.
Question 120: What factors should the Commission use in determining whether an exchange is operating a trading facility in the United States and is not a bona fide foreign market?
Registration with the Commission.
Question 120a. If exchange-owned terminals are located in the United States, should this constitute operating a trading facility in the United States?
Not necessarily. Ownership of the terminals is unimportant; operational control should prevail.
Question 121: What effect would a reinterpretation of the term "exchange" under Section 3(a)(1) of the Exchange Act have on any Commission proposal to regulate SIP and broker-dealer access providers?
The term "exchange" should be scrapped, and replaced with the term "market center," which should be defined as any facility, automated or otherwise, which allows bids and offers of national market-eligible securities to execute against each other. This would cover existing stock exchanges, over-the-counter markets, crossing systems, matching systems, and any other system which permits buyers and sellers to execute orders in securities traded in the United States.
Question 122: If the Commission decides to regulate access providers to foreign markets, should the Commission require access providers to transmit orders only to foreign markets that are willing to share, and capable of sharing, information with the Commission in connection with investigations involving violations of U.S. securities laws?
No, as long as the foreign markets agree to warn US investors that they are not protected by the SEC.
Question 122a. If so, what standard should the Commission use in determining whether a foreign market would provide meaningful assistance to the Commission?
Question 122b. If commenters believe that SIP and/or broker-dealer access providers should be permitted to transmit orders to any foreign market, indicate how the Commission could ensure that it has the ability to enforce the applicable provisions of the federal securities laws.
They cant. However, US broker-dealers must have warned customers about lack or regulation by US regulators.
Question 123: Should the Commission require access providers to transmit orders only to foreign markets that are located in countries that have entered into arrangements with the Commission to provide enforcement and information sharing assistance?
No, provided clients have been informed of the status.
Question 124: If the Commission regulated access providers through the approach described above, should SIP access providers be limited to providing their services to sophisticated institutions or should they be allowed to provide any U.S. investor with the capability of directly trading on foreign markets as members?
Not applicable. See answer to Question 123.
Question 124a. If so, should broker-dealer access providers be subject to similar requirements?
Not applicable. See answer to Question 123.
Question 125: If the Commission permits SIP access providers to offer their services only to broker-dealers and certain sophisticated institutions, how should this category of sophisticated institutions be defined?
By objective criteria, which should not necessarily include net worth. Knowledge, not money, should be the criterion.
Question 126: Should the Commission permit SIP and broker-dealer access providers to transmit orders to foreign markets for the securities of U.S. issuers or only for the securities of non-U.S. issuers?
No. Only for securities not traded on US market centers.
Question 127: Should the Commission limit the ability of SIP and broker-dealer access providers to transmit orders to foreign markets for the securities of non-U.S. issuers if the "principal market" for those securities is located in the United States?
Question 127a. If so, how should the Commission determine when the "principal market" of a non-U.S. security is located in the United States?
Question 128: If the Commission permits SIP and broker-dealer access providers to transmit orders to foreign markets only for securities of non-U.S. issuers, how should the Commission distinguish between U.S. and non-U.S. issuers?
Not applicable. See answer to Question 127a.
Question 129: If the Commission decides to regulate access providers to foreign markets, should they be required to make and keep records?
Question 129a. What records should registered SIP and broker-dealer access providers be required to maintain?
The usual ones.
Question 130: Should access providers be required to file periodic reports?
Question 130a. If so, what information should those contain?
Question 131: Should broker-dealer access providers be required to keep records of denials of access to their services?
Question 131a. Should they be required to notify the Commission of such denials of access?
No. Those who have been denied access, if they believe they have been discriminated against, wont need any help.
Question 132: What types of risks should be disclosed to users of SIP and broker-dealer access providers?
Just the usual fair dealing disclosures.
Question 132a. For example, should SIP and broker-dealer access providers be required to disclose the listing and maintenance standards of foreign markets to which they transmit orders on behalf of U.S. persons?
Question 132b. What would be the costs associated with such a requirement?
Question 133: Should access providers be required to make disclosures to sophisticated institutions?
No. Caveat emptor should prevail.
Question 134: What market information should SIP and broker-dealer access providers be required to provide to the users of their services?
Whatever their marketing departments believe is necessary to make the sale.
Question 135: Should direct trading in foreign listed companies be limited to those that satisfy U.S. disclosure standards in order to better protect U.S. investors?
Question 136: Is it sufficient to merely disclose to investors that the information available about a foreign security may significantly differ from the information that would be available about U.S. securities?
Question 136a. Do public policy concerns dictate that the Commission make distinctions based on whether investors receive adequate information?
Question 137: Are there circumstances under which unregistered foreign securities should be permitted to trade on foreign markets through an access provider?
Question 137a. For example, should the Commission establish some de minimis threshold for a foreign security based on the dollar value of the U.S. float or trading volume in that security, or on the relative percentage of U.S. float or trading volume compared to that of the home or worldwide markets?
Question 138: Should the exemption from registration under Exchange Act Rule 12g3-2(b) be available if a significant portion of an issuer's float is traded in the United States?
Question 139: Given that broker-dealers currently trade unregistered securities for customers, should the Commission reconsider its approach to securities registration requirements in this context?
Question 139a. Are there other viable alternatives that would ensure adequate disclosure to U.S. investors trading on foreign markets?
Question 140: Is trading in unregistered foreign securities through an access provider to a foreign market appropriate if access is limited to sophisticated investors?
Question 140a. For example, should access providers be permitted to transmit orders for unregistered foreign securities to a foreign market on behalf of qualified institutional buyers as defined in Rule 144A of the Securities Act?
The rule should be changed to make it read "educated" investors, not "institutional" investors. Individuals may well be as sophisticatedor more sophisticatedthan institutional investors.
Question 141: Are there uniform procedures that the Commission should impose on foreign markets or on access providers to assure that securities are not sold to U.S. investors in circumstances that result in a public distribution of securities in the United States that are not registered under the Securities Act?
Question 142: What are the consequences to SEC reporting companies if unregistered foreign securities listed on foreign markets are available to be purchased or sold through access providers?
It will probably make them look better as investment vehicles.
Question 143: Would any of the approaches described above provide an effective means of addressing the issues raised by foreign market activities in the United States, including providing key protections for U.S. investors?
No, but the one I have recommended might do so.
Question 143a. What would be the benefits of each approach?
Question 143b. What would be the drawbacks of each approach?
I dont envy the Commission its task of having to read and analyze the comment letters that will be generated by this Concept Release. However, I pray the Commission will take this as a God-given opportunity to simplify and streamline the national market system we have been waiting for so long.
Once again, I appreciate having an opportunity to comment on the Release. Enjoy!
Very truly yours,
/s/ Junius W. Peake
Junius W. Peake
Monfort Distinguished Professor of Finance
University of Northern Colorado
SECURITIES EXCHANGE ACT OF 1934
Securities Exchange Act of 1934
Section 11A. National Market System for Securities; Securities Information Processors
(a) (1) The Congress finds that--
(A) The securities markets are an important national asset which must be preserved and strengthened.
(B) New data processing and communications techniques create the opportunity for more efficient and effective market operations.
(C) It is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure--
(i) economically efficient execution of securities transactions;
(ii) fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets;
(iii) the availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities;
(iv) the practicability of brokers executing investors' orders in the best market; and (v) an opportunity, consistent with the provisions of clauses (i) and (iv) of this subparagraph, for investors' orders to be executed without the participation of a dealer.
(D) The linking of all markets for qualified securities through communication and data processing facilities will foster efficiency, enhance competition, increase the information available to brokers, dealers, and investors, facilitate the offsetting of investors' orders, and contribute to best execution of such orders.
(2) The Commission is directed, therefore, having due regard for the public interest, the protection of investors, and the maintenance of fair and orderly markets, to use its authority under this title to facilitate the establishment of a national market system for securities (which may include subsystems for particular types of securities with unique trading characteristics) in accordance with the findings and to carry out the objectives set forth in paragraph (1) of this subsection. The Commission, by rule, shall designate the securities or classes of securities qualified for trading in the national market system from among securities other than exempted securities. (Securities or classes of securities so designated hereinafter in this section referred to as "qualified securities".)
(3) The Commission is authorized in furtherance of the directive in paragraph (2) of this subsection--
(A) to create one or more advisory committees pursuant to the Federal Advisory Committee Act (which shall be in addition to the National Market Advisory Board established pursuant to subsection (d) of this section) and to employ one or more outside experts;
(B) by rule or order, to authorize or require self-regulatory organizations to act jointly with respect to matters as to which they share authority under this title in planning, developing, operating, or regulating a national market system (or a subsystem thereof) or one or more facilities thereof; and
(C) to conduct studies and make recommendations to the Congress from time to time as to the possible need for modifications of the scheme of self-regulation provided for in this title so as to adapt it to a national market system.
(b) (1) Except as otherwise provided in this section, it shall be unlawful for any securities information processor unless registered in accordance with this subsection, directly or indirectly, to make use of the mails or any means or instrumentality of interstate commerce to perform the functions of a securities information processor. The Commission, by rule or order, upon its own motion or upon application, may conditionally or unconditionally exempt any securities information processor or class of securities information processors or security or class of securities from any provision of this section or the rules or regulations thereunder, if the Commission finds that such exemption is consistent with the public interest, the protection of investors, and the purposes of this section, including the maintenance of fair and orderly markets in securities and the removal of impediments to and perfection of the mechanism of a national market system:
Provided, however, That a securities information processor not acting as the exclusive processor of any information with respect to quotations for or transactions in securities is exempt from the requirement to register in accordance with this subsection unless the Commission, by rule or order, finds that the registration of such securities information processor is necessary or appropriate in the public interest, for the protection of investors, or for the achievement of the purposes of this section.
(2) A securities information processor may be registered by filing with the Commission an application for registration in such form as the Commission, by rule, may prescribe containing the address of its principal office, or offices, the names of the securities and markets for which it is then acting and for which it proposes to act as a securities information processor, and such other information and documents as the Commission, by rule, may prescribe with regard to performance capability, standards and procedures for the collection, processing, distribution, and publication of information with respect to quotations for and transactions in securities, personnel qualifications, financial condition, and such other matters as the Commission determines to be germane to the provisions of this title and the rules and regulations thereunder, or necessary or appropriate in furtherance of the purposes of this section.
(3) The Commission shall, upon the filing of an application for registration pursuant to paragraph (2) of this subsection, publish notice of the filing and afford interested persons an opportunity to submit written data, views, and arguments concerning such application. Within ninety days of the date of the publication of such notice (or within such longer period as to which the applicant consents) the Commission shall--
(A) by order grant such registration, or
(B) institute proceedings to determine whether registration should be denied. Such proceedings shall include notice of the grounds for denial under consideration and opportunity for hearing and shall be concluded within one hundred eighty days of the date of publication of notice of the filing of the application for registration. At the conclusion of such proceedings the Commission, by order, shall grant or deny such registration. The Commission may extend the time for the conclusion of such proceedings for up to sixty days if it finds good cause for such extension and publishes its reasons for so finding or for such longer periods as to which the applicant consents.
The Commission shall grant the registration of a securities information processor if the Commission finds that such securities information processor is so organized, and has the capacity, to be able to assure the prompt, accurate, and reliable performance of its functions as a securities information processor, comply with the provisions of this title and the rules and regulations thereunder, carry out its functions in a manner consistent with the purposes of this section, and, insofar as it is acting as an exclusive processor, operate fairly and efficiently. The Commission shall deny the registration of a securities information processor if the Commission does not make any such finding.
(4) A registered securities information processor may, upon such terms and conditions as the Commission deems necessary or appropriate in the public interest or for the protection of investors, withdraw from registration by filing a written notice of withdrawal with the Commission. If the Commission finds that any registered securities information processor is no longer in existence or has ceased to do business in the capacity specified in its application for registration, the Commission, by order, shall cancel the registration.
(5) (A) If any registered securities information processor prohibits or limits any person in respect of access to services offered, directly or indirectly, by such securities information processor, the registered securities information processor shall promptly file notice thereof with the Commission. The notice shall be in such form and contain such information as the Commission, by rule, may prescribe as necessary or appropriate in the public interest or for the protection of investors. Any prohibition or limitation on access to services with respect to which a registered securities information processor is required by this paragraph to file notice shall be subject to review by the Commission on its own motion, or upon application by any person aggrieved thereby filed within thirty days after such notice has been filed with the Commission and received by such aggrieved person, or within such longer period as the Commission may determine. Application to the Commission for review, or the institution of review by the Commission on its own motion, shall not operate as a stay of such prohibition or limitation, unless the Commission otherwise orders, summarily or after notice and opportunity for hearing on the question of a stay (which hearing may consist solely of the submission of affidavits or presentation of oral arguments). The Commission shall establish for appropriate cases an expedited procedure for consideration and determination of the question of a stay.
(B) In any proceeding to review the prohibition or limitation of any person in respect of access to services offered by a registered securities information processor, if the Commission finds, after notice and opportunity for hearing, that such prohibition or limitation is consistent with the provisions of this title and
the rules and regulations thereunder and that such person has not been discriminated against unfairly, the Commission, by order, shall dismiss the proceeding. If the Commission does not make any such finding or if it finds that such prohibition or limitation imposes any burden on competition not necessary or appropriate in furtherance of the purposes of this title, the Commission, by order, shall set aside the prohibition or limitation and require the registered securities information processor to permit such person access to services offered by the registered securities information processor.
(6) The Commission, by order, may censure or place limitations upon the activities, functions, or operations of any registered securities information processor or suspend for a period not exceeding twelve months or revoke the registration of any such processor, if the Commission finds, on the record after notice and opportunity for hearing, that such censure, placing of limitations, suspension, or revocation is in the public interest and necessary or appropriate for the protection of investors or to assure the prompt, accurate, or reliable performance of the functions of such securities information processor and that such securities information processor has violated or is unable to comply with any provision of this title or the rules or regulations thereunder.
(c) (1) No self-regulatory organization, member thereof, securities information processor, broker, or dealer shall make use of the mails or any means or instrumentality of interstate commerce to collect, process, distribute, publish, or prepare for distribution or publication any information with respect to quotations for or transactions in any security other than an exempted security, to assist, participate in, or coordinate the distribution or publication of such information, or to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any such security in contravention of such rules and regulations as the Commission shall prescribe as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of this title to--
(A) prevent the use, distribution, or publication of fraudulent, deceptive, or manipulative information with respect to quotations for and transactions in such securities;
(B) assure the prompt, accurate, reliable, and fair collection, processing, distribution, and publication of information with respect to quotations for and transactions in such securities and the fairness and usefulness of the form and content of such information;
(C) assure that all securities information processors may, for purposes of distribution and publication, obtain on fair and reasonable terms such information with respect to quotations for and transactions in such securities as is collected, processed, or prepared for distribution or publication by any exclusive processor of such information acting in such capacity;
(D) assure that all exchange members, brokers, dealers, securities information processors, and, subject to such limitations as the Commission, by rule, may impose as necessary or appropriate for the protection of investors or maintenance of fair and orderly markets, all other persons may obtain on terms which are not unreasonably discriminatory such information with respect to quotations for and transactions in such securities as is published or distributed by any self-regulatory organization or securities information processor;
(E) assure that all exchange members, brokers, and dealers transmit and direct orders for the purchase or sale of qualified securities in a manner consistent with the establishment and operation of a national market system; and
(F) assure equal regulation of all markets for qualified securities and all exchange members, brokers, and dealers effecting transactions in such securities.
(2) The Commission, by rule, as it deems necessary or appropriate in the public interest or for the protection of investors, may require any person who has effected the purchase or sale of any qualified security by use of the mails or any means or instrumentality of interstate commerce to report such purchase or sale to a registered securities information processor, national securities exchange, or registered securities association and require such processor, exchange, or association to make appropriate distribution and publication of information with respect to such purchase or sale.
(3) (A) The Commission, by rule, is authorized to prohibit brokers and dealers from effecting transactions in securities registered pursuant to section 12(b) otherwise than on a national securities exchange, if the Commission finds, on the record after notice and opportunity for hearing, that--
(i) as a result of transactions in such securities effected otherwise than on a national securities exchange the fairness or orderliness of the markets for such securities has been affected in a manner contrary to the public interest or the protection of investors;
(ii) no rule of any national securities exchange unreasonably impairs the ability of any dealer to solicit or effect transactions in such securities for his own account or unreasonably restricts competition among dealers in such securities or between dealers acting in the capacity of market makers who are specialists in such securities and such dealers who are not specialists in such securities; and (iii) the maintenance or restoration of fair and orderly markets in such securities may not be assured through other lawful means under this title.
The Commission may conditionally or unconditionally exempt any security or transaction or any class of securities or transactions from any such prohibition if the Commission deems such exemption consistent with the public interest, the protection of investors, and the maintenance of fair and orderly markets.
(B) For the purposes of subparagraph (A) of this paragraph, the ability of a dealer to solicit or effect transactions in securities for his own account shall not be deemed to be unreasonably impaired by any rule of an exchange fairly and reasonably prescribing the sequence in which orders brought to the exchange must be executed or which has been adopted to effect compliance with a rule of the Commission promulgated under this title.
(4) The Commission is directed to review any and all rules of national securities exchanges which limit or condition the ability of members to effect transactions in securities otherwise than on such exchanges.
(5) No national securities exchange or registered securities association may limit or condition the participation of any member in any registered clearing agency.
(d) (1) Not later than one hundred eighty days after the date of enactment of the Securities Acts Amendments of 1975, the Commission shall establish a National Market Advisory Board (hereinafter in this section referred to as the "Advisory Board") to be composed of fifteen members, not all of whom shall be from the same geographical area of the United States, appointed by the Commission for a term specified by the Commission of not less than two years or more than five years. The Advisory Board shall consist of persons associated with brokers and dealers (who shall be a majority) and persons not so associated who are representative of the public and, to the extent feasible, have knowledge of the securities markets of the United States.
(2) It shall be the responsibility of the Advisory Board to formulate and furnish to the Commission its views on significant regulatory proposals made by the Commission or any self-regulatory organization concerning the establishment, operation, and regulation of the markets for securities in the United States.
(3) (A) The Advisory Board shall study and make recommendations to the Commission as to the steps it finds appropriate to facilitate the establishment of a national market system. In so doing, the Advisory Board shall assume the responsibilities of any advisory committee appointed to advise the Commission with respect to the national market system which is in existence at the time of the establishment of the Advisory Board.
(B) The Advisory Board shall study the possible need for modifications of the scheme of self-regulation provided for in this title so as to adapt it to a national market system, including the need for the establishment of a new self-regulatory organization (hereinafter in this section referred to as a "National Market Regulatory Board" or "Regulatory Board") to administer the national market system. In the event the Advisory Board determines a National Market Regulatory Board should be established, it shall make recommendations as to:
(i) the point in time at which a Regulatory Board should be established;
(ii) the composition of a Regulatory Board;
(iii) the scope of the authority of a Regulatory Board;
(iv) the relationship of a Regulatory Board to the Commission and to existing self-regulatory
(v) the manner in which a Regulatory Board should be funded.
The Advisory Board shall report to the Congress, on or before December 31, 1976, the results of such study and its recommendations, including such recommendations for legislation as it deems appropriate.
(C) In carrying out its responsibilities under this paragraph, the Advisory Board shall consult with self-regulatory organizations, brokers, dealers, securities information processors, issuers, investors, representatives of Government agencies, and other persons interested or likely to participate in the establishment, operation, or regulation of the national market system.
-- Emphasis added.
-- National Market