June 2, 2006
The Commission has before it a proposal to exempt from Exchange Act registration New York Stock Exchange (NYSE) traded corporate bonds (Release No. 34-51998). The release was issued for public comment on July 7, 2005, with comments due by August 7, 2005. To date, over eight months after the end of the comment period, there has been no action on this proposal. There is no reason for the Commissions further delay.
For fourteen years, I was closely involved with this NYSE exemption effort, first as an Exchange employee and for these past four years, until the end of 2005, as a consultant. During most of the 1970s I worked for Weeden Company and was actively involved with key market structure issues being addressed by the Congress and the SEC – including unfixed commission rates, the consolidated tape and quotation systems, barriers to competition, and the enactment of the Securities Act amendments of 1975. During most of the 1960s, I worked for the SEC in Washington, DC the first two years for the Special Study of Securities Markets followed by six-plus years with, what was then the Division of Trading and Markets.
The requested exemption would allow the NYSE to trade corporate bonds of NYSE-listed equity issuers and their wholly-owned subsidiaries without requiring bond issuers to list those securities. This proposed exemption is not as broad as that first sought by the NYSE in 1992, which in part, was for bond issuers subject to Exchange Act financial reporting. Despite the 1992 elimination of bond listing fees for almost all bonds, bond underwriters recommend against such listing, for reasons that need not be stated. From 1992 through 2005, the inventory of NYSE-listed corporate bonds steadily declined from 1,626 to 528. With that decline, NYSE bond volume plummeted. During 1991-1992, RJR-Nabisco bonds were the most traded on the NYSE. It was believed that NYSE volume in RJR bonds averaged well over 30 percent of their total traded volume. There were days when the number of NYSE trades in individual RJR bonds exceeded the number of trades in the equities of either ATT or IBM. This is mentioned to show what the NYSE bond market could do then – and can do today – with the ability to trade a broad inventory of corporate bonds.
During all these years no one, at the SEC or anywhere else, ever articulated an even remotely coherent reason for the continuation of an unnecessary competitive barrier in the trading of corporate debt – continued Exchange Act registration required for exchange trading and the absence of such registration for o-t-c bond trading. It is simply a case of perpetuating useless authority, at the individual bond investors expense.
While consideration of the NYSE exemption proposal continued, the SEC encouraged, received application for, and approved an NASD filing for the collection and reporting of over-the-counter trades in corporate bonds. The program, TRACE (Trade Reporting and Compliance Engine) was filed in 1999, approved in 2001, and commenced in 2002.
A comparison of the essential differences between TRACE and NYSE bond price disclosure shows the inadequacy of TRACE and the large investor benefits of the NYSE bond market.
TRACE: prices reported by brokers and dealers, from many diverse sources trade reports are at prices inclusive of mark-ups/mark-downs some trades are reported at weighted-average prices fifteen-minute window for submitting trade prices trades not reported in precise time sequence caps on the size of the trade being reported and, no collection/dissemination of bond quotes (actionable or otherwise) with quote sizes.
NYSE: ABS (Automated Bond System) the NYSEs bond trading system, started in 1977. It is a remote access, order-driven trading system, allowing subscriber firms to enter and monitor ABS orders. ABS matches orders on a strict price and time priority basis, displaying all orders anonymously, except for the entering firms orders. The system disseminates completed trade prices and volumes and live, actionable quotations, with size, in precise time sequence, on an absolute real-time basis. All reported and quoted prices are exclusive of commissions (no mark-up/mark-down). As with equities, commissions are separately disclosed on the customers confirmation. The system also calculates the accrued interest for each trade, which calculation is disclosed on the confirmation and included in the locked-in submission to clearing at DTCC.
In brief, it is ABS transparency v. TRACE obscurity.
ABS is aimed at, but not limited to, the small-lot (individual) bond market, where the disclosure it provides is most needed. There are no size caps on ABS trade reports, and when large ($1million to $5million par value and higher) trades take place, the full size is reported. In 1991 and 1992, many such trades took place.
Also, as noted below, the publics orders can, and do, meet directly on ABS, whereas on the o-t-c market, all orders go through dealers and are double-counted.
Individual investors are those currently disadvantaged in the bond markets and the ones for whom ABS-type disclosure is, as just noted, most needed. Many bond dealers resist this type of disclosure, but why has the SEC failed to act for fourteen years?
Is TRACE-type disclosure preferred by the commission staff? I have long believed that one of the SECs primary obligations is to protect the individual investor. Would TRACE-type disclosure pass muster in corporate equity trading? If not, why should it be acceptable for corporate bonds – especially when an equity-like price disclosure alternative exists?
Between bond purchases and sales, the range of o-t-c mark-ups/mark-downs can reach ten percent No wonder there are elements in the industry fighting the type of bond price disclosure ABS provides.
As individual bond investors, what would the commissioners prefer: paying undisclosed mark-ups, or seeing disclosed commissions always having to buy from, or sell to, a bond dealer, or having the opportunity to be part of the quote having a wide choice of bonds to choose from, or having that choice limited to what the dealer has in inventory?
The Division of Market Regulation has called NYSE bond-trading rules thin. Since the NYSEs key bond trading rule is based on matching orders using the elegance of strict price and time priority, what else could be required? In addition to providing an opportunity for public orders to meet directly (see Section 11A of the Exchange Act), NYSE bond rules, among other things, cover accrued interest calculations, and recognition and reflection of changes in the status of bonds, such as redemptions and flat trading. None of these is recognized in the NASDs TRACE rules. What are the NASD bond trading rules? They do not exist. TRACEs thick rules involve how bond trades are reported to TRACE within the fifteen-minute window, and by whom. In all fairness, there is a TRACE rule recognizing bond calls. Somewhere in that dense package is a requirement for the reporting of trades in called bonds within 365 days. NASD oversight efforts are consumed by slogging through endless analytic contortions to measure the fairness of undisclosed mark-ups and mark-downs.
If you have any questions, I would be pleased to try to answer them, in person, or otherwise.
It should be noted that for most of these past fourteen years, the exemption was stuck in the Division of Corporation Finance, which has the primary responsibility for Exchange Act registration under Section 12.