May 18, 2000

Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549

Re: SEC File No. SR-NYSE-99-48

Dear Mr. Katz:

The Philadelphia Stock Exchange, Inc. ("Phlx") appreciates the opportunity to comment on the questions regarding market fragmentation raised in Release No. 34-42450 (February 23, 2000) ("Release") of the Securities and Exchange Commission ("Commission"), concerning New York Stock Exchange ("NYSE") Rule 390. As the Commission knows, the Phlx has long favored the abolition of Rule 390 because of its fundamentally anticompetitive effects, and we applaud the Commission's decision to approve its abolition.

Before addressing specific questions raised in the Release, we note that those questions arise in the context of unparalleled technological advances affecting our markets and consequent uncertainty regarding basic issues of market structure. As Chairman Levitt noted on March 16 in a speech at the Northwestern University School of Law, "the very ground beneath our feet is undergoing seismic shifts." In the midst of this uncertainty, the Commission has received requests from various quarters to take basic steps that would preempt market forces and affect the structure of our markets, by governmental fiat, for years to come. Not surprisingly, many of these requests are inconsistent, even dramatically opposed to one another. At one extreme, for example, the NYSE seeks to withdraw from, and thereby destroy, the Intermarket Trading System1 which, however imperfect, remains the basic linkage between the equity markets. Such a step would be a radical departure from the Commission's history of encouraging the interaction of U.S. securities markets and would be a risky wager. At the other extreme, a group of large market participants has endorsed a plan by which the Commission would mandate a "Super National Market System," or "Super-NMS," that would involve, among other things, technologically advanced linkages among self-regulatory organizations ("SROs") and electronic communications networks ("ECNs") and strict price-time priority for orders, so that orders would flow automatically to the market that first posted the best price.2 Such a step may be consistent with the Commission's emphasis on market integration, but it would be a departure from the Commission's record of regulating rather than dictating the manner in which our markets function. As Chairman Levitt noted in that same speech at Northwestern Law School, a single monolithic market might make the world simpler. "But I believe Congress was visionary in choosing not to mandate such a market. Over the last 25 years, our system of competing market centers has been the driving force behind faster and cheaper executions, spawning new trading systems that provide anonymity and greater liquidity."

The Phlx agrees with the position long held by the Commission3 that the public would benefit from firm linkages among equity market centers, possibly together with some form of rule on price-time priority that would reward a participant who takes the risk of improving prices. As Chairman Levitt noted last February, the technology exists to put such a system in place, with appropriate rules relating to order size, among other things. The Commission's views on market integration were a major impetus for the formation in 1978, pursuant to section 11A(a)(3)(B) of the Securities Exchange Act of 1934, of the Intermarket Trading System ("ITS").4 ITS is a commitment system and not a composite book. Nevertheless, it permitted the various market centers to interact to a degree not previously possible and provided enhanced protection for limit orders. In approving the ITS plan, however, the Commission declined to impose a consolidated book on the industry. Doing so, it said, "would have an impact on existing market institutions which could properly be viewed as a fundamental change in the manner in which securities trading is now conducted, and it is difficult to foresee, and to provide against, the problems and difficulties which might arise."5 This view remains sound today. It is apparent from the conflicting positions taken by market participants that there is no consensus in the equities market for a consolidated order book or for strict price-time priority. It is also apparent that without a significant degree of market consensus, the Commission cannot impose a system by fiat without the risk of creating an inefficient, government-mandated trading system that would be relatively inflexible and slow to adapt to on-going market developments.

The Phlx is convinced that competitive results can be achieved by a variety of market structures, including both a highly integrated structure and a structure characterized by competing, independent, but linked market centers. We therefore believe that the Commission should presently eschew measures that would preempt the market's evolution or alter its fundamental structure or operation. Rather, the Commission should ensure that a freely evolved market structure continues to operate in an increasingly fair and transparent manner, and should hold the present course of moderate regulation and incremental improvement designed to curb abuses and promote quality executions.

The Commission is right to be concerned that the emergence of ECNs, the demise of Rule 390, the growth of the so-called third market, the possible entry of new exchanges, and other factors, while creating a healthy competitive environment for inter-market competition, have the potential for creating pools of liquidity where orders and other market interest do not interact sufficiently, thereby resulting in harm to investors. The Phlx believes, however, that the market has not yet had a chance to fully adapt its systems and business practices to the very large number of major new initiatives affecting the equities markets. Some of these initiatives, such as the promulgation of Regulation ATS and the Order Handling Rules, the partial opening of ITS, and decimalization, have been introduced or fostered by the SEC. Others have been the result of spontaneous market forces and have been, if possible, even more far-reaching. Neither the Commission nor members of the industry can now predict with confidence how these changes will affect our marketplace even in the fairly short term. Moreover, no one has defined or measured fragmentation at this stage (if it exists), or shown that it is inconsistent with investor protection and the other goals of the National Market System. We therefore believe that it would be prudent for the Commission to observe and study the impact of these developments and initiatives for a reasonable period of time before introducing structural or other basic changes in the market.

With this general approach in mind, we now turn to certain specific questions posed in the Release.

1. Effect of Fragmentation on the Markets

a. Fragmentation in General

b. Internalization and Payment for Order Flow

c. Best Execution of Investor Limit Orders

2. Possible Options for Addressing Fragmentation

a. Require Greater Disclosure by Market Centers and Brokers Concerning Trade Executions and Order Routing.

b. Restrict Internalization and Payment for Order Flow

c. Require Exposure of Market Orders to Price Competition

d. Adopt an Intermarket Prohibition Against Market Makers Trading Ahead of Previously Displayed and Accessible Investor Limit Orders

f. Establish Price/Time Priority for All Displayed Trading Interest


Rapid technological advances have improved the operation of capital markets around the world and have significantly enhanced competition and the consequent benefits to investors. The Order Handling Rules, the recent removal of a major anti-competitive obstacle in the form of NYSE Rule 390, and other regulatory reforms have also made the market more transparent, have increased competition, and have benefited investors. The market's competitive engine is dynamic and powerful, and while it advances in fits and starts, it works. At this juncture, we strongly counsel against all of the more radical steps now under discussion - creating a CLOB, destroying ITS, imposing rules that would preempt different modes of competition - and urge instead that the Commission pursue a course of steady, incremental reforms, including the improvement of ITS, combined with increased vigor in the enforcement of already existing rules. The Phlx appreciates the opportunity to make these comments.

Yours truly,

Meyer S. Frucher
Chairman and Chief Executive Officer

cc: The Hon. Arthur Levitt, Chairman
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Norman S. Johnson, Commissioner
The Hon. Paul R. Carey, Commissioner
The Hon. Laura S. Unger, Commissioner
Annette L. Nazareth, Esq., Director, Division of Market Regulation
Robert L. D. Colby, Esq., Deputy Director, Division of Market Regulation


1 Letter from James E. Buck to Jonathan G. Katz regarding Release No. 34-42208, SEC File No. 57-28-99, p. 23.

2 "Responding to Chairman Levitt's Call: A Plan for Achieving a True National Market System," Wall Street Journal Interactive, February 29, 2000

3 See, e.g., Statement on the Future Structure of the Securities Markets (1972); Policy Statement of the Securities and Exchange Commission on the Structure of a Central Market System (1973); Release No. 34011942 (Dec. 19, 1975).

4 Release No. 34-14416 (Jan. 26, 1978).

5 Release 34-14116.

6 Report on the Practice of Preferencing Pursuant to Section 510(c) of the National Securities Markets Improvement Act of 1996 (April 11, 1997).