Mr. Jonathan G. Katz Secretary, Office of the Secretary Mail Stop 0609 Securities and Exchange Commission 450 Fifth Street, NW Washington, D.C. 20549 Re: Comments Concerning File Nos. SR-NYSE-00-18 and SR-NYSE-00-19 Dear Mr. Katz:
This letter sets forth the comments of Archipelago, L.L.C. (“Archipelago”) in
response to two proposed rule changes filed with the Securities and Exchange Commission (“SEC” or “Commission”) by the New York Stock Exchange, Inc. (“Exchange”). The first proposal—SR-NYSE-00-18—would enhance the ability of investors to access trading interest displayed on the Exchange through the creation of an “auto-ex” order (“Access Proposal”). The second proposal—SR-NYSE-00-19—would create an internalization facility by which Exchange members could route matched orders that had been traded “upstairs,” provided that such internalizing members met certain price improvement standards (“Internalization Proposal”).
Archipelago is a large electronic communications network that provides order
handling and routing to a varied subscriber base, which includes market makers, institutional investors, online retail brokerage firms, proprietary traders, and options market makers. Currently, Archipelago accounts for nearly 5% of volume executed in over-the-counter securities listed by The Nasdaq Stock Market, Inc. (“Nasdaq”). Archipelago handles a substantially smaller—but rapidly growing—portion of volume executed in Exchange-listed securities, primarily due to the practical difficulties of
1 SEC Release No. 34-42913 (June 8, 2000), 65 FR at 37587 (“Access Release”).
2 SEC Release No. 34-43110 (July 31, 2000), 65 FR at 48776 (“Internalization Release”).
Mr. Jonathan G. Katz File Nos. SR-NYSE-00-18 & SR-NYSE-00-19 December 15, 2000 Page 2 achieving an electronic linkage to the trading interest displayed by the Exchange. Consequently, Archipelago is keenly interested in providing its views on both proposals to the Commission.
The Access Proposal would allow Exchange members to route an auto ex order, in
the form of a marketable limit order, to the Exchange floor for immediate Execution. A size limitation of 1099 shares would apply to such auto ex orders. In addition, the Exchange intends to exclude executions of auto ex orders from the calculation of the “tick test” required by Rule 10a-1 under the Securities and Exchange Act of 1934 (“Act”).
On the whole, Archipelago supports the Access Proposal because it represents a
substantial improvement to the current ability to reach out to the Exchange via electronic means. Although the 1099-share limit for auto ex orders is restrictive, Archipelago is hopeful that the Exchange will soon remove, or at a minimum reduce, this constraint. The days of manual interaction with every order by requirement, and of 22-second average Exchange response times, will soon be an unpleasant memory. By taking steps to advance electronic access to the Exchange floor, the Access Proposal is consistent with Section 11A of the Act, which requires marketplaces to seek to assure efficient execution of investor orders.
That being said, Archipelago does not agree that auto ex orders should be
excluded from the tick test for the purposes of contemporaneously-effected transactions on the Exchange floor. First, from a fairness perspective, it is unclear from the Access Proposal if other market centers would be able to discern executions of auto ex orders, in order to similarly except such executions from the tick test. Second, a number of market centers that trade Exchange-listed securities offer automated execution systems today, typically without 1099-share limits. Again, from a fairness perspective, these market centers are prohibited from availing themselves of a tick test exception in connection with such systems. Consequently, Archipelago respectfully suggests that the Commission require the deletion of proposed Exchange Rule 1003, which sets forth the tick test exception.
Under the Internalization Proposal, Exchange members will be able to route
“coupled orders” to the Exchange floor that, provided such orders meet price
3 Access Release, supra note 1, at 37587. A marketable limit order is a limit order to buy (sell) at
a price that is greater (less) than, or equal to, the displayed best offer (bid) quote on the Exchange.
4 Access Release, supra note 1, at 37588.
Mr. Jonathan G. Katz File Nos. SR-NYSE-00-18 & SR-NYSE-00-19 December 15, 2000 Page 3 improvement requirements, shall be “printed” by the Exchange. For agency crosses, in which both components of the coupled order represent the trading interest of non-broker dealers, the coupled order may be priced at either: (1) the best bid (offer) displayed on the Exchange, provided that the buy (sell) component of the coupled order was entered before the sell (buy) component; or, (2) at a price within the bid-ask spread displayed by the Exchange. For internalized trades, in which one component of the coupled order represents the proprietary trading interest of an Exchange member, the coupled order may be priced at either: (1) the best offer (bid) displayed on the Exchange, provided that the buy (sell) component of the coupled order represents the proprietary interest of an Exchange; or, (2) at a price within the bid-ask spread displayed by the Exchange. As with auto ex orders, a 1099-share limit for coupled orders would apply.
The Internalization Proposal marks a significant change in thinking at the
Exchange, which heretofore has been in strident opposition to internalization. Through the Internalization Proposal, the Exchange has made a business decision to facilitate off-Exchange trading within its purview, provided internalizing members meet certain price improvement standards. Archipelago notes that the standards for “cross orders”—essentially equivalent to coupled orders, but without a size limitation—proposed by the Pacific Stock Exchange, Inc. (“PCX”) in connection with the Archipelago Exchange, an electronic facility for trading equities on PCX, are substantially similar to those contemplated by the Internalization Proposal. Indeed, both proposals stand in stark
6 Internalization Release, supra note 2, at 48776.
10 See, e.g., SEC Release No. 34-42450 (February 23, 2000), 65 FR at 10579. In this filing, the
Exchange proposed to rescind Exchange Rule 390, which prohibited Exchange members from proprietary off-Exchange trading. The Exchange argued that the intent and effect of the rule was to limit the practice of internalization, which, in the opinion of the Exchange, increases market fragmentation.
11 See proposed PCX Rule 7.6, Commentary .06, SEC Release No. 34-43608 (November 21,
2000), 65 FR at 78856 (“ARCA/PCX Proposal”). The two proposals differ in that the price improvement standards of the ARCA/PCX Proposal are more stringent then those contemplated by the Internalization Proposal. Specifically, the ARCA/PCX Proposal: (1) does not have a less restrictive standard for agency crosses; (2) requires a price improvement of the greater of the minimum pricing increment and 10% of the spread; and, (3) does not allow an order to step ahead of the other side of the market in the course of price improvement.
For example, if the market was $10 to $10 ¼, with the $10 ¼ offer representing a 300-share
investor limit order, it would be possible under the Internalization Proposal for a dealer to trade with an incoming customer sell order at $10 ¼, despite the fact that an investor order resides on the book at that
Mr. Jonathan G. Katz File Nos. SR-NYSE-00-18 & SR-NYSE-00-19 December 15, 2000 Page 4 contrast to Nasdaq, a marketplace that does not hold internalizing dealers to price improvement standards.
The Internalization Proposal is silent on whether coupled orders would be held to
the existing trade-through provisions of the Intermarket Trading System. Archipelago assumes that, if the Internalization Proposal were approved, coupled orders would be required to conform in this fashion.
By facilitating off-Exchange trading, the Internalization Proposal enhances
competition for trading venues of Exchange-listed securities. Further, by allowing agency orders to cross without the proprietary positioning of floor-based Exchange members, the Internalization Proposal allows for investor orders to interact without participation of a dealer. On both counts, the Internalization Proposal is consistent with Section 11A of the Act.
For the foregoing reasons, therefore, Archipelago encourages the Commission to
approve both the Access Proposal, with the suggested modification, and the Internalization Proposal. Archipelago is happy to further discuss either proposal at the request of the Commission.
_________________________________ Gerald D. Putnam
price. By preventing the dealer from price improving the incoming order to $10 ¼, or to a price superior thereto, the ARCA/PCX Proposal preserves price-time priority for investor orders.
In addition, if the market was $10 to $11, the ARCA/PCX Proposal would require a dealer to price
improve an customer sell order to $10.10 before internalization could occur; under the Internalization Proposal, the dealer could internalize the sell order at $10.01.
Mr. Jonathan G. Katz File Nos. SR-NYSE-00-18 & SR-NYSE-00-19 December 15, 2000 Page 5 cc:
Chairman and Chief Executive Officer, New York Stock Exchange, Inc.
Director of Market Regulation, Securities and Exchange Commission
Deputy Director of Market Regulation, Securities and Exchange Commission
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