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As noted above, the SEC's advisory committee suggested that the central processor of market information might be either jointly owned and controlled by the exchanges and the NASD or a quasi-governmental entity created for the purpose. In their initial letters of comment on the SEC rule, in May 1972, the N YSE and AMEX proposed that the processing of transaction information for vendors be done by Securities Industry Automation Corporation (SIAC), an entity jointly owned by the NYSE and AMEX, to which those two exchanges have transferred a substantial part of their data processing activities. 46 The advisory committee, in its July report, stated that it could not yet determine whether the SIAC proposal "satisfied the criteria which we have suggested,” that the processor "should be a neutral body (i.e., not under the control or domination of any particular market
The Subcommittee believes that it is extremely important that the processor of market information meet the criterion of neutrality laid down by the advisory committee, to avoid discrimination among different market centers. In passing on the plans submitted by the various exchanges and NASD pursuant to its new rule, the SEC should insist that this criterion be met. To the extent the SEC's failure to propose regulatory standards for such processors reflects uncertainty as tol whether the SEC has jurisdiction over such entities, the Subcommittee believes that uncertainty should be remedied by legislation clearly confirming the SEC's authority and responsibility to regulate such; entities.
An alternative method of assuring “neutrality” in the operation of the system, as the advisory Committee noted, is to delegate he task to a “quasi-governmental entity.” It was recently reported thati the NYSE refused to participate in the composite systeni unless it is run by SIAC—an entity in which the NYSE has a controlling interest and unless any changes in that system are subject to an NYSE vetoi power.48 If this is the case, and if rigorous standards canno: be estabfished to assure fair access for all affected interests in a privately-owned communication system, the Subcommittee will have to give consideration to the establishment of a quasi-governmental entity to operate the system.
The Subcommittee will continue to watch closely the development of the "composite tape” and other centralized transaction reporting systems, to assure that they do not become another vehicle for restriction of competition in the securities business. As the Policy Planning Director of the Antitrust Division of the Department of Justice noted in a recent statement, the existence of a single computer facility, while not necessarily raising antitrust questions by its mere existence, may create antitrust problems under Supreme Court decisions if access to its monopoly services are not available on reasonable and nondiscriminatory terms to all in the trade." 49 46 Letters, dated May 22, 1972, from NYSE and AMEX, commenting on Rels. Nos. 95:29 and 9530. 47 Report, note 38 above, at 4. The Department of Justice "strongly endorse[d] the Advisory Committee recommendation that such a processor should be a 'neutral' hody, neither
controlled nor do:ninated
by any. particular market center." Comments of Department of Justice, su pra note 45, at 8. 48 Wall St. J., Dec. 20, 1972, p. 8, col. 2.
i 49 Remarks hy Donald I. 'Baker, Policy Planning Director, Antitrust Division, Department of Justice, before Int'l Conf. on Computer Communication, Washington, D.C., October 25, 1972; Wal: St. JI, Oct. 26, 1972, p. 13, col. 3.
ii. Composite Quotation System.
The creation of a central market system necessarily envisions a composite system for reporting current quotations, as well as past transactions, so that persons with orders to be executed can take those orders to the market where the best price is available.
At the same time the SEC issued its first proposed rule on composite transaction reporting in March 1972, it issued a companion rule requiring all exchanges and the NASD to make available to vendors of market information, on a current and continuing basis, quotations of all specialists and OTC market-makers in listed securities. Action on this proposal was deferred pending adoption of the rule on transaction reporting.
On September 25, 1972, the NYSE submitted to the SEC a proposal approved by its Board of Directors, under which the NYSE and regional exchanges would make bid-and-asked quotations in duallytraded stocks available to each other on a reciprocal basis.50 This proposal, however, envisioned exclusion of the third market from the central quotation system. On October 13, the SEC replied to the NYSE proposal, noting that:
the system which the Board of Directors asks the Commission to endorse is premised on what is, in effect, a requirement that non-exchange members be prohibited from engaging in transactions in listed securities. As you know, the Commission has on several occasions made clear its view that the third market should play a part in the developing central market system' and that the proper approach should be to determine how best to integrate it into that system by including it in the composite transaction and quotation systems and subjecting it to appropriate market responsibilities and other regulatory requirements. We would hope to receive your views on the best way to progress toward our stated objective of a central market system into which all trading in listed stocks, whether taking place on exchanges
or elsewhere, would be effectively integrated.51 On November 2, 1972, the NYSE announced that its Board of Directors had approved "an $8 million automation program which will ultimately enable NYSE specialists to see bid and asked stock price quotations and last-sale prices in listed stocks in other exchange markets." WYSE Chairman Needham also stated that this program would "equip us to carry out the comprehensive proposal for exchange of competing bid-asked quotations that was advanced by the Board in September.”
Under present law, this automation program does not require SEC approval, and apparently the SEC was not even aware of the proposal prior to the time it was publicly announced.52 The Subcommittee believes it is important that the SEC should pass upon all substantial steps toward development of a central market system, to assure that 50 See 3 Study Hearings at 226. 51 Letter, dated Oct. 13, 1972, from SEC to NYSE. 52 Letter from William J. Casey, Chimn., SEC, to Sen. Harrison A. Williams, Jr., Nov. 27, 1972. Under SEC Rule 17a-8, an exchange must file with the SEC any proposed amendments to its rules at least three weeks before final action is taken on such amendment. The implementation of an automation program, however, was not treated as a rule change subject to Rule 17a-8. See Chapter III. D. 1. 2. ii., below.
each such development is consistent with the overall goal of a fair and efficient market structure. In this area, as in the clearance and settlement of securities transactions, it is important that these questions be thoroughly examined before the investment is made, $0 that the industry does not find itself financially committed to a system which is inferior to others that could have been implemented.
The SEC should therefore make a prompt determination as to whether the system proposed by the NYSE (a) is in any way inconsistent with the type of central market system envisioned in the Commission's statement on market structure, or (b) is inefficient or duplicative of existing facilities for the dissemination of quotations, such as the NASDAQ system. The SEC has taken the position however, that, while it has authority “to adopt and administer rules governing exchange activities of the kind the Exchange has proposed," its "obligations ... will be properly discharged by promulgation of a revised Rule ... setting forth the general criteria for a composite quotation system and providing for implementation of its terms by means of a plan to be filed with the Commission by affected exchanges and the NASD.54 In the Subcommittee's view, this is an unduly narrow reading of the Commission's responsibility in this area. The history of the efforts to develop a central clearing and settlement system shows how the absence of effective Commission leadership can lead to substantial investment in systems that suit the competitive interests of the organization which sponsors them but åre ill-suited to the needs of the public and the rest of the industry. The Subcommittee therefore believes that the SEC should make a formal determination, including exposure for public comment, on the respective merits of all available composite quotation systems, including that proposed by the NYSE.
During the period while the NYSE was formulating its proposal, the SEC's Industry Advisory Committee on Market Disclosure completed its work on a composite quotation system and submitted its report to the Commission on November 21, 1972.55 That report recommended:
1. There should be a single system for quotations in all listed securities, which would be the exclusive medium for any person wishing to quote a regular two-sided market in those securities. 56
2. The system would be operated by the same entity that operated the composite transaction reporting system.
3. Quotations could be inserted in the system by any "responsible market-maker.” Responsibility would be defined in terms of capital requirements and willingness to make continuous two-sided markets.
53 See 3 House Hearings at 1436-37. 54 Letter, note 52 above. The Commission appears to have been satisfied by having "been advised by the Exchange that (there is) ... nothing inherent in the technology of the Exchange's proposed program which would be inconsistent with the kind of central market system outlined by the Commission." Id. 65 Report
to the SEC by the Advisory Committee on Market Disclosure on a Composite Quotation System (Nov. 21, 1972), reprinted in BNA, Sec. Reg. & L. Rep. No. 178, at H-1 (Nov. 22, 1972).
58 One member of the Advisory Committee "strongly dissented” from all recommendations for making the suggested system the "exclusive" means for disseminating quotations for listed stocks. He argued that exclusivity had not been shown to be necessary, since “if the proposed system is any good, the users will confer all the exclusivity required.” He also argued that it was unwise, because it is bound to prove divisive" and would unduly prejudice the interests of existing
vendors of market information. s7 The same member who dissented from the preceding recommendation
also dissented from this recommendation,
arguing that the "narrow orientation and limited responsibilities of the entity responsible for the transaction reporting system made it an inadequate model for the composite quotation system board, which should include representatives from the public, broker members of the industry and dealers responsible for maintaining markets.
4. Quotations inserted in the system would have to be firm for one unit of trading (or larger designated amount). The system should be designed to permit market-makers to update their quotations directly and instantaneously.
5. The information displayed would designate the name of the exchange or market-maker inserting each quote. Bids and offers of public customers inserted in the system would be appropriately designated, and would have to be given priority in any transaction in which a broker-dealer participated.
6. Any person should be entitled to see the quotations in the system on a real-time basis, subject to payment of the applicable subscription charges. Access to the system could be regulated to prohibit misuse of quotations, but could not be denied on the basis of competitive considerations.
7. A permanent record of all quotations in the system would be available for surveillance purposes. The Advisory Committee stated that “the guiding principles underlying our effort are the convictions that an investor or his broker should be able to determine, at any given time, where he can effect a particular transaction in a listed security at a price most favorable to him and that increased market-maker participation should be encouraged in order to achieve more orderly markets with greater depth and liquidity.”
The Subcommittee believes that the SEC's Advisory Committee has correctly stated the goals of a composite quotation system, and that its specific proposals are a realistic and constructive approach to the realization of those goals. Many of the questions relating to the quotation system are similar to those involving the transaction reporting system, particularly those relating to the composition and control of the entity which operates the system. It is equally important that the SEC have clear authority over the quotation system to assure that it is fairly and independently managed and is open to all market makers on a competitive basis. The SEC should also consider carefully the questions raised by the dissenting member of the advisory committee, as to whether there is any need to prohibit alternative quotation media and whether the entity which runs the composite transaction reporting system is necessarily the appropriate entity to run the composite quotation system.
In this connection, it is noteworthy that the NASDAQ system is already in operation, providing subscribers with quotations of all market makers in 3,470 stocks. Over the opposition of the NYSE and AMEX, it was broadened to include the quotes of third marketmakers in listed stocks.59 While NYSE members are prohibited by their Rule 438 from entering bids and offers in NASDAQ for NYSĚ stocks, the specialists on one regional exchange have been entering their quotes in 11 securities on an experimental basis since May 1972.60 The SEC should therefore carefully consider the feasibility of utilizing NASDAQ as the vehicle for dissemination of quotations in listed as well as unlisted stocks before authorizing the construction of 38 Id. at 1-2. 59 The history of the efforts to prevent the inclusion in NASDAQ of third market quotes in listed securities is detailed in the Subcommittee's Examination of the Decisions Involved in the Inclusion of Listed Securities in NASDAQ, 3 Study Hearings 3-17. Bo See Wall St. J., May 2, 1972, p. 6, col. 3.
another system which may increase costs to the industry—which in turn will be passed on to the public—without any corresponding public benefits.
The Subcommittee expects the SEC to proceed promptly with the promulgation of the rule it proposed in March, setting forth the guidelines for the operation of the quotation system and establishing the deadline by which it should be in operation. Based on current information, the Subcommittee believes it is reasonable to insist that the composite quotation system be in full operation not more than six months after the composite transaction reporting system is fully implemented. d. Elimination of Regulatory Barriers
The second major impediment to development of a central market system is the existence of regulatory or economic barriers to transactions involving participants in different markets.
The principal regulatory impediment to such transactions is NYSE Rule 394, which prohibits an NYSE member from taking a customer's order to the third market and dealing net with a third market-maker, even where by so doing he could obtain a better price for his customer. Prior to 1965, that prohi. ition was absolute. At the insistence of the SEC, based on a staff study of the operation of Rule 394, the NYSE in that year amended the Rule to permit the consummation of such transactions after the NYSE member had complied with a complex procedure which involves checking twice with the Exchange floor. An indication of the difficulty of compliance with the requirements of Rule 394 is that during the three-year period 1969-71, during which approximately 25 million transactions were reported on the NYSE tape, there were a total of only 44 inquiries by members—about one a month-resulting in a total of 30 transactions being executed wholly or partly in the third market.61
In 1965, the SEC staff conducted a detailed study of the operation of Rule 394. The SEC refused to release the report for six years until late 1971, when it finally made the report public as a result of a lawsuit and Congressional pressure.62 The staff report noted the dual aspect of Rule 394—that while a rule of that sort could serve a valuable purpose in assuring priority for public orders and in preventing NYSE members from taking orders to markets in which there was no reporting of transactions, it was in fact administered as a support to the fixed minimum commission rate structure by preventing members from dealing net with non-members-often to the detriment of the members' public customers:
The Rule does contribute to the depth and liquidity of the market in the sense of bringing all orders to the floor, but the additional depth is at the expense of a competing market. In this connection Rule 394 is predicated on the theory that the best market is a central marketplace in which the specialist has a monopoly position and is not subject to competitive pressures by non-members who make markets. The Rule, by prohibiting members from seeking out and executing orders in such market, tends to inhibit the viability of such competing markets. Although an Exchange member can trade
with a non-member dealer on-board and obtain a commission 617 House Hearings at 3594. 62 See 6 House Hearing at 2983-84. The full text of the report is printed in 6 House Hearings at 3293-3371.