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may participate in accordance with their respective capa-
regulation but also by the forces of competition. In its subsequent Statement on the Future Structure of the Securities Markets, issued in February 1972, the Commission reaffirmed and amplified its commitment to these objectives:
In order to maximize the depth and liquidity of our markets, so that securities can be bought and sold at reasonably continuous and stable prices, and to ensure that each investor will receive the best possible execution of his order, regardless of where it originates, it is generally agreed that action must be taken to create a single central market system for listed securities. The Commission in its letter transmitting the Instituticnal Investor Study to Congress called for a central market system with open access by all qualified brokers and market-makers. This represented something of a shift in the historic position of the Commission, which over many years, extending from before World War II to at least the Special Study Report of 1963, tended to favor competing but separate markets. This shift resulted from technological derelopments which made it possible to tie markets together so that one could foster competition within a central market rather than among separate competing markets and also from the need to strengthen the existing market structure, including increased market-making capacity within the structure, in order to cope with the pressures created by the growth of institutions and the voume of their trading. This central market system must be one which will attract and reflect all bids, offers and market-making activity in order to
maintain maximum liquidity and depth.27 In contrast to the SEC approach of creating a central system in which all existing markets can operate, the report prepared for the New York Stock Exchange by William McChesney. Martin in August 1971 envisioned the development of a "national exchange system to proride a single, national auction market for each security qualified for listing.” Mr. Martin found that "the New York Stock Exchange has, to some extent, all of the characteristics prescribed . . . for the proposed national exchange system.” He envisioned a "vital role” for the regional exchanges "because of their geographical locations and their identification with local needs,” but was not clear as to whether this role would involve their serving as alternative markets for securities traded in the NYSE "division" of the central exchange system. His proposal also envisioned that "transactions now being executed in the third market [should be effected] on the Exchange, (so that] they would . . . enhance the depth and liquidity of the central public auction market . . ." 28
In testimony before the Subcommittee in October 1972, the NYSE reaffirmed that it was "committed” to "the goal of a central exchange 26 1 Institutional Investor Study XXIV, XXV. 27 Market Structure Statement 7-8. 28 W. Martin. The Securities Markets: A Report, With Recommendation (1971) (hereinafter cited as "Martin Report") at 5, 6, 16.
system.” 29 Chairman Neelham carried this proposal further in a speech in December, calling for division of the securities markets into two completely separate markets: “One would consist of an amalgamation of the existing exchange markets in listed securities. The other would limit itself to trading over-the-counter securities and would be operated by the NASD.” 30 Commissioner Loomis of the SEC commented at the Subcommittee hearings that the NYSE approach "would mean that the third market would be abolished. . :1. It is contrary to the stated position of the Commission both in its statement of the future structure of the securities markets and earlier in its transmittal of the Institutional Investor report.” 31
The Subcommittee strongly supports the SEC position on this question. The NYSE approach would create an artificial division in the market. The Subcommittee, as set forth more fully in Section B below, believes that public investors are entitled to more than half a market; they are entitled to the benefits of the present combination of markets, freed of the restrictions which distort the allocation of orders and deprive them of best execution of their transactions. The efforts of government and industry in this area should be directed, not to the creation of barriers between different groups of participants in the securities markets, but to the elimination of barriers which presently impede their communication and competition. b. Barriers to Communication and Competition
There are two substantial barriers to communication and competition among the NYSE and the other markets in which NYSE-listed securities are traded.
The first barrier is the absence of a central communication system through which all transactions in a particular security in all markets can be promptly reported, and through which all current quotations in a particular security can be simultaneously ascertained.
The second barrier is the existence of rules and other restrictions prohibiting brokers from taking customers' orders to the market in which the best price is available. The principal such impediment is NYSE Rule 394, which prohibits NYSE members from taking orders to the third market, except after compliance with burdensome procedures. These two barriers are separately described below. c. Central Communications Systems
The only systematic public reporting of transactions in securities which is now generally available is through the NYSE and AMEX "tapes”, and through display devices and newspaper tables which compile the information reported on those two “tapes." 32 The NYSE and AMEX tapes, of course, report only the transactions effected through the facilities of those two exchanges. However, as noted above, while the amount of "off-board” trading omitted from the AMEX tape is insignificant, the “off-board” trading omitted from the NYSE tape amounts to about one-sixth of the volume of all NYSElisted issues and about one-third of the volume in the most activelytraded issues.
29 3 Study Hearings at 200. 30 Needham, Address, su pra note 20, at 6. 31 3 Study Hearings 229. 32 Certain regional exchanges report their transactions on "tapes” but none of these are widely available.
Similarly, while current quotations of NYSE specialists, regional exchange specialists, and third-market makers in NYSE-listed stocks can all be made available through display units furnished by independent vendors of market information, 33 there is no system through which all current quotes can be seen on a comparable basis, as in NASDAQ. Furthermore, there is no central system through which public limit orders entered on the specialist "books” of the various exchanges can be made known to people who have orders to execute.
The failure to develop a central communication system-the heart of a "central market system”—is not due to the absence of technological capability. It is clear that the necessary computer and communication facilities could be developed fairly rapidly once there was agreement on how the system should be run.34 The obstacle to creation of the system has been disagreements within the industry--principally between the NYSE and AJIEX, on the one hand, and the regional exchanges and the NASD, on the other as to who should run the system, and who should have access to it on what terms.
i. Composite Transaction Reporting Systems
At the time the SEC issued its statement on market structure in February 1972, an informal industry task force had been working for some time on the development of a consolidated tape for reporting all transactions in listed securities. Progress had been deadlocked, however, by disagreement between the regional exchanges and the NYSE as to where regional exchange and third market transactions in NYSE stocks would be shown. The regional exchanges wanted them shown on the NYSE tape while the NYSE wanted them shown on the AMEX tape.
Because of the industry's inability to reach agreement on a "common tape”, the SEC was required to take the initiative in developing a coordinated communication system. On Varch 8, 1972, it proposed two new rules under Section 17(a) of the 1934 Act requiring all exchanges and all third market makers to provide to "vendors of market information," on a current basis, (a) reports of all transactions in listed securities and (b) quotations of specialists and third marketmakers in such securities. 36
On March 29, the Commission appointed three industry "advisory committees” to submit recommendations with respect to various questions involved in the creation of a central market system.37 One was assigned to study the implementation of a market disclosure system, one was to study the questions arising from the trading of large blocks of stocks, and one was to consider the type of regulation required in a "central market system”. The advisory committee on market disclosure was specifically instructed to submit recommendations regarding a composite transaction reporting and quotation system. On July 17, the Committee submitted its first report, dealing with the
33 The "present policy (of the NYSE) limits the distribution of [its) bids and offers to NYSE members." Letter, from the NYSE to the SEC, Sept. 25, 1972.
34 See, e.g., proposals of Bunker-Ramo Corp., reported in Wall St. J., Mar. 9, 1972, p. 3, col. 2; N.Y. Times, Mar. 9, 1972, p. 57, col. 5; letter from Trans-Lux Corp. to the SEC, Oct. 14, 1971. 35 See 7 House Fearings at 3660-80; N.Y. Times, Mar. 3, 1972, p. 53, col. 5. 36 Sec. Ex. Act Rel. Nos. 9529, 9530 (Mar. 8, 1972). 37 N.Y. Times, March 30, 1972, p. 57, col. 2.
composite transaction reporting system.38 The committee recommended that:
1. All trades in any given security would be reported on the same display terminal, regardless of the market in which the transaction took place.
2. There should be two separate "streams” of data, one consisting of all trading in stocks listed on the NYSE and the other consisting of all trading in all other listed stocks.
3. The three basic means of disclosure would be moving displays or tapes, interrogation devices, and newspaper stock tables. The report of eacs trade would indicate the market in which it was effected "until regulation in all markets is appropriately equal for the protection of the public interest."
4. Ail transactions within the United States in any listed security which involve a registered broker-dealer as prircipal or agent would be reported.
5. The various exchanges and the NASD should each collect and validate their own data and transmit it to a central processor or service bureau for processing. This processor might be jointly owned and controlled by the exchanges and the NASD or might be a quasi-governmental entity created for the purpose. Its rules would be subject to approval by the SEC.
6. The central processor would make the information available to vendors of market information at reasonable and non-discriminatory rates, subject to SEC oversight. It would be empowered to control access by subscribers for the purpose of preventing misuse of data, but not for the purpose
of limiting or regulating competition. On August 14, the SEC published for comment an expanded version of the rule it had proposed in March with respect to reports of transactions in listed securities. The revision reflected the recommendations of its advisory committee and other comments received on its initial proposal.39 The principal additions were:
1. Transaction information about a particular security must be furnished by vendors and displayed by subscribers only on a composite basis: that is, one which shows all trades in that security in all markets.
2. Transaction reports should identify the market in which the transaction is executed, "at least until a central market system is developed.”
3. Exchanges and the NASD may establish “joint procedures” for furnishing market information to vendors. On November 8, the SEC formally adopted the rule as proposed in August, with minor amendments.40 Under the new rule, each exchange and the NASD must file a plan by January 26, 1973, and all last sale information after February 26, 1973 must be furnished in accordance
38 Report to the SEC by the Advisory Committee on Market Disclosure on a Composite Transaction Reporting System (July 17, 1972), reprinted in BNA, Sec. Reg. & L. Rep. No. 161, at È-1 (July 19, 1972). 39 Sec. Èx. Act Rel. No. 9731. 40 Sec. Ex. Act Rel. No. 9850.
with such plan, which may provide a phase-in period of up to 40 weeks before becoming fully effective. 41
The approach taken by the SEC and its advisory committee represent to some extent a compromise between the conflicting views of the NYSE and AMEX, on the one hand, and the regional exchanges and the NASD on the other. The provision requiring all transactions in a particular security to appear on the same tape was initially opposed by the NYSE.42 On the other hand, the provision requiring designation of the market in which the transaction was executed was opposed by the regional exchanges and, even more strongly, by the NASD, which argued that it will unduly expose the inventory positions of third market makers. 43
The SEC's failure to accept the recommendation of its advisory committee that one of the two "data streams" should include all listed stocks other than those listed on the NYSE represents a concession to the AMEX argument that the identity of its market should not be diluted by being combined with reports of trading in securities listed only on regional exchanges.44 This poses a dilemma. Unless some variation of the advisory committee recommendation is eventually adopted, it is unlikely that regional exchanges will be able to offer viable competition to the NYSÉ and AMEX as primary markets for listed securities, since their listed securities would simply be unable to obtain the degree of public exposure available to the latter. On the other hand, listing requirements on regional exchanges are in many cases substantially lower than the requirements for listing on the AMEX, so that expansion of the list to include all regional-only listed stocks could result in inclusion of many stocks of companies which do not meet the standards of size and responsibility which investors have been led to expect of securities reported on the AMEX tape. To resolve this problem, the Subcommittee believes that the appropriate approach is to authorize the entity which administers the composite transaction reporting system to set minimum criteria, subject to review by the SEC, for securities to be shown in each data "stream." This authority should be set forth in the legislation authorizing the SEC to regulate such entities.
The principal difference between the advisory committee recommendation and the rule adopted by the SEC is the SEC's failure to make any decisions regarding the make-up and supervision of the entity which will process transaction data received from the exchanges and the NASD and transmit it to the vendors. The importance of this entity cannot be over-estimated. It will play a key role in determining the manner in which information about transactions in listed securities will reach the public. Its decisions as to who may report transactions through its facilities, and in what manner, will have an important influence on the extent and nature of competition between different market facilities. And its decisions as to who may receive and disseminate the market information which it processes will similarly have an important influence on competition among vendors of market information.45
41 The original deadline of December 26, 1972 was extended for 1 month by the Commission at the request of the exchanges, because of their inabilityto agree on a joint plan. See Sec. Ex. Act Rel. No. 9924 (Jan. 3, 1973); Wall St. J., Dec. 20, 1972, p. 8, col. 2.
42 See note 35 supra.