Federal Register: December 1, 2000 (Volume 65, Number 232)
DOCID: FR Doc 00-30132
SECURITIES AND EXCHANGE COMMISSION
CFR Citation: 17 CFR Part 240
RIN ID: RIN 3235-AH96
DOCUMENT ID: [Release No. 34-43591; File No. S7-17-00]
NOTICE: Part IV
DOCUMENT ACTION: Final rule.
Firm Quote and Trade-Through Disclosure Rules for Options
The Securities and Exchange Commission (``SEC'' or
``Commission'') is adopting an amendment to Rule 11Ac11 under the
Securities Exchange Act of 1934 (``Exchange Act'') to require options
exchanges and options market makers to publish firm quotes. The
Commission also is adopting new Rule 11Ac17 under the Exchange Act to
require a brokerdealer to disclose to its customer when its customer's
order for listed options is executed at a price inferior to a better
published quote and what that better quote was, unless the transaction
was effected on a market that is a participant in an intermarket
options linkage plan approved by the Commission. These rules will
facilitate the ability of market participants to obtain the best price for customer orders.
Effective Date: February 1, 2001.
Securities and Exchange Commission,
Table of Contents
I. Executive Summary
A. Prior Attempts to Limit Intermarket TradeThroughs
B. Application of the Quote Rule in the Options Market III. Description of Proposed Rulemaking
A. Proposed TradeThrough Disclosure Rule
B. Proposed Amendments to the Quote Rule
A. TradeThrough Disclosure Rule
1. Minimum Requirements for Linkage Plans
2. Mandatory Participation in a Linkage Plan
3. Exception from Disclosure Requirement for Block Trades
4. Definition of TradeThrough
a. OPRA Delays
b. Systems Malfunctions
c. Relief from Firm Quote Obligation
d. ThirtySecond Delay
e. Trades Not Excluded from the Definition of TradeThrough
5. Compliance Date
B. Amendments to the Quote Rule
1. Collecting and Making Available Quotation Sizes
2. Firm Quote Sizes for Customer and BrokerDealer Orders
3. Minimum Quote Size
4. Automatic Execution Systems
5. Exception During Trading Rotations
6. ThirtySecond Response
7. OnePercent Exception
8. Amendments to Defined Terms
9. Compliance Date
V. Paperwork Reduction Act
A. Use and Disclosure of the Information Collected
B. TradeThrough Disclosure Rule
1. Capital Costs
2. Burden Hours
C. Amendments to the Quote Rule
1. Capital Costs
2. Burden Hours
VI. Costs and Benefits of Final Rules
A. Costs and Benefits of the TradeThrough Disclosure Rule
B. Costs and Benefits of Amendments to the Quote Rule
VII. Effects on Competition, Efficiency, and Capital Formation VIII. Final Regulatory Flexibility Analysis
A. Need for, and Objectives of, the Rules
B. Significant Issues Raised by Public Comment
C. Small Entities Subject to the Rules
D. Projected Reporting, Recordkeeping, and Other Compliance Requirements
E. Agency Action to Minimize Effect on Small Entities IX. Statutory Authority
I. Executive Summary
Recent increases in the multiple listing of options classes
previously listed on a single exchange have intensified the competition
among the option exchanges and heightened the need to further integrate
the options markets into the national market system. The marked
increase in multiple trading is indicative of the dynamic environment
in which the options markets currently operate.\1\ While the growth in
multiple trading has increased the competition between markets, it also
has dramatically altered the environment in which options market
participants conduct their trading. In particular, multiple trading
raises new best execution challenges for brokers.\2\ When an option is
listed on only one exchange, brokers do not have to decide where to
route an order, and consequently, satisfying their best execution
obligations is simpler than when they must consider the relative merits
of routing an order to two or more market centers. With as many as five options exchanges currently trading
certain options classes, brokers are required to regularly and rigorously evaluate the execution quality available at each options exchange.
\1\ For example, in August 1999, only 32% of equity options classes were traded on more than one exchange. By the end of September 2000, the number of equity options classes that were multiplytraded had risen to 45%. In addition, aggregate options volume traded only on a single exchange fell from 61% to 15% over this same period. :
\2\ In accepting orders and routing them to an exchange for execution, brokers act as agents for their customers and owe them a duty of best execution. A broker's duty of best execution is derived from common law agency principles and fiduciary obligations. It is incorporated both in selfregulatory organizations' rules and in the antifraud provisions of the federal securities laws through judicial and Commission decisions. This duty requires a broker to seek the most favorable terms reasonably available under the circumstances for a customer's transaction. As a result, brokers must periodically assess the quality of competing markets. See Securities Exchange Act Release No. 37619A (September 6, 1996), 61 FR 48290 (September 12, 1996). :
Directly relevant to a broker's ability to obtain best execution for its customers is the ability to get the best price available. The considerable growth in the number of options classes traded on more than one exchange has significantly increased the likelihood that an order may be executed at a price that is inferior to a quoted price available on another exchange (``intermarket tradethrough''). According to preliminary data analyzed by the Commission's Office of Economic Analysis, during the week of June 26, 2000, 5 percent of all trades in the 50 most active multiplytraded equity options were executed at prices inferior to the best price quoted on a competing market. Currently, it is difficult to ensure that a customer order sent to one exchange will receive the best available price because of the absence of fair access and an efficient mechanism allowing a market participant at one exchange to reach a better price published by another exchange. As a result, better prices quoted on another exchange do not always receive price priority, and customer orders may receive inferior executions.
Because of our concerns about the increasing likelihood of
intermarket tradethroughs in the options markets, on October 19, 1999,
the Commission issued an Order directing the options exchanges to act
jointly to file a national market system plan for linking the options
markets.\3\ On July 28, 2000, the Commission approved an intermarket
linkage plan proposed by three of the options exchanges (``Linkage
Plan'') \4\ and subsequently, the other two exchanges filed with the
Commission amendments to permit their participation in the Linkage Plan. \5\
\3\ See Securities Exchange Act Release No. 42029, 64 FR 57674 (October 26, 1999) (``October 19, 1999 Order''). The October 19, 1999 Order directed the American Stock Exchange LLC (``Amex''), Chicago Board Options Exchange, Inc. (``CBOE''), Pacific Exchange, Inc. (``PCX''), and Philadelphia Stock Exchange, Inc. (``Phlx'') to act jointly in discussing, developing, and submitting for Commission approval an intermarket linkage plan. The Commission's Order also requested the International Securities Exchange LLC (``ISE'') to participate with the options exchanges in the development of an intermarket linkage plan. The ISE was subsequently registered as a national securities exchange for options trading on February 24, 2000. See Securities Exchange Act Release No. 42455, 65 FR 11387 (March 2, 2000).
\4\ See Securities Exchange Act Release No. 43086, 65 FR 48023 (August 4, 2000). As originally approved, the Amex, CBOE, and ISE were the only participants in the Linkage Plan.
\5\ See Securities Exchange Act Release Nos. 43573 (November 16, 2000); and 43574 (November 16, 2000). The Commission issued orders to permit Phlx and PCX to participate in the Linkage Plan.
In conjunction with its approval of the Linkage Plan, the
Commission proposed a new rule, Exchange Act Rule 11Ac17 (``Trade
Through Disclosure Rule''),\6\ to require a brokerdealer to disclose
to its customer when the customer's order for a listed option is
executed at a price inferior to a better published quote and that
better quote, unless the transaction was effected on a market that
participates in an intermarket linkage plan approved by the
Commission.\7\ In addition, the Commission proposed to amend Exchange
Act Rule 11Ac11 (``Quote Rule'') \8\ to require options exchanges and
options market makers to publish firm quotes. \9\ These proposed rules
were intended to facilitate the ability of market participants to
obtain the best price for customer orders without mandating a specific linkage.
\6\ Exchange Act Rule 11Ac17, 17 CFR 240.11Ac17.
\7\ See Securities Exchange Act Release No. 43085 (July 28, 2000), 65 FR 47918 (August 4, 2000) (``Proposing Release''). \8\ Exchange Act Rule 11Ac11, 17 CFR 240.11Ac11.
\9\ See Proposing Release, supra note 7.
With the current expansion of multiple trading in options, the
Commission is increasingly concerned about intermarket tradethroughs
of customer orders. The Commission believes that adoption of the new
rule and amendment to the Quote Rule are necessary at this time to
encourage the removal of barriers to access to, and the use of
efficient vehicles to reach, better prices on another market.
Consequently, as discussed below, the Commission today is adopting the
TradeThrough Disclosure Rule \10\ and amending the Quote Rule,\11\
substantially as proposed, with certain modifications recommended by commenters.
\10\ Exchange Act Rule 11Ac17, 17 CFR 240.11Ac17.
\11\ Exchange Act Rule 11Ac11, 17 CFR 240.11Ac11.
Section 11A of the Exchange Act,\12\ enacted as part of the
Securities Acts Amendments of 1975,\13\ sets forth Congress' findings
concerning the establishment of a national market system. Congress
found, among other things, that it was in the public interest and
appropriate for the protection of investors and the maintenance of fair
and orderly markets to assure the availability to brokers, dealers, and
investors of quote and transaction information.\14\ Congress also found
that linking all of the markets for qualified securities would ``foster
efficiency, enhance competition, increase the information available to
brokers, dealers, and investors, facilitate the offsetting of
investors' orders, and contribute to best execution of such orders.'' \15\
\12\ 15 U.S.C. 78k1.;
\13\ Pub. L. No. 9429, 89 Stat. 97 (1975) (``1975
Amendments''). In the 1975 Amendments, Congress directed the Commission to oversee the development of a national market system. Congress granted the Commission broad, discretionary powers to oversee the development of a fully integrated national market system for the processing and settlement of securities transactions. See also infra note 16.
\14\ Section 11A(a)(1)(C) of the Exchange Act, 15 U.S.C. 78k 1(a)(1)(C).
\15\ Section 11A(a)(1)(D) of the Exchange Act, 15 U.S.C. 78k 1(a)(1)(D).
The national market system was intended by Congress to potentially
encompass ``all segments of corporate securities including all types of
common and preferred stocks, bonds, debentures, warrants, and
options.'' \16\ Congress included all types of securities because it
believed that many of the goals of a national market system, such as
the availability of information with respect to price, volume, and quotations, would be universally beneficial.\17\
\16\ Senate Committee on Banking, Housing, and Urban Affairs, Report to Accompany S. 249, S. Rep. 9475, 94th Cong., 1st Sess. 7 (1975) (``Senate Report''). See also Committee of Conference, Report to Accompany S. 249, H.R. Rep. No. 94229, 94th Cong., 1st Sess. 2 (1975) (``Conference Report'').
Congress did, however, recognize the differences between the
markets and granted the Commission broad powers to implement a national
market system without forcing all securities markets into a single
mold.\18\ Accordingly, Congress granted the Commission the authority to
implement the objectives of the 1975 Amendments,\19\ while allowing the
Commission to recognize and classify markets, firms, and securities in
any manner appropriate or necessary in the public interest or for the protection of investors.\20\
\18\ See Senate Report. See also Conference Report. In the Conference Report, the Committee stated that the unique
characteristics of securities other than common stocks may require different treatment in a national market system.
\19\ The two primary objectives of the 1975 Amendments were (1) ``the maintenance of stable and orderly markets with maximum capacity for absorbing trading imbalances without undue price movements,'' and (2) ``the centralization of all buying and selling interest so that each investor will have the opportunity for the best execution of his order, regardless of where in the system it originates.'' See Senate Report.
\20\ Section 11A(a)(2) of the Exchange Act authorizes the Commission to designate, by rule, securities qualified for trading in the national market system. 15 U.S.C. 78k1(a)(2).
Many of the national market system initiatives were implemented in the equities markets at a time when
standardized options trading was relatively new.\21\ Therefore, even though Congress had intended to include options in a national market system, the Commission deferred applying many of the national market system initiatives to options to give options trading an opportunity to develop.\22\ Today, the options markets continue to operate with limited market integration facilities.\23\
\21\ The trading of standardized options on securities exchanges began in 1973 with the organization of the CBOE as a national securities exchange. See Securities Exchange Act Release No. 9985 (February 1, 1973) 1 S.E.C. Doc. 11 (February 13, 1973). Currently, Amex, CBOE, ISE, PCX, and Phlx are the only national securities exchanges that trade standardized options.
\22\ In October 1977, in response to allegations of widespread manipulation in the market for exchangetraded options, the Commission initiated an investigation and special study of the options markets. The result of the Commission's investigation was The Report of the Special Study of the Options Markets, issued on December 22, 1978 (``Options Study''). Report of the Special Study of the Options Markets to the Securities and Exchange Commission, 96th Cong., 1st Sess. (Comm. Print No. 96IFC3, December 22, 1978) (examining the major issues of market structure in standardized options markets, including multiple trading). In the Options Study, the Commission acknowledged that Congress had intended to include options in a national market system, and set forth a number of issues to be explored before the options markets could be fully integrated into the national market system. Options Study at 1029 1030. The Options Study delineated the following as among the issues to be explored in the options market: (1) A comprehensive quotation system for the dissemination of firm quotes; (2) market linkage and order routing systems to enable the best execution of orders; (3) nationwide limit order protection to ensure that agency orders receive auctiontype trading protections; and (4) offboard trading restrictions. Subsequently, the Commission approved, pursuant to Section 11A of the Exchange Act and Rule 11Aa32 thereunder, a national market system plan that collects and disseminates consolidated quotes and trades for the options markets, the Options Price Reporting Authority (``OPRA'') Plan for Reporting of Consolidated Options Last Sale Reports and Quotation Information (``OPRA Plan''). See Securities Exchange Act Release No. 17638 (March 18, 1981).
\23\ The Commission has repeatedly called for increased national market system initiatives in the options markets. See Securities Exchange Act Release No. 16701 (March 26, 1980), 45 FR 21426 (April 1, 1980) (deferring expansion of multiple trading to afford the options exchanges an opportunity to consider the development of market integration facilities); Securities Exchange Act Release No 22026 (May 8, 1985), 50 FR 20310 (May 15, 1985) (urging options market participants to consider the development of market
integration facilities); Directorate of Economic and Policy Analysis, ``The Effects of Multiple Trading on the Market for OTC Options'' (November 1986); Office of the Chief Economist,
``Potential Competition and Actual Competition in the Options Market'' (November 1986); and Securities Exchange Act Release No. 26871 (May 26, 1989), 54 FR 24058 (June 5, 1989) (requesting comment on three measures, including an intermarket linkage). In 1989, the Commission adopted Exchange Act Rule 19c5, which generally prohibits any exchange from adopting rules limiting its ability to list any stock options class because that options class is listed on another exchange. See Securities Exchange Act Release No. 26870 (May 26, 1989), 54 FR 23963 (June 5, 1989). In 1990, then Chairman Breeden requested that the options exchanges develop an intermarket linkage plan. See letter from Chairman Breeden to the Registered Options Exchanges dated January 9, 1990.
A. Prior Attempts To Limit Intermarket TradeThroughs
To address the limited market integration facilities in the options
market, the Commission has repeatedly encouraged the exchanges to
implement mechanisms to limit tradethroughs.\24\ For example, in 1980,
at the time the Commission ended the voluntary moratorium on expansion
of standardized options trading, it asked for comment on several
approaches to more fully integrate the options markets into the
national market system, including a market linkage system similar to
the Intermarket Trading System (``ITS''),\25\ requiring brokerage firms
to route retail orders on an orderbyorder basis to the market center
showing the best quotation, and an order exposure system for options public limit orders.\26\
\25\ In the equity markets, the ITS Plan includes a trade through rule protecting displayed bids and offers for ITSeligible exchangelisted securities. See Securities Exchange Act Release No. 17703 (April 9, 1981), 22 S.E.C. Doc. 707. In conformance with the ITS Plan, each participating exchange and the National Association of Securities Dealers (``NASD'') has adopted rules that limit trade throughs in exchangelisted securities. See Securities Exchange Act Release No. 17704 (April 9, 1981), 46 FR 22520 (April 17, 1981). The NASD submitted a proposed tradethrough rule for exchangelisted stocks, which the Commission approved on May 6, 1982. See Securities Exchange Act Release No. 18714, 47 FR 20429 (May 12, 1982). On June 21, 1985, the Commission requested comment on, among other things, the extent to which securities listed on The Nasdaq Stock Market, Inc. (``Nasdaq'') should be subject to tradethrough rules. See Securities Exchange Act Release No. 22127 (June 21, 1985), 50 FR 26584 (June 27, 1985). In addition, in recently adopting amendments to the ITS Plan to expand the linkage to all listed securities, the Commission concluded that the NASD should continue to consider modifications to its existing tradethrough rule to cover nonITS participants, but that such modifications were not a precondition to approval of the expanded linkage. See Securities Exchange Act Release No. 42212 (December 9, 1999), 64 FR 70297 (December 16, 1999).
\26\ See Securities Exchange Act Release No. 16701 (March 26, 1980), 45 FR 21426 (April 1, 1980) (``Moratorium Termination Release'').
Subsequently, the Commission's adoption of Exchange Act Rule 19c5
in 1989 \27\ created the need for some mechanism to ensure that
customers' orders for multiplytraded options could be executed at the
best available price. Accordingly, in 1990, the Amex, CBOE, New York
Stock Exchange (``NYSE''),\28\ and PCX filed with the Commission a
proposed Joint Industry Plan providing for the creation and operation
of an Options Intermarket Communications Linkage (``Proposed
Plan'').\29\ The Commission sought comment on the Proposed Plan,\30\
but neither the Proposed Plan nor its Model TradeThrough Rule was
adopted, in part, because the options exchanges could not reach a consensus on several critical elements.
\27\ Exchange Act Rule 19c5, 17 CFR 240.19c5. See Securities Exchange Act Release No. 26870, supra note 23.
\28\ The NYSE has since sold its options business to the CBOE. See Securities Exchange Act Release No. 38542 (April 23, 1997), 62 FR 23521 (April 30, 1997).
\29\ The filing was amended on April 29, 1991, when the signatories to the Proposed Plan submitted a Model Option Trade Through Rule as Exhibit A to the Proposed Plan (``Model Trade Through Rule''). The Model TradeThrough Rule would have been incorporated into each of the options exchanges' rules. The Model TradeThrough Rule provided that, absent reasonable justification or excuse, a member in a participant market should avoid initiating a tradethrough when purchasing or selling an options contract permitted to be transmitted through the proposed linkage.
\30\ See Securities Exchange Act Release No. 30187 (January 14, 1992), 57 FR 2612 (January 22, 1992).
During the comment period on the Proposed Plan, an alternative plan
was considered that involved the gradual phasein of multiple trading,
along with the adoption of exchange rules and operational enhancements
linking the markets nonelectronically (``PhaseIn Plan'').\31\
Specifically, the PhaseIn Plan would have provided for the rerouting
of orders received through automated systems to other execution
facilities, in conjunction with a tradeorfade rule.\32\ Again,
however, the exchanges did not agree to the PhaseIn Plan and it was not adopted.
\31\ The PhaseIn Plan was put forth by the Securities Industry Association (``SIA'') and endorsed by the Committee on Options Proposals (``COOP''). See letters to Jonathan G. Katz, Secretary, SEC, from Thomas P. Hart, Chairman, SIA Options and Derivative Products Committee, dated March 10, 1992; and Michael Schwartz, Chairman, COOP, dated March 11, 1992.
\32\ Id. See also letter from Richard C. Breeden, Chairman, SEC, to Alger B. Chapman, Chairman & CEO, CBOE, dated June 30, 1992 (setting forth the Commission's understanding of the elements of the PhaseIn Plan).
In 1994, the markets adopted tradeorfade rules, which require a
market maker to revise its quote if it is unwilling to trade at its
published quote with an order sent to it by a market maker from another
exchange.\33\ The tradeorfade rules do not provide efficient means of
access between the markets. They also provide little incentive to try to reach a better quote
in another market, because that quote need not be firm when reached. Thus, the tradeorfade rules have done little to promote price priority or discourage intermarket tradethroughs. As described below, the rules adopted by the Commission today respond to changes in the options markets and reflect a different approach to limiting intermarket tradethroughs and promoting price priority.
\33\ See Securities Exchange Act Release Nos. 34431, 34432, 34444, 34434, and 34435 (July 22, 1994), 59 FR 38994 (August 1, 1994) (orders approving proposed rule changes filed by Amex, CBOE, NYSE, Phlx, and PCX, respectively). See also Amex Rule 958A, Commentary 01; CBOE Rule 8.51(b); PCX Rule 6.37(d); Phlx Rule 1015(b); and ISE Rule 804.
B. Application of the Quote Rule in the Options Market
As a testament to the importance of firm quotes in the securities
markets, one of the first national market system initiatives
implemented by the Commission in the equity markets was the Quote
Rule.\34\ The Quote Rule requires all national securities exchanges and
associations to establish procedures for collecting from their members
bids, offers, and quotation sizes with respect to reported securities,
and for making such bids, offers, and sizes available to quotation
vendors. It also requires that quotation information made available to vendors be ``firm,'' subject to certain exceptions.
\34\ Exchange Act Rule 11Ac11, 17 CFR 240.11Ac11. The
reliability and availability of quotation information are basic components of a national market system and are needed so that brokerdealers are able to make best execution decisions for their customers' orders, and customers are able to make order entry decisions. See Securities Exchange Act Release No. 12670 (July 29, 1976), 41 FR 32856 (August 5, 1976) (proposing Exchange Act Rule 11Ac11).
By its terms, the Quote Rule currently does not apply to options.
At the time the Quote Rule was adopted in 1978,\35\ standardized
options had been listed and traded on the options exchanges for only a
few years, and the Commission had imposed a moratorium that restricted
the expansion of options trading.\36\ For example, in 1980, when the
Commission lifted the moratorium on options listings, it also set forth
its vision on the future of options multiple trading, including the
feasibility of firm quotes.\37\ Successful implementation of a linkage
among the markets was thought to depend upon the quality and
reliability of quotation information disseminated by each market
center. At that time, however, the Commission believed that the
imposition of a firm quote requirement on the options markets and market participants was unworkable.\38\
\35\ See Securities Exchange Act Release No. 14415 (January 26, 1978), 43 FR 4342 (February 1, 1978), as amended in Securities Exchange Act Release Nos. 37619A (September 6, 1996), 61 FR 48290 (September 12, 1996); and 40760 (December 8, 1998), 63 FR 70844 (December 22, 1998).
\36\ See supra notes 21 and 22 and accompanying text.
\37\ See Moratorium Termination Release, supra note 26. \38\ In 1980, quotes were updated manually; thus, the options exchanges argued that it would be virtually impossible for a market maker to update its quotes in a timely fashion each time the underlying stock price moved.
In conjunction with the Commission's adoption in 1989 of Rule 19c5
\39\ relating to multiple trading of options, the Commission published
a staff concept release that discussed options market structure issues
associated with multiple trading, and outlined suggestions for possible
market structure enhancements.\40\ The release emphasized that the
availability and reliability of comprehensive quotation information for
options are important elements in considering the concerns traditionally associated with multiple trading.
\39\ See Securities Exchange Act Release No. 26870, supra note 23.
\40\ See Securities Exchange Act Release No. 26871, supra note 23.
The release discussed whether the thenexisting quote and trade
reporting mechanism for options needed to be adapted for multiple
trading by requiring that equity options quotes be firm. Market
participants had, in the past, argued against a firm quote requirement
in the options markets for a number of reasons.\41\ These concerns,
however, were recognized as largely moot due to the development of
autoquote \42\ and automatic execution \43\ systems, which indicated that firm quotes were, at the very least, possible.\44\
\41\ One major concern of market participants was that due to the derivative nature of options, and the need to adjust quotes in numerous series in response to a single price change in the underlying security, it would be impossible, or at least
impractical, to require options market makers to honor their disseminated quotes. Further, it was thought to be difficult for an exchange to identify which member of a trading crowd was responsible for a quote and to provide a mechanism for quotes to be modified or withdrawn.
\42\ Autoquote systems enable options market professionals to update their quotes in numerous options series simultaneously. \43\ Automatic execution systems provide, in effect, firm quotes for public customer orders.
\44\ See Securities Exchange Act Release No. 26871, supra note 23..
Today, each options market requires its market makers to have firm
quotes for some types of orders. \45\Therefore, the Commission believes
that imposing a marketwide firm quote obligation on options market
participants should not be unduly burdensome. While the exchanges' firm
quote rules and automatic execution systems provide their public
customers with firm quote guarantees, these rules currently do not
extend to other market participants. As described below, the amendments
to the Quote Rule adopted by the Commission today require that options
quotes be firm for brokerdealer orders for at least one contract.
\45\ See generally Amex Rule 958A (requiring a specialist to
sell/buy at least 10 contracts at the offer/bid displayed when the
order reaches the trading post); CBOE Rule 8.51 (generally requiring
a trading crowd to sell/buy at least the RAES contract limit
applicable to a particular options class at the offer/bid displayed
when a customer order reaches the trading station); PCX Rule 6.86
(generally requiring a trading crowd to provide a depth of 20 contracts for all nonbrokerdealer orders at the bid/offer
disseminated at the time an order is announced at the trading post); Phlx Rule 1015 (requiring that public customer orders be filled at the best market for a minimum of 10 contracts); and ISE Rule 804 (requiring a market maker to enter the number of contracts it is willing to buy or sell at its quote and prohibiting a market maker from entering a bid or offer for less than 10 contracts).
III. Description of Proposed Rulemaking \46\
\46\ In response to the Proposing Release, the Commission received comment letters from fourteen commenters representing the views of four exchanges, seven firms, and four other interested parties. See letters to Jonathan G. Katz, Secretary, SEC, from Samuel F. Lek, Chief Executive Officer, Lek Securities Corporation, dated September 20, 2000 (``Lek Letter''); Michael J. Simon, Senior Vice President and Secretary, ISE, dated September 18, 2000 (``ISE Letter''); George Brunelle, Brunelle & Hadjikow, dated September 15, 2000 (``Brunelle Letter''); Juan Carlos Pinilla, Managing Director, J.P. Morgan Securities, Inc. (``JPMorgan Letter''); Thomas A. Bond, CBOE, dated October 9, 2000 (``CBOE Letter''); Phillip D. DeFeo, Chairman and Chief Executive Officer, PCX, dated October 10, 2000 (``PCX Letter''); Michael G. Vitek, President, Botta, dated September 29, 2000 (``Botta Letter''); Joel Greenberg, Managing Director, Susquehanna Investment Group, dated September 22, 2000 (``Susquehanna Letter''); Chris Delzio, Amex Member, dated August 15, 2000 (``Delzio Letter''); Lewis Singletary, Journeyman Holdings Corporation, dated September 30, 2000 (``Singletary Letter''); Meyer S. Frucher, Phlx, dated September 18, 2000 (``Phlx Letter''); Edward Provost, Executive Vice President, Business Development Division, CBOE, dated September 13, 2000 (asking for an extension of the comment period); Robert Bellick, CoManaging Partner, Wolverine Trading, L.L.P., dated October 25, 2000 (``Wolverine Letter''); Robin Roger, Managing Director and Counsel, Morgan Stanley Dean Witter, dated October 25, 2000 (``Morgan Stanley Letter''); and William McGowen, Chairman, Options Committee, SIA, dated October 31, 2000 (``SIA Letter'').
A. Proposed TradeThrough Disclosure Rule
In the Proposing Release, the Commission proposed new Rule 11Ac17
under the Exchange Act \47\ to require a brokerdealer to disclose to a
customer when the customer's order to buy or sell a listed option is
executed at a price inferior to the best quote published at the time of
execution of the customer's order. The proposal identified seven
circumstances in which a trade executed at a price inferior to a
published price on another market would, nevertheless, not be considered a tradethrough for purposes of the
rule.\48\ In addition, as an incentive for markets to cooperate in developing effective means to access the quotes of other markets to avoid intermarket tradethroughs, the Commission's proposal excepted brokerdealers from the proposed disclosure requirements if they effected their customer orders on options markets that participated in an intermarket linkage plan approved by the Commission that had provisions reasonably designed to limit intermarket tradethroughs. \47\ See Proposing Release, supra note.
\48\ The seven exceptions to the proposed definition of a trade through included when: (1) The market publishing the better price was experiencing systems problems, which made the quote
inaccessible; (2) OPRA was experiencing queuing; (3) the market publishing the better price was experiencing unusual market conditions; (4) the market showing the better price was in a trading rotation; (5) the customer order was executed as part of a trading rotation in that options class; (6) the customer order was executed as part of a complex trade; or (7) the market publishing the better quote fails to respond to an order routed to it within 30 seconds of receiving the order. See Proposing Release, supra note.
B. Proposed Amendments to the Quote Rule
The Commission also proposed to amend Exchange Act Rule 11Ac11 to
require options exchanges and options market makers to publish firm
quotes.\49\ Because OPRA currently does not have the ability to collect
from the exchanges and disseminate to quotation vendors size
information, the Commission proposed to amend the Quote Rule so that
brokerdealers would not be required to communicate, and options
exchanges would not be required to collect and make available on a
quotebyquote basis, the size associated with each quotation in listed
options. Instead, an options exchange would be required to establish by
rule and periodically publish the size for which its best bid or offer
in each options series that is listed on the exchange is firm. If,
however, an exchange does collect quotations with size from its broker
dealers, it would have to make such information available as currently required under the rule.\50\
\49\ See Proposing Release, supra note.
\50\ As noted above, OPRA does not have the capability to collect size information from the options exchanges, but it anticipates implementing systems changes to accommodate quotes with size in January 2001.
In addition, the Commission proposed two alternatives relating to the flexibility an exchange would have to establish the size for which its quotes were firm for different types of orders. Specifically, under proposed Alternative A, the size for which an exchange's best bid or offer is firm would have to be the same for orders received from customers as for orders received from brokerdealers. Under proposed Alternative B, however, an exchange could allow market makers to establish different firm quote sizes for brokerdealer orders and for customer orders.
Finally, the Commission proposed to require a responsible broker or
dealer to respond to an order within 30 seconds by either executing the
entire order or executing at least that portion of the order equal to its applicable firm quote size and revising its quote.
A.TradeThrough Disclosure Rule
After carefully reviewing the comment letters, the Commission has
decided to adopt the TradeThrough Disclosure Rule, with several
modifications from the proposal. Under this rule, a broker is required
to disclose to its customer when the customer's order for listed
options is executed at a price inferior to a better published quote,
and to disclose the better published quote available at that time.\51\
This disclosure must be made to the customer in writing at or before
the completion of the transaction,\52\ and may be provided in
conjunction with the confirmation statement routinely sent to
investors. Such disclosure must be displayed as prominently as the transaction price disclosed to the customer.
\51\ Exchange Act Rule 11Ac17(b)(1), 17 CFR 240.11Ac17(b)(1). The Commission believes that a brokerdealer should be allowed to rely on the market of execution to notify the brokerdealer when a tradethrough has occurred and the best quote available at that time. One commenter suggested that the TradeThrough Disclosure Rule require that exchanges provide all relevant information to the brokerdealers, including a determination of whether a tradethrough has occurred. See Morgan Stanley Letter. The Commission does not believe it is necessary at this time to impose such a requirement and expects that an exchange that does not participate in a linkage plan will have strong incentives to provide a brokerdealer executing orders on its market with any information the broker dealer needs to comply with disclosure obligations.
\52\ The term ``completion of the transaction'' in the Trade Through Disclosure Rule shall have the meaning provided in Exchange Act Rule 15c11(b)(1), 17 CFR 240.15c11(b)(1). Exchange Act Rule 11Ac17(b), 17 CFR 11Ac17(b).
The TradeThrough Disclosure Rule provides, however, that a broker
dealer is not required to disclose to its customer an intermarket
tradethrough if the brokerdealer effects the transaction on an
exchange that participates in an approved linkage plan that includes
provisions reasonably designed to limit customers' orders from being
executed at prices that trade through a better published price.\53\ In
addition, brokerdealers will not be required to provide the disclosure
required by the TradeThrough Disclosure Rule if the order is executed as part of a block trade.\54\
\53\ Exchange Act Rule 11Ac17(b)(2)(i), 17 CFR 240.11Ac1 7(b)(2)(i). The TradeThrough Disclosure Rule also provides the Commission with the authority to exempt any broker or dealer from the requirements of the rule. Exchange Act Rule 11Ac17(c), 17 CFR 240.11Ac17(c).
\54\ Exchange Act Rule 11Ac17(b)(2)(ii), 17 CFR 240.11Ac1 7(b)(2)(ii). The Commission sought comment on whether brokerdealers should be excepted from the tradethrough disclosure requirement if they systematically route customer orders on an orderbyorder basis to the exchange with the best price at the time the order is routed. Only one commenter addressed this issue, noting that simply routing orders to an exchange displaying the best price at the time the order is routed is not sufficient because of variances in the national best bid and offer (``NBBO''), the possibility that the receiving market does not offer tradethrough protection, or the possibility of price improvement. At this time, the Commission has decided not to provide brokerdealers with an exemption from the disclosure requirements of the TradeThrough Disclosure Rule on this basis.
A number of commenters supported the Commission's proposal to
require brokerdealers to disclose tradethroughs.\55\ In particular,
one commenter believed that intermarket tradethroughs virtually would
be eliminated if a brokerdealer were required to disclose to a
customer that an order was executed at a price that was inferior to the
bestpublished quote.\56\ Another commenter disagreed with this view,
however, stating that the imposition of a disclosure requirement would
not have a significant impact on the frequency of intermarket trade throughs.\57\
\55\ See Lek Letter; PCX Letter; JPMorgan Letter; and ISE Letter.
\56\ See Lek Letter.
\57\ See CBOE Letter.
In addition, several commenters noted that the disclosure required
by the TradeThrough Disclosure Rule would never need to be made by
brokerdealers if all exchanges join the Linkage Plan.\58\ The
Commission notes, however, that under the current terms of the Linkage
Plan, any participant may withdraw from the plan with 30 days prior
written notice to each of the other plan participants and the
facilities manager, if any.\59\ In addition, there may be new options
exchanges entering the market in the future and those exchanges may
decide not to participate in the Linkage Plan or any other intermarket linkage plan approved by
the Commission. Moreover, as discussed further below, the Linkage Plan approved by the Commission must still be amended before the Commission would consider it to be reasonably designed to limit intermarket trade throughs and, therefore, satisfy the exception from tradethrough disclosure. Therefore, the Commission continues to believe that the TradeThrough Disclosure Rule is needed to ensure that, if the exchange on which their orders are executed does not belong to an approved linkage plan designed to limit intermarket tradethroughs, investors receive disclosure when their orders are not executed at the best price.
\58\ See JPMorgan Letter; ISE Letter; CBOE Letter; Phlx Letter; and Wolverine Letter. Another commenter argued that the focus of the Commission and the options industry should be on preventing the occurrence of intermarket tradethroughs by moving ahead
aggressively on implementing the Linkage Plan, rather than by disclosing intermarket tradethroughs to investors after the fact. See SIA Letter.
\59\ See Linkage Plan, Section 12.
It is an important feature of the TradeThrough Disclosure Rule
adopted today that it does not prohibit intermarket tradethroughs. At
times, investors may value speed, size, or liquidity over price. By not
prohibiting intermarket tradethroughs, the rule permits investors to
achieve their goals and provides them with information that will
facilitate their ability to actively monitor whether the quality of
executions they receive is satisfactory.\60\ Therefore, the Commission
believes that the rule will help to ensure that the decision not to
pursue publiclydisplayed, superior prices is rooted in the interests
of customers, not that of intermediaries. In addition, the Commission
believes that in the absence of direct linkages, the rule will
encourage brokerdealers to develop effective means of accessing better
quotes published by other markets and thereby, avoid intermarket trade throughs.\61\
\60\ One commenter contended that the proposal would do nothing to improve the transparency of execution quality. See Wolverine Letter. The Commission disagrees with this assertion. Although the disclosures about execution quality adopted today for the equity markets provides much more information to investors than the Trade Through Disclosure Rule does, the Commission believes that, before execution quality disclosures could be required for options trading, potentially difficult issues, such as the absence of a consolidated NBBO in the options market, would have to be resolved. See Securities Exchange Act Release No. 43590 (November 17, 2000). \61\ The Commission notes, however, that the TradeThrough Disclosure Rule does not replace the wellestablished duty that brokers provide best execution to their customers. To the contrary, brokers remain obligated to seek the most favorable terms possible under the circumstances for their customers. See supra note.
1. Minimum Requirements for Linkage Plans
The TradeThrough Disclosure Rule excepts from its requirements any
brokerdealer that executes customer orders on exchanges that
participate in an intermarket linkage plan that is reasonably designed
to limit intermarket tradethroughs. The Commission believes that to be
reasonably designed to limit intermarket tradethroughs, a plan should
contain, at a minimum, provisions to: (1) Limit participants from
trading through, not only the quotes of other linkage plan
participants, but also, the quotes of exchanges that are not
participants in an approved linkage plan; (2) require plan participants
to actively surveil their markets for trades executed at prices
inferior to those publicly quoted on other exchanges; and (3) make
clear that the failure of a market with a better quote to complain
within a specified period of time that its quote was tradedthrough may
affect potential liability, but does not signify that a tradethrough
has not occurred. Accordingly, the Linkage Plan must be amended before
brokerdealers effecting transactions on exchanges participating in the
plan would be excepted from the disclosure requirements of the Trade
Through Disclosure Rule.\62\ The Commission does not agree that these
modifications to the Linkage Plan would add significant costs without
adding significant additional deterrence to intermarket tradethroughs,
as stated by one commenter,\63\ and believes that the minimum
requirements are important factors to consider in assessing whether a
linkage plan is ``reasonably designed to limit tradethroughs'' and
therefore, vitiate the need for brokerdealers to provide disclosure to their customers.
\62\ In addition, to comply with these standards, an exchange participating in a linkage would have to adopt rules to allow the exchange to sanction specialists or market makers that trade through better prices of other exchanges, maintain policies and procedures that would limit the occurrence of intermarket tradethroughs, and maintain records that would identify intermarket tradethroughs and any review or remedial action taken by the exchange in response to such intermarket tradethroughs.
\63\ See JPMorgan Letter.
The Commission requested comment on what provisions a linkage plan should include and whether the minimum factors set forth above are sufficient. In particular, the Commission asked for comment on whether, instead of requiring that a linkage plan limit intermarket trade throughs of the quotes disseminated by markets that do not participate in an approved linkage plan, a linkage should only be required to limit intermarket tradethroughs of markets that participate in an approved linkage plan. In this regard, one commenter asserted that the Commission should not require a linkage plan to protect against trading through those markets that are not participants of the same linkage plan because those markets would be difficult to access effectively. This commenter noted that a linkage plan provides an efficient and almost instantaneous means by which one exchange participating in the plan can access another exchange participating in the plan, as well as minimum size guarantees for orders routed through the linkage, and therefore, assures customers and dealers access to the best bid or offer. In contrast, for markets that do not participate in the linkage plan, the lack of effective access simply increases the time needed to execute a customer order without any corresponding guarantee of execution.\64\
\64\ See CBOE Letter.
Other commenters, however, supported the notion that a linkage plan
must provide some form of protection against trading through any
exchanges that do not participate in the linkage plan.\65\ One of the
commenters stated that options exchanges should adopt reasonable rules
and procedures to address tradethroughs of markets that do not
participate in an approved linkage plan because, to instill investor
confidence in the options market, there must be the same basic
protections against tradethroughs as are available in the equity
market.\66\ Another commenter argued that firms that do not execute
transactions on an exchange that participates in a linkage plan should
be required to disclose intermarket tradethroughs of both participant
and nonparticipant markets, particularly in light of the possibility that a market could opt out of the plan.\67\
\65\ See ISE Letter and Phlx Letter.
\66\ See ISE Letter.
\67\ See Phlx Letter.
In proposing this rule, the Commission recognized that, by
providing an incentive for markets to cooperate in developing effective
means to access other markets, intermarket tradethroughs would be
minimized. However, the value of the TradeThrough Disclosure Rule
would be greatly diminished to the extent that: (1) One or more options
exchanges decide not to participate in an approved linkage plan; (2)
intermarket tradethroughs were not minimized by the implementation of
a linkage plan because the plan fails to provide protection across all
markets, including markets that do not participate in the linkage plan;
(3) away markets fail to complain about intermarket tradethroughs; or
(4) market makers or specialists were not subject to potential
sanctions for intermarket tradethroughs. Accordingly, the Commission believes that to provide sufficient
incentives to markets to avoid intermarket tradethroughs under the TradeThrough Disclosure Rule, an intermarket linkage plan must contain the provisions described above provide brokerdealers executing orders on markets participating in the plan with an exception to the disclosure requirements of the rule. Specifically, the Commission believes that to maintain the integrity and value of a TradeThrough Disclosure Rule, a linkage plan must provide protection against orders trading through the quotes of all markets, regardless of whether that market participates in the plan. However, to allow the options exchanges to retain greater flexibility, the Commission is not mandating participation in a particular intermarket linkage plan. 2. Mandatory Participation in a Linkage Plan
The Commission also sought comment on whether it should order the
options exchanges to become participants in the Linkage Plan or any
other intermarket linkage plan. In response, several commenters
expressed their view that the proposed TradeThrough Disclosure Rule
was a vehicle to compel options exchanges to join an intermarket
linkage plan,\68\ and one argued that the Commission should directly
require all options exchanges to become participants in a qualified
linkage plan rather than ``creating a disclosurebased exception that
accomplishes de facto the same result.'' \69\ Another commenter,
however, expressly stated that it did not believe that participation in
a single linkage plan should be mandatory. This commenter concurred
with the Commission's contention in the Proposing Release that a single
linkage may fail to adapt over time and may impede the entry of new market participants.\70\
\68\ See ISE Letter; Phlx Letter; and CBOE Letter.
\69\ See CBOE Letter.
\70\ See PCX Letter. On the other hand, another commenter expressed concern that a disclosurebased approach to creating incentives for markets to link will not be as effective in fostering quote and order competition and interaction as a direct Commission role in mandating a universal linkage. See Morgan Stanley Letter. The Commission is not, however, attempting to foster quote and order interaction by adopting the TradeThrough Disclosure Rule, but is, instead, trying to achieve the more limited goal of reducing the possibility for investors' orders to be executed at a price inferior to the best available price.
The Commission intends for the intermarket linkage plan exception to the TradeThrough Disclosure Rule to encourage options markets to participate in a Commissionapproved intermarket linkage plan. In fact, all five options exchanges are now participants in the Linkage Plan.\71\ However, at this time, the Commission continues to be reluctant to force, by government mandate, all options exchanges to participate in a single linkage system that may, for example, fail to maintain uptodate technology. The Commission believes that, in the absence of barriers to access, the growth of electronic orderrouting systems may enable the options exchanges to access one another's markets directly through agreedupon methods, or indirectly through brokerdealers. As a result, the Commission continues to believe that, given effective access, there may well be a variety of equally effective, or more effective, ways in which technology may be employed by the markets to encourage price priority and decrease the likelihood of intermarket tradethroughs in the options markets. Consequently, rather than mandating exchange participation in any one linkage plan, the Commission is adopting the more flexible approach, as proposed, that provides incentives for the markets and their members to develop mechanisms to reduce the frequency of intermarket tradethroughs, while allowing market participants to choose the form of mechanism employed. \71\ See supra notes 4 and 5.
3. Exception From Disclosure Requirement for Block Trades
Finally, in response to comments, the Commission is adopting an
exclusion from the tradethrough disclosure requirement for block
trades.\72\ The Commission sought comment on whether to except block
trades from the tradethrough definition because of their size in
relation to the quote, their special handling needs, and the greater
resources of customers placing block orders to monitor the quality of
executions they receive. Two commenters specifically supported such an exception.\73\
\72\ Exchange Act Rule 11Ac17(b)(2)(ii), 17 CFR 240.11Ac1 7(b)(2)(ii). The term ``block trade'' is defined as a transaction in an options series that is for 500 or more contracts and has a premium value of at least $150,000. Exchange Act Rule 11Ac17(a)(1), 17 CFR 240.11Ac17(a)(1).
\73\ See JPMorgan Letter and SIA Letter.
For ease of administration, the Commission has adopted, in part,
the definition of ``block trade'' used in the Linkage Plan,\74\ which
was developed by the options exchanges. Because a block trade would
involve 500 contracts or more and a premium value of at least $150,000,
the Commission anticipates that only highly sophisticated investors
will place such trades. Moreover, as noted by commenters, because of
the size of these block orders, market participants placing such orders
do not necessarily expect execution of the full order at the best
quoted price.\75\ As a result, the Commission believes that the value
of a tradethrough disclosure for market participants placing such orders likely would be minimal.
\74\ See Linkage Plan, Section 2 (3).
\75\ See JPMorgan Letter and SIA Letter. One of these commenters noted that with respect to blocksized orders, the quote bears ``little relationship to the average price that the customer could get for the entire order.'' See JPMorgan Letter. The other of these commenters argued that ``because large orders are far more dependent on liquidity than smaller orders, the ability to get a block off on a timely, efficient basis may be severely impacted by strict adherence to a tradethrough rule.'' See SIA Letter.
4. Definition of TradeThrough
The Commission is adopting the definition of a tradethrough and
the exceptions to the definition of a tradethrough, substantially as
proposed. Specifically, a tradethrough occurs when a customer order is
executed at a price inferior to a quote published by another market at
the time of execution.\76\ The rule also identifies four circumstances
in which a trade executed at a price inferior to a published price on
another market would, nevertheless, not be considered a tradethrough for purposes of the rule.\77\
\76\ Exchange Act Rule 11Ac17(b)(3), 17 CFR 240.11Ac17(b)(3). \77\ Exchange Act Rule 11Ac17(b)(4), 17 CFR 240.11Ac17(b)(4).
a. OPRA Delays. Because a brokerdealer should not be required to disclose to its customer that its order was executed at a price inferior to a ``stale'' quote, a trade will not be considered a trade through if it occurs while OPRA is experiencing queuing.\78\ In the past, the aggregate message traffic generated by the options exchanges has, at times, surpassed OPRA systems capacity, which could result in the dissemination of quotes that are no longer accurate or accessible. \78\ Exchange Act Rule 11Ac17(b)(4)(ii), 17 CFR 240.11Ac1 7(b)(4)(ii).
b. Systems Malfunctions. Similarly, the Commission believes that it
is appropriate to exclude from the definition of tradethrough trades
that are executed at a time when an exchange has verified that the
market publishing the better price was experiencing systems
malfunctions, thus resulting in inaccessible quotes.\79\ For example,
this may occur when a brokerdealer has attempted to access the
superior published quote and has been unsuccessful because of systems [[Page 75446]]
problems in the quoting market. The Commission believes that there is no value in requiring a brokerdealer to disclose an inability to access a market's quote that has been verified as inaccessible. \79\ Exchange Act Rule 11Ac17(b)(4)(i), 17 CFR 240.11Ac1 7(b)(4)(i).
c. Relief from Firm Quote Obligation. The definition of trade
through also excludes a trade executed at a price inferior to a price
published by another exchange if the other exchange or its members were
relieved of their obligations under the Quote Rule because the exchange
has determined, for example, that, as a result of unusual market
conditions,\80\ it is incapable of accurately collecting and disseminating quotes.\81\
\80\ Exchange Act Rule 11Ac11(b)(3), 17 CFR 240.11Ac11(b)(3). Currently, each options exchange has rules that allow the exchange to suspend its firm quote requirements if, for example, a systems malfunction or other circumstance impairs the exchange's ability to disseminate or update market quotes in a timely and accurate manner. See Amex Rule 958A; CBOE Rule 8.51(a); PCX Rule 6.86(d); Phlx Rule 1015(a)(ix); and ISE Rule 804(d). The options exchanges may have to amend these rules to conform to the Quote Rule's exception for unusual market conditions.
\81\ Exchange Act Rule 11Ac17(b)(4)(iii), 17 CFR 240.11Ac1 7(b)(4)(iii).
One commenter recommended that the Commission provide brokers with discretion to interpret the exceptions broadly in light of their duty of best execution, instead of forcing a broker to incur the risk of subsequently providing an inferior price to a public customer against its better judgment. This commenter argued that a broker should have discretion to ``use the `unusual market circumstances' exception to refuse to route a trade to an exchange that has a history of disseminating `flickering' quotes, rather than being forced to disclose to the customer a tradethrough of a phantom `better' price that, in all likelihood, never existed.'' \82\
\82\ See JPMorgan Letter.
The Commission agrees that brokers must always consider their best
execution obligations to their customers.\83\ The TradeThrough
Disclosure Rule does not prohibit intermarket tradethroughs; it merely
requires a firm to provide information to its customer about the market
at the time of execution. Therefore, the Commission does not agree that
brokerdealers should be granted discretion to avoid disclosure if they
trade through another market quote because of their discomfort with the
quality of that market's quote. While the Commission appreciates the
commenter's concerns regarding ``flickering quotes,'' the Quote Rule
amendments adopted today are designed to address this issue by
requiring that disseminated quotes be firm up to the applicable firm quote size.
\83\ See supra note 2. One commenter asserted that under the Commission's proposal, brokers would no longer have to make best execution evaluations. See Wolverine Letter. The Commission strongly disagrees with this view and expects brokers to continue to fulfill their obligations to seek the most favorable terms reasonably available under the circumstances for a customer's order.
d. ThirtySecond Delay. In addition, the TradeThrough Disclosure Rule excludes from the definition of tradethrough a trade that occurs after an exchange member attempts to access a betterpublished quote for a customer order and the market publishing the better quote fails to respond to the order routed to it in a timely fashion.\84\ \84\ Exchange Act Rule 11Ac17(b)(4)(iv), 17 CFR 240.11Ac1 7(b)(4)(iv).
Although one commenter contended that the Commission should not
adopt this exception to the definition of a tradethrough because it
condones the actions of a market maker who simply ignores an incoming
customer order that is unfavorable or inconvenient,\85\ the Commission
believes that a brokerdealer should not be obligated to disclose a
tradethrough in the event that an exchange member attempted to access
a better published quote for a customer order, but the market
publishing the better quote failed to respond to the order routed to it
within 30 seconds of receiving the order. In this instance, the
exchange member has attempted to access the superior published quote
and has been unsuccessful. The Commission believes that the originating
brokerdealer should not be obligated to provide the disclosure when
the member of another exchange has failed to satisfy its obligations
under the Quote Rule. In addition, the Commission believes that there
is no value in requiring an exchange member to repeatedly attempt to
access an inaccessible quote, especially in a volatile market where
substantial delays may result in far inferior executions for the
investor. Further, the Commission believes that the amendments to the
Quote Rule adopted today will ensure that responsible brokerdealers
honor their quotes up to the size for which they are required to be
firm, and expects exchanges to surveil their members to ensure compliance with the amended Quote Rule.
\85\ See Brunelle Letter. Another commenter, however, supported this proposed exception. See ISE Letter.
e. Trades Not Excluded from the Definition of TradeThrough. In the Proposing Release, the Commission sought comment on whether a trade through disclosure requirement should apply to all tradethroughs, or only when an order is executed at a price that trades through a better price by a certain price increment or amount. The Commission noted that this question is particularly important in a decimals trading environment, where quotes may be for a smaller size and the trade through price for smaller increments, and with respect to large orders, where the quote size may be small in relation to the order size.
Several commenters supported such a ``materiality'' standard.\86\
For example, one commenter argued that all orders would benefit,
regardless of size, from an exception to the disclosure requirement for
tradethroughs of price increments immaterial in relation to the
spread. This commenter believed that any tradethough disclosure should
include the size of the tradedthrough quote, but that a materiality
exception would be preferable to disclosure of the size of the quote,
because such size disclosure would be more costly for market
participants, including customers.\87\ Another of these commenters
believed the disclosure requirement should not apply if the price and
size of the tradethrough was de minimus. Although this commenter did
not define de minimus, the commenter argued that given the imminent
conversion to decimal pricing, the burdens of disclosing when an order
trades through a quote that is better by a very small amount or is only
for a small size would not be justified.\88\ On the other hand, one
commenter opposed adopting a de minimus exception to the tradethrough
definition due to the inherent difficulty in defining what constitutes
de minimus, and the possibility that opportunities for the unbundling
of orders to avoid tradethough liability would be created.\89\ \86\ See JPMorgan Letter; CBOE Letter; and PCX Letter.
\87\ See JPMorgan Letter.
\88\ See PCX Letter.
\89\ See CBOE Letter.
The Commission believes that it is inappropriate at this time to attempt to establish a materiality standard. The Commission notes that, as of September 25, 2000, only 36 options are trading in decimals. As a result, the Commission does not believe that it, the options exchanges, or other market participants has had sufficient experience with a decimals environment. The Commission notes, however, that it will continue to evaluate this issue as decimal pricing is expanded to all options classes and the markets adapt to the decimals environment. [[Page 75447]]
In addition, a few commenters recommended that the tradethrough disclosure requirement not be applied to orders from upstairs broker dealers and orders of customers who consent to the potential for an execution at an inferior price.\90\
\90\ See PCX Letter and Brunelle Letter.
Because upstairs brokerdealers' orders are not eligible to be transmitted through the linkage pursuant to the Linkage Plan, one commenter argued that brokerdealers should not be required to disclose an execution at a price inferior to the best price. \91\ The Commission notes that the tradethrough disclosure requirement would not require disclosure to upstairs brokerdealers because it only applies when a brokerdealer executes a nonbrokerdealer order.
\91\ See PCX Letter
A commenter also recommended including an exception for trades of customers who request that their orders be executed on a particular market, regardless of whether a better price is available on another market. This commenter contended that a customer may give such consent because of its greater interest, for example, in the speed of execution. \92\ Another commenter suggested an exception for when customers provide instructions to route, or avoid routing, their orders to a particular exchange, irresp
FOR FURTHER INFORMATION CONTACT
Deborah Flynn, Senior Special Counsel, at (202) 9420075, Kelly Riley, Special Counsel, at (202) 9420752, John Roeser, Attorney, at (202) 9420762, Terri Evans, Special Counsel, at (202) 9424162, and Heather Traeger, Attorney, at (202) 9420763, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 205491001.