
[Federal Register: May 27, 2008 (Volume 73, Number 102)]
[Notices]               
[Page 30436-30439]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27my08-103]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57845; File No. SR-NYSE-2008-32]

 
Self-Regulatory Organizations; the New York Stock Exchange LLC; 
Notice of Filing and Immediate Effectiveness of Proposed Rule Change, 
and Amendment No. 1 Thereto, To Amend NYSE Rule 123A.30 To Permit 
Certain Convert-and-Parity Orders To Trade on Parity With Other Limit 
Orders, Including Orders Entered Through Its Designated Order 
Turnaround System[supreg]

May 21, 2008.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 24, 2008, the New York Stock Exchange LLC (``NYSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been substantially prepared by the Exchange. 
Originally, NYSE filed the proposed rule change pursuant to Section 
19(b)(2) of the Act.\3\ On May 16, 2008, however, NYSE filed Amendment 
No. 1 to the proposed rule change pursuant to Section 19(b)(3)(A) of 
the Act \4\ and Rule 19b-4(f)(6) thereunder.\5\ Accordingly, the 
proposal became effective upon the filing of Amendment No. 1 with the 
Commission. The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 15 U.S.C. 78s(b)(2).
    \4\ 15 U.S.C. 78s(b)(3)(A).
    \5\ 17 CFR 240.19b-4(f)(6). Amendment No. 1 superseded the 
original filing in its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend NYSE Rule 123A.30 to permit certain 
convert-and-parity (``CAP'') orders to trade on parity with other limit 
orders, including orders entered through NYSE's Designated Order 
Turnaround (``DOT'') system[supreg]. The text of the proposed rule 
change is available at the Exchange, the Commission's Public Reference 
Room, and www.nyse.com.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    This rule filing effects an amendment to NYSE Rule 123A.30, which, 
together with NYSE Rule 1000, governs the automatic execution of CAP 
orders. The amendment permits passively converted CAP orders--that is, 
CAP orders that are converted by the specialist for the purpose of 
bidding or offering--to trade on parity with other limit orders, 
including DOT system orders that were on NYSE's Display Book[supreg] at 
the time of the conversion and could trade on the same side of the 
market and at the same price as the converted CAP orders. Before this 
amendment, CAP orders were placed in the same parity group as DOT 
orders for purposes of parity allocations among all orders upon 
execution. Within that parity group, those DOT orders had priority over 
the converted CAP orders.
a. Background
    The Exchange states that CAP orders are not actually live orders, 
but rather are memoranda of orders that can be made live either 
automatically via an electing trade (a trade at a price that 
automatically triggers the CAP order to become a live order and 
immediately execute at the triggering price) or manually via conversion 
by the specialist. In the latter situation, the specialist converts the 
CAP into a limit order, and bids or offers on behalf of that order 
(referred to as a ``passive conversion''). Thereafter, a trade may take 
place against some or all of the converted CAP order; any portions that 
are not executed may be ``unconverted'' and revert to their status as 
CAP orders.
    The Exchange states that, although they are not live orders, CAP 
orders nevertheless represent public customer interest in which the 
customer has consented to trading on parity with the specialist when 
they are either elected or converted. Because CAP orders are linked, 
either through election or conversion, to other customer interest at a 
given price, CAP orders give customers a way to participate in trades--
that is, to ``go along'' with other interest at a price--but protect 
them from either initiating a trade or constituting 100% of one side of 
a trade.
    The Exchange states that, at the time that specialists were given 
the ability to passively convert CAP orders as agents for customers, 
the Commission was concerned that specialists not have unfettered 
discretion in representing those orders; although the Commission 
recognized that the specialist could exercise some degree of control 
over the timing and size of the conversions, the Commission insisted 
on, and the Exchange agreed to implement, certain restrictions that 
would prevent the specialist from misusing CAP orders to drive the 
price of a security up or down inappropriately.\6\ Among these 
restrictions was the requirement that passively converted CAP orders 
could not be executed before ``conventional'' limit orders, e.g., DOT 
orders, that were on the Display Book at the time of the conversion and 
could trade at the same price and on the same side as the converted CAP 
order.
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    \6\ See Securities Exchange Act Release No. 24505 (May 22, 
1987), 52 FR 20484 (June 1, 1987) (SR-NYSE-1985-01).

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[[Page 30437]]

b. Amendment to NYSE Rule 123A.30
    The instant proposal would change the treatment of passively 
converted CAP orders to permit the CAP orders to trade as a group on 
parity with other agency interest, including same-side same-price DOT 
orders (i.e., DOT orders that can trade on the same side of the market 
and at the same price as the CAP orders). The Exchange states that the 
proposed rule change is necessitated by other changes that the Exchange 
is making that will permit market participants to enter non-displayed 
reserve interest directly into the Display Book.
    As initially implemented, under Rule 123A.30, passively converted 
CAP orders were combined with DOT orders for purposes of determining 
the overall parity allocation in any trade; this so-called ``DOT 
group'' was treated as a single agent in the parity divisor. Thus, for 
example, in an execution involving two brokers' orders, DOT orders, and 
passively converted CAP orders, all on parity, the DOT group and the 
brokers would each be allocated one-third of the traded shares, even 
though the DOT group contained two different customer groups 
(conventional limit orders and passively converted CAP orders). The 
Exchange's system would then internally allocate shares within the DOT 
group in time priority. As a consequence of this allocation 
methodology, passively converted CAP orders did not receive allocations 
until all DOT orders that were on the Display Book at the time of the 
conversion were satisfied in full.
    As noted above, NYSE implemented foundational changes to its 
systems that permit customers to enter undisplayed reserve orders from 
off-Floor directly into the Display Book through DOT (previously, only 
Floor brokers could enter undisplayed reserve interest on behalf of 
customers).\7\ Such off-Floor reserve interest will be included in the 
DOT group for purposes of parity allocations when there is a trade and, 
despite being non-displayed, would within that DOT group, currently be 
entitled to priority over passively converted CAP orders.
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    \7\ See Securities Exchange Act Release Nos. 57792 (May 7, 
2008), 73 FR 27601 (SR-NYSE-2008-36) and 57688 (April 18, 2008), 73 
FR 22194 (SR-NYSE-2008-30).
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    NYSE has determined that it is not feasible at this time to have 
the system differentiate between displayed DOT interest and non-
displayed DOT interest when doing parity allocations. This could result 
in two unintended consequences vis-[agrave]-vis passively converted CAP 
orders: First, the changes will result in non-displayed interest (DOT 
reserves) taking priority over displayed interest (passively converted 
CAP orders); and second, if there is substantial interest in reserve, 
the change will make it difficult (if not impossible) for passively 
converted CAP orders to receive an execution, since all displayed and 
non-displayed DOT interest would need to be satisfied first.
    The Exchange has further determined that it is not feasible to undo 
the various foundational programming changes necessary to implement 
off-Floor reserves in the near future. To address these issues, the 
Exchange is proposing to amend NYSE Rule 123A.30 to change the parity 
allocation methodology. Under the proposed rule change, passively 
converted CAP orders would become their own parity group for purposes 
of the parity divisor. For example, in the execution described above, 
involving two brokers, DOT orders and passively converted CAP orders, 
each group would receive one-fourth of the executed shares, instead of 
the DOT orders and CAP orders sharing a one-third allocation.
    The Exchange believes that the instant proposal is appropriate 
because fundamental changes in the market--both in terms of market 
structure and in terms of the behavior of market participants--have 
made it significantly less likely that specialists could or would use 
passively converted CAP orders to engage in manipulative or 
destabilizing conduct.
    The Exchange states that, among other things, the restrictions on 
passive CAP conversions were implemented at a time when NYSE enjoyed a 
market share in excess of 80% of transactions in its listed securities. 
Today, NYSE market share is approximately half that amount. The 
Exchange states that, where the specialist once had substantial 
influence over the price of a stock, and could extend his influence 
further through the misuse of CAP orders, the specialist today has 
significantly less influence over the price of a stock.
    According to the Exchange, market share aside, the process of 
converting CAP orders also impedes the specialist's ability in an 
automated market to misuse CAP orders to drive the market. Passive 
conversions must be conducted by the specialist manually. The Exchange 
states that, because of the increased automation of modern markets, and 
the resulting exponential increase in the pace of trading over years 
past, the delay inherent in a manual process further erodes the 
possibility that a specialist could realistically use the passive 
conversion of CAP orders to manipulate the market.
    The Exchange believes that a specialist's ability to drive the 
market through CAP conversions is further diminished simply by the fact 
that the number of customers using CAP orders has dropped off 
substantially. For example, during March 2008, there was an average of 
2,125 conversions per day across the entire NYSE Floor, as compared to 
4,401 conversions per day during October 2007 and 6,762 conversions 
during June 2007. More tellingly, the average number of passive 
conversions during 2008 (an average of 2,484 conversions per day, year-
to-date) represented only .0004% of quotes initiated per day by 
specialists (``s-quotes'') during the same period,\8\ and .000045% of 
all quotes disseminated per day overall.\9\ Therefore, the Exchange 
believes that the likelihood that a specialist could misuse a passive 
conversion to affect prices is small.
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    \8\ Specialists have averaged 5,268,000 s-quotes per day during 
2008.
    \9\ NYSE has disseminated an average of 54,201,000 quotes per 
day during 2008.
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    According to the Exchange, the sharp reduction in the number of CAP 
orders reflects the increased popularity of reserve orders, which 
permit customers to achieve the same go-along benefits of CAP orders, 
but retain greater control of the pricing of their orders. 
Significantly, despite the fact that reserve interest and CAP orders 
can perform similar functions, they receive disparate parity treatment: 
reserve interest trades on parity,\10\ while CAP interest does not.
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    \10\ See NYSE Rule 70.20.
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    Finally, the Exchange states that it is also important to keep in 
mind that, under the current scheme, CAP orders, although they 
represent public customer orders, are penalized in their parity 
treatment for no other reason than that they have been entrusted to the 
specialist for execution. When the specialist had outsized influence in 
the market, this was arguably appropriate because, in return for 
inferior parity treatment, CAP orders received the benefit of the 
specialist's knowledge of the market and expertise on the optimal time 
to bid or offer. But in today's environment, where market fragmentation 
has reduced the specialist's ability to know the overall market, the 
Exchange believes this trade-off no longer makes sense. Accordingly, 
the proposed rule change would eliminate this disadvantage to CAP 
orders. At the same time, the proposal would not eliminate all 
disadvantages to CAP order relative to e-Quotes: all passively 
converted CAP orders would share one slice of the allocation on an 
execution, whereas

[[Page 30438]]

brokers using e-Quotes each take their own slice. Thus, the parity 
divisor is being increased by one, though only on executions where: (1) 
There are passively converted CAP orders being bid or offered; and (2) 
the execution size is in an amount less than necessary to completely 
fill all orders at that price. The Exchange states that, because this 
will be the case only a very few times per day (fewer than once per day 
per stock, on average), it does not believe that the potential harm to 
DOT orders is significant.
    In short, given the ways in which liquidity has been fractured 
among markets, the sharply reduced number of conversions today, the 
disparate treatment of passively converted CAP orders and reserve 
interest, and the automation of markets making manual trades 
commensurately more difficult, the Exchange believes that: (1) The harm 
of manipulation-by-passive-conversion that NYSE set out to protect 
against in 1985 is not present today; and (2) when weighed against the 
fact that CAP orders are agency orders on behalf of public customers 
just as DOT orders are, it does not seem appropriate to continue to 
discriminate against the passively converted CAP orders by forcing them 
to step behind the DOT orders.
    For these reasons, NYSE proposes to eliminate the restriction on 
giving passively converted CAP orders parity with other limit orders, 
including resting DOT orders.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act,\11\ in general, and furthers the 
objectives of Section 6(b)(5) of the Act,\12\ in particular, in that it 
is designed to prevent fraudulent and manipulative acts and practices, 
to promote just and equitable principles of trade, to foster 
cooperation and coordination with persons engaged in facilitating 
transactions in securities, and to remove impediments to and perfect 
the mechanism of a free and open market and a national market system. 
As described more fully above, the proposed rule change is intended to 
ensure fair treatment of displayed public orders (passively converted 
CAP orders) in connection with changes being made to other Exchange 
systems to permit customers to directly place non-displayed interest 
into the Display Book. In addition, the Exchange believes that in view 
of both the substantial changes to the marketplace and the Exchange 
since the original rule was adopted, and the paucity of affected 
orders, the proposed change does not substantially affect the public 
interest or unreasonably disadvantage another group of public 
customers. Conversely, without the proposed rule change, the Exchange 
states that there is a substantial risk that a group of public 
customers would be shut out of the market entirely, or would receive an 
inferior treatment vis-[agrave]-vis non-displayed interest, which the 
Exchange believes is contrary to the policy of the Commission regarding 
rewarding customers willing to display liquidity in the market.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange states that written comments on the proposed rule 
change were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing proposed rule change: (1) Does not 
significantly affect the protection of investors or the public 
interest; (2) does not impose any significant burden on competition; 
and (3) by its terms does not become operative for 30 days after the 
date of this filing, or such shorter time as the Commission may 
designate if consistent with the protection of investors and the public 
interest, the proposed rule change has become effective pursuant to 
Section 19(b)(3)(A) of the Act \13\ and Rule 19b-4(f)(6) 
thereunder.\14\
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    \13\ 15 U.S.C. 78s(b)(3)(A).
    \14\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)(iii) 
requires a self-regulatory organization to provide the Commission 
with written notice of its intent to file the proposed rule change, 
along with a brief description and text of the proposed rule change, 
at least five business days prior to the date of filing of the 
proposed rule change, or such shorter time as designated by the 
Commission. The Exchange has fulfilled this requirement.
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    A proposed rule change filed under Rule 19b-4(f)(6) normally does 
not become operative for 30 days after the date of filing. However, 
Rule 19b-4(f)(6)(iii) permits the Commission to designate a shorter 
time if such action is consistent with the protection of investors and 
the public interest. The Commission notes NYSE's representation 
regarding its determination that it is not feasible at this time to 
have the Exchange's system differentiate between displayed DOT interest 
and non-displayed DOT interest when doing parity allocations. 
Accordingly, given the fact that CAP orders represent customer orders, 
the Commission believes that waiving the 30-day operative delay is 
consistent with the protection of investors and the public 
interest.\15\
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    \15\ For purposes only of waiving the 30-day operative delay, 
the Commission has also considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
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    At any time within 60 days of the filing of the proposed rule 
change, the Commission may summarily abrogate such rule change if it 
appears to the Commission that such action is necessary or appropriate 
in the public interest, for the protection of investors, or otherwise 
in furtherance of the purposes of the Act.\16\
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    \16\ 15 U.S.C. 78s(b)(3)(C). For purposes of calculating the 60-
day period within which the Commission may summarily abrogate the 
proposal, the Commission considers the period to commence on May 16, 
2008, the date on which the Exchange submitted Amendment No. 1.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-NYSE-2008-32 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-NYSE-2008-32. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/
sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the

[[Page 30439]]

Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. Copies of the filing also will be available for inspection and 
copying at the principal office of the Exchange. All comments received 
will be posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-NYSE-2008-32 and should be submitted on 
or before June 17, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-11808 Filed 5-23-08; 8:45 am]

BILLING CODE 8010-01-P
