of public interest. The advantages enjoyed by floor traders in relation to the general public can be grouped under two headings:

1. Advantages of time and place;

2. Advantages in dollar costs.

Technically speaking, it would be impossible for floor trading to take place unless the floor trader were on the floor; therefore, it is impractical to try to restrict or modify the "place" advantage if floor trading is to continue. However, the floor trader could still remain on the floor, and yet forego certain time priorities which he now possesses, should any restrictions in this direction appear warranted. It would of course also be possible to impose certain modifications on his present cost advantages, such as are now imposed on members who trade off the floor, should it be determined that it was just and proper that such modifications of present operating costs be imposed."

484

The report went on to suggest that rules regarding three specific trading procedures might be desirable to deal with "certain of the problems which exist." These problem areas, described as "matching," "precedence," and "stopping stock," eventually became the subject of Exchange rules, discussed below. By way of general recommendations, the report stated that every effort should be made to encourage floor trading that is stabilizing in nature, and similarly that every effort should be made to discourage floor trading of a destabilizing nature.

Conferences held between Commission representatives and officers of the NYSE, including a public conference, failed to produce agreement. On June 28, 1945, the board of governors of the NYSE approved new rules to govern floor trading, but held in abeyance, at the Commission's request, the formal adoption of these rules. In a letter to Ganson Purcell, Chairman of the Commission, Emil Schram, president of the Exchange, stated:

The Exchange will observe closely, as we feel sure the Securities and Exchange Commission will, the operation of the new rules to the end that their usefulness and effectiveness may be determined on the basis of a fair trial. A period of 6 months should be sufficient for such a test; I earnestly request on behalf of the New York Stock Exchange that, meanwhile, the Commission withhold action with respect to the proposals which its Trading and Exchange Division has made on the subject of floor trading.

This request, repeated again on August 2, was initially rejected by the Commission. On August 8, 1945, the Commission tentatively voted to abolish floor trading, but after continued deliberation determined to grant the Exchange's request. The reasons for this decision are set forth in the press release of August 28, 1945, which announced the Commission's decision as follows:

We have reviewed the information available to us from the sources just described, including the discussions subsequent to the conference of May 16, and are satisfied that floor trading as now conducted gives an undue advantage to floor traders over the public; that frequently it accelerates market movements and accentuates fluctuations in particular securities or groups of securities; and that more often than not it detracts from the stability of the market. We are convinced that it is essential to make effective as soon as practicable regulation that will minimize or eliminate those influences of floor trading which impair the stability of the market.

The New York Stock Exchange has urged us, in lieu of abolishing floor trading at this time, to afford it the opportunity to apply certain regulations which it believes will minimize the undesirable features of floor trading, yet preserve certain asserted benefits. The New York Curb Exchange has expressed its desire to put similar rules into effect.

The proposed rules would generally require floor traders who have acquired a position by purchasing stock on a price rise or selling on a decline to hold

484 Exchange Report at pp. 41-42.

that position until the beginning of the second succeeding trading day; they would prohibit members on the floor from availing themselves of the privilege of "stopping" stock unless the stock is "stopped" against the order of another member; and they would terminate the existing privilege of members on the floor, while acquiring a position in a security, of claiming priority over a public order at the same price either by the toss of a coin or by reason of the greater size of his order.

We are not convinced that it is impossible to devise measures more effective than these to minimize the undesirable effects of floor trading and permit the realization of whatever contribution it might make to market stability.485 Nevertheless, we believe that a prohibition of the kind proposed by our staff should not be imposed until the Exchanges, which now have recognized that floor trading gives rise to problems that require regulation more drastic than any heretofore attempted, are given a reasonable opportunity to demonstrate whether it is feasible for them to eliminate the abuses that have been associated with floor trading in the past. We propose to give them that opportunity.

If at any time it becomes evident to us that the Exchanges' rules, either in the form now proposed, or as they may be modified, are inadequate for the effective regulation of floor trading, we shall reconsider the recommendations of our staff, or any appropriate modification of those recommendations, and take such action as, in our opinion, will provide an adequate solution of the problems created by floor trading."

480

Almost immediately upon the release of the Commission's decision, three new rules-apparently those earlier approved by the board of governors were adopted by the Exchange setting forth restrictions on floor traders.

d. Rule 108: prohibiting floor trader parity or precedence with offfloor orders

The first rule, designed to moderate one element of the floor traders' on-floor advantages, dealt with the problems of "matching" and "precedence" that were discussed by the Exchange Report. These terms refer to techniques employed to determine which of two or more parties is entitled to the first transaction when such parties have placed bids (or offers) in a security at the same price. Such "deadlocks" are broken by the application of one or more of three principles, referred to as "priority," "precedence," and "parity." 487

These principles allow the floor trader to exercise his on-floor advantages by being the first to bid, or by adjusting the size of his bid or offer to gain precedence over or parity with other parties at the post. The rule adopted by the Exchange, now rule 108, therefore provided that a member acquiring or increasing a position on the floor was not entitled to parity with a bid or offer originating off the floor. Subsequently the Exchange extended this prohibition to precedence, first

485 Commission minutes of Aug. 22, 1946, at which time the decision to permit a trial period for the Exchange rules was made, state the Commission's feelings on this point more strongly : "The Commission, having given due consideration to various methods proposed for dealing with these problems, including the methods embodied in the rules proposed by the Exchange, expressed itself as doubting that the rules proposed by the Exchange would meet the more serious problems arising out of floor trading, especially the tendency of such trading to exaggerate market movements and aggravate fluctuations. The Commission considered, however, that each of the several alternative proposals, short of complete abolition of floor trading, which had been proposed and discussed with officials of the Exchange, involves some possible difficulties of administration and requires further study in order to determine whether any of them is capable of effective administration in a way that would minimize the undesirable effects of floor trading and at the same time retain whatever contribution it might make toward preserving a stable and orderly market and towards providing liquidity when it is needed instead of mere enhanced volume of trading which from time to time in the past has aggravated fluctuations." 480 Securities Exchange Act of 1934, release No. 3727, Thursday, Aug. 28, 1945.

487 The operation of these rules is explained in pt. B.1.a, above. Generally, persons first in time have "priority," while the largest bid (or offer) receives "precedence." "Parity" is broken by the flipping of a coin.

by interpretation and later by amendment. By further interpretation under the present rule, a floor trader bidding for "long" stock on a plus or zero-plus tick may not retain priority over off-floor orders nor may he have parity with or precedence over such orders. Also by interpretation, a floor trader bidding for "long" stock on a minus or zero-minus tick is entitled to priority, but not parity or precedence, over off-floor orders. Finally, floor trader offers designed to create or extend short positions may retain priority over off-floor orders, but may not claim precedence or parity.

This rule and its interpretations moderate the floor traders' trading advantages only slightly. It permits priority to floor trader offers to sell "short" stock. It places no restrictions on bids intended to cover short positions. It permits priority to floor traders making bids on minus or zero-minus ticks. Finally, and most important, it in no way prevents floor traders from outbidding or underoffering off-floor traders. 488

e. Rule 109: prohibiting the "stopping" of stock on floor trades

The second rule, now rule 109, prohibits floor traders from accepting the privilege of "stopping" stock. In July of 1946 the Division of Trading and Exchanges said of this rule:

It does not appear from any of our studies that the privilege of "stopping stock" has been of any material aid to floor traders. Accordingly, denying them the privilege appears to be of no particular consequence in solving the problems which floor trading creates.

f. Rule 110: the major floor trading rule

Since the adoption of these rules in August of 1945, rules 108 and 109 have remained relatively unchanged. Rule 110, however, by far the most important of the floor trading rules, has undergone frequent and often substantial change.

Originally adopted as rule 374, it provided that (1) if a member acquired or increased a long position by purchasing stock on the floor on a plus or zero-plus tick, he could not sell any of that issue until the second succeeding trading day unless he sold at a loss, and (2) if a member sold "long" stock on the floor on a minus or zero-minus tick, he could not replace the stock until the second succeeding trading day. Exceptions to the rule were provided for transactions to cover short sales and certain other transactions.

In February of 1947 the rule was amended and this "lock in" device was abandoned. In its stead the Exchange provided simply that floor traders could not purchase stock on a plus tick, again subject to certain exceptions including purchases to cover short positions. Under this rule the Exchange developed a policy that limited floor traders' purchases on zero-plus ticks to 300 shares or 30 percent of the amount offered, whichever was greater; when these limits were reached no further floor trader purchases on zero-plus ticks could be effected in that stock for a period of 15 minutes. This policy excepted purchases to cover short positions and purchases of stocks which floor traders

488 It should also be noted that the rule does not apply to limit orders placed by floor traders with specialists. Floor traders may therefore retain all rights to priority, precedence, etc., simply by paying floor brokerage to the specialist (i.e., by placing their order with the specialist). Although the floor trader forfeits a certain degree of his on-floor advantage by designating the specialist as his agent, he retains a significant advantage by virtue of the fact that he is still able to observe the trading as it takes place (rather than on the tape), and is able to place or cancel his order in a matter of seconds.

intended to hold for long-term investment. Through subsequent amendments of this rule, this control of "frozen stock"-whereby a stock is declared temporarily unavailable for certain types of floor trader purchases after a certain amount of floor trader purchases have been effected on plus ticks or zero-plus ticks-has become the major, almost exclusive, system of floor trader control utilized by the Exchange.

In July of 1947, the policy exemption granted to floor trader purchases of stock for investment purposes was rescinded. In October of 1947 the policy was further revised to allow floor traders to buy more than the limited amount of any stock if the prior approval of a floor governor was obtained, but any stock so purchased could not be sold, unless at a loss, for 2 business days. This revision, in effect, reinstated the "lock in" device, but only with respect to stock purchased with the prior approval of a floor governor.

Two changes were effected in the policy in April of 1948. The limitation on zero-plus tick purchases was raised from 300 shares or 30 percent of the offered amount to 300 shares or 50 percent, whichever was greater, and this limit was made applicable to purchases to cover short positions as well as purchases of "long" stock.

The rule was amended in December of 1948 so as to prohibit only plus tick purchases at or above the prior day's closing price of a stock. Purchases to cover short positions were not subject to the rule. Plus tick purchases below the prior day's close were limited, by exchange policy, to 300 shares or 50 percent of the offered amount, whichever was greater. Purchases of the limited amounts would then inaugurate a 15-minute freeze during which floor traders could not effect plus or zero-plus tick purchases. At this same time, all policy restrictions on zero-plus tick purchases below the prior close were abandoned.

Liberalization of the rule continued with an amendment adopted in August of 1949. The prohibition against plus tick purchases at or above the prior close was eliminated in favor of (1) a 300 share or 50-percent limitation on plus tick purchases above the prior close (which could be taken only if the offer quotation remained unchanged), and (2) a prohibition against plus tick purchases above the prior close if floor traders had twice purchased on plus ticks on their own bids within 15 minutes. The amended rule also allowed zeroplus tick purchases above the prior close of up to 500 shares or 75 percent of the offered amount, but this amount could not be taken if it would cause the offer quotation to change. Exempt from this rule were all purchases to cover short positions and purchases made, with the prior approval of a floor governor, with intent to hold the stock for at least 2 business days.

It is perhaps significant that the only two periods found by the Division of Trading and Exchanges in which floor traders tended to trade against rising price movements were the periods of July 1945 to February 1946, and August 1947 through July 1948.189 The findings for the 1945-46 period are apparently accounted for by the "lock in' device then in effect. The latter period is marked by several rule and policy changes, but the major controls in effect through the period in

489 See app. VI-H.4.g. A breakdown of floor trader balances into daily figures for the August 1947-July 1948 period also indicated that floor traders were trading against rising price movements. See app. VI-H.4.h.

cluded an absolute prohibition against plus tick purchases, limitations on zero-plus tick purchases, and the "lock in" device on stock purchased with the prior approval of a floor governor. Since the 1949 amendment, which eliminated the absolute prohibition on plus tick purchases, and liberalized restrictions on zero-plus tick purchases, floor traders have tended to trade with rising price trends.490

In 1953, all of the above restrictions on floor trading were abandoned as the exchange rescinded rule 374, the predecessor of the present rule 110. Control of floor trading was then left largely to a rule adopted in 1949 which provided simply that members purchasing "long" stock

(1) shall not congregate in a particular stock, and individually or as a group, dominate the market in that stock; (2) shall not effect such purchases except in a reasonable and orderly manner and they shall not be conspicuous in the general market or in the market in a particular stock.

This very general rule, discussed below, has remained in effect unchanged, and today constitutes the formal statement of rule 110. Willard K. Vanderbeck, vice president in charge of the Floor Department, testified that these general prohibitions must be interpreted and applied in a flexible or "commonsense" fashion. He defined "congregation" as the "assembling of a number of floor traders" at a post, "dominating the market" as a series of floor trader purchases or sales that effectively prevent others from trading until the floor traders are prepared to take the other side of the market, and "trading in a conspicuous manner" as effecting transactions in other than "an orderly way." The occasions on which Vanderbeck has deemed it advisable to direct a "cautionary word" to one or another floor trader with respect to these rather vague prohibitions have been, he testified, relatively rare.

Although these general prohibitions constitute the formal statement of the rule, the Exchange began in 1955 to revive the concept of "frozen stock" in "clarification" materials supplementing the general rule. It is almost entirely upon these materials, twice amended since 1955, that the Exchange bases its regulation of floor trading. It is clear, without for the moment considering the exact nature of these materials, that they have not prevented floor traders from accentuating price movement and that they have not channeled floor trader liquidity into those securities and trading periods where it is most needed. They have, in short, failed to meet the conditions set forth by the Commission in 1945 under which the Commission declared that it would permit the continuation of floor trading.

Study of the clarification itself reveals the reasons for this failure. The complexity of the material defies brief description,191 but gen

490 The erosion of floor trading controls during the years 1948 and 1949 was apparently due in part to unrest among certain floor members, and to pressure exerted by these members on the governors of the exchange. In June of 1949 these members, headed by an informal "Committee of 17," successfully petitioned for changes in the exchange constitution which, among other things, increased floor member control over floor matters. (See ch. XII.B.) Although none of their demands dealt directly with floor trading rules, a high exchange official ascribed the unrest to the fact that floor members were not making enough money, noted that they blamed this on "too many restrictions" on trading, and stated that these members wanted to remove all restrictions on floor trading.

401 See app. VI-I for full text of clarification.