Securities Markets, Facilities and Trading

Natural Market System-During the past fiscal year, continued progress was made in the development of a national market system. Most significantly, the Commission initiated an experiment designed to increase competition in exchange-traded securities.

On June 11, 1980, the Commission adopted Rule 19c-3 under the Securities Exchange Act of 1934 (Exchange Act). The rule precludes the application of off-board trading restrictions to certain securities that become exchange-listed after April 26, 1979, including those securities which had been listed previously, but failed to remain so.

In its release adopting Rule 19c-3, the Commission noted that the rule will provide the opportunity for competition between over-the-counter and exchange markets. By permitting exchange members to effect transactions in-house, the rule may also result in cost savings for brokers, dealers and investors. Furthermore, by limiting expansion of off-board trading restrictions, the rule will maintain the status quo pending resolution of the broader issues associated with such anti-competitive requirements generally. Finally, the rule will permit the Commission and the industry to gain valuable experience regarding the effects of concurrent over-the-counter and exchange trading. Among other matters, experience under the rule should enable the Commission to observe the effectiveness of existing trading systems, particularly the Intermarket

Trading System (ITS) and the Cincinnati Stock Exchange's automated National Securities Trading System (NSTS), in addressing the needs of such an environment. The lessons of this experience may provide incentives to improve those systems or to develop new systems to accommodate any changes in trading patterns that occur.

In a separate release, the Commission noted that it did not expect to take further action in the near future with respect to off-board trading restrictions generally.2 Accordingly, the Commission withdrew an earlier proposal-proposed Rule 19c-2 under the Exchange Act-with respect to offboard trading rules. That proposal, which was published in June 1977,3 would have eliminated all remaining exchange restrictions on off-board principal transactions and on "in-house agency crosses," (i.e., off-board agency transactions in which a member acts as agent for both buyer and seller in the same transaction), with respect to reported securities.

On December 5, 1979, the Commission proposed Rule 11Aa3-2 under the Exchange Act, which, if adopted, would establish procedures relating to the filing and approval of plans governing planning, developing, operating or regulating a national market system or its facilities. The rule is proposed to be adopted pursuant to Section 11A(a)(3)(B) of the Exchange Act, which provides for Commission approval of joint industry action with respect to the establishment of a national market system. At the close of the fiscal year, the Commission was analyzing the comments received in response to pro

posed Rule 11Aa3-2 and was considering further action with respect to it.

On February 19, 1980, the Commission adopted two proposals designed to refine the operation of the consolidated transaction reporting and quotation systems. First, the Commission adopted an amendment to existing Rule 17a-155 (redesignated as Rule 11Aa3-1) under the Exchange Act which eliminates, subject to one condition, the preexisting prohibition on retransmission of transaction information for purposes of creating a moving ticker display. It also sets forth procedures for amending transaction reporting plans filed pursuant to the rule.

Second, the Commission adopted Rule 11Ac1-2 under the Exchange Act, which imposes minimum requirements regulating the manner in which securities information vendors display transaction and quotation information. Most importantly, the rule requires that the NASDAQ system disseminate, for securities traded solely over-the-counter, the best bid and best offer as opposed to a "representative" quotation. This provision of the rule became effective on July 5, 1980. On June 24, 1980, in order to allow time for development of certain quotation processing facilities related to compliance with the rule, the Commission extended the effective date of portions of the rule regulating the display of quotation and transaction information for exchange-traded securities.7

During the fiscal year, the Commission continued its efforts to achieve its goal of intermarket price protection, initially for public limit orders, and ultimately for all orders. The Commission reviewed comments received on proposed Rule 11Ac1-3 under the Exchange Act, which, if adopted, would prohibit any broker or dealer from executing any order to buy or sell certain securities at a price inferior to the price

of any public limit order displayed at the time of execution unless the broker or dealer assures that those limit orders are satisfied. In addition, the Commission continued to encourage the ITS participants to implement their commitment to develop a joint plan for protection of public limit orders. At the end of the fiscal year, the Commission was anticipating the receipt of an amendment to the ITS plan that would provide for the implementation and operation of a pilot Limit Order Information System (LOIS). LOIS would provide, on the floor of each ITS participant, a display of limit orders entered from all participant exchanges at various price levels. LOIS, in combination with ITS, is intended to provide a mechanism through which nationwide limit order protection with respect to certain block transactions may be achieved. Finally, the ITS participants have, on their own initiative, begun discussions about a rule that would preclude the execution of transactions on one ITS participant at prices inferior to the quotations disseminated by any other ITS participant.

The Commission has also continued to encourage the development of linkages between the ITS and the over-thecounter market and between the ITS and the NSTS. In its release adopting Rule 19c-3, the Commission stated that it expected that the ITS participants and the National Association of Securities Dealers, Inc. (NASD) would quickly reach agreement on an automated linkage between the ITS and the NASDAQ system, which was recently enhanced to provide the capability for automated execution against third market maker quotations. The Commission also stated that it expected that the ITS participants and the NSTS would quickly reach agreement on a linkage between their systems.

Shortly before the end of the fiscal year, the Commission received a status

report from each of the relevant parties on the implementation of a linkage in the near term between the ITS and the NSTS. However, the ITS participants did not commit themselves to the implementation of an automated linkage between the ITS and the NASDAQ system. While hopeful of achieving voluntary industry agreement with respect to the linkage between the ITS and the NASDAQ system, the Commission, at the close of the fiscal year, was considering regulatory measures to ensure the implementation of that linkage if no voluntary agreement is reached.

National System for Clearance and Settlement of Securities Transactions - During the fiscal year, substantial progress was made in the Commission's effort to foster development of a national system for clearance and settlement of securities transactions. The staff continued its review of the two issues remanded by the United States Court of Appeals for the District of Columbia Circuit in Bradford National Clearing Corporation v. Securities and Exchange Commission.9 In that decision, the court affirmed the Commission's decision granting the application of National Securities Clearing Corporation (NSCC) for registration as a clearing agency. The Commission has viewed that registration as a key step in achieving a national clearance and settlement system. While not disturbing NSCC's registration, the court remanded two issues to the Commission for further consideration: (a) NSCC's selection of Securities Industry Automation Corporation as the facilities manager of its consolidated system without competitive bidding; and (b) NSCC's use of geographic price mutualization (GPM). GPM is the practice of charging all participants the same fees regardless of whether the participants deal with the clearing agency at its main facility or through a branch office.

In March 1979, the Commission solicited public comment on those two issues.10 In addition to the 11 comment letters received by the Commission in the previous fiscal year, the Commission received three letters in fiscal 1980 from NSCC in response to those comment letters, as well as a report on the economic aspects of competitive bidding and GPM, submitted on behalf of NSCC. The Commission also received an economic report submitted on behalf of Bradford National Corporation in response to NSCC's report. The Commission is completing its review of those letters, reports, and other available information and expects to announce its decision on these issues in fiscal year 1981.

The Commission continued its review of the issues raised by proposed rule changes submitted by Bradford Securities Processing Services, Inc. and NSCC that would establish automated comparison and clearance systems for municipal securities. Such systems have resulted in significant improvements in the processing of equity and corporate debt securities. Specifically, the proposed systems would (a) enable municipal securities brokers and dealers to compare transactions through a central entity rather than having to relate directly to each broker and dealer with whom they execute transactions; (b) increase standardization in the processing of transactions in municipal securities; and (c) provide the settlement and financial benefits that accrue from the netting of transactions in the same security.

Progress toward a national system was also evident in other areas. The expansion of interfaces among securities depositories was furthered by the Commission's approval of proposed rule changes filed by The Depository Trust Company and the Philadelphia Depository Trust Company establishing an in