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Release No. 34-14713 April 27, 1978
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 Table of Contents
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I. EXEMPTIVE RULE FOR BOND TRANSACTIONS
(TEMPORARY RULE 11a1-4(T))
As discussed above, Section 11(a)(1) prohibits a member of a national securities exchange from effecting transactions on such exchange for its own account or the account of its associated person. That proscription encompasses transactions in any type or class of security listed or admitted to trading on the exchange.
Commentators on the March 1978 Release and the Commissions two prior releases on Section 11(a), the January 1976 Release and Securities Exchange Act Release No. 13388 (Mar. 18, 1977) (the "March 1977 Release"), 8 requested that the Commission exercise its exemptive authority under Section 11(a)(1)(H) to permit members to effect transactions for their own accounts in bonds listed on an exchange. In support of that request, they contended that the over-the-counter market is the primary market in listed bonds; that bond trading on exchanges is essentially an odd-lot business; and that bond transactions on the exchange are over-whelmingly conducted by members on a principal basis and therefore Section 11(a)(1) could and probably will eliminate the great majority of exchange transactions in listed bonds. Commentators further urged that such principal bond transactions are not subject to the member trading advantages identified by the Congress as a reason for enacting Section 11(a). Bond trading is different in that respect, they suggested, because, among other things, bonds are priced on the basis of factors, such as the money supply and interest rates, which are independent of the influence of exchange market activities. Consequently, they argued, fluctuations in bond prices are usually small, and the ability of members to avail themselves of time and place advantages in bond transactions for their own accounts is limited. 9
In December 1977, the New York Stock Exchange, Inc. (the "NYSE"), requested the Commission to adopt rules under Section 11(a)(1)(H) exempting certain types of member transactions from the prohibition of Section 11(a). Among the rules suggested was a rule which would exempt proprietary transactions in listed bonds which are effected to facilitate an order of a public customer. 10 In the March 1978 Release, the Commission determined that the NYSE had not provided a sufficient rationale for such an exemption. 11 Upon further consideration of members principal transactions in exchange-traded bonds, however, the Commission has determined to adopt Temporary Rule 11a1-4(T) (the "bond trading rule") under Section 11(a)(1)(H) of the Act to exempt from Section 11(a)(1) all bond transactions on an exchange for the account of a member or its associated person. The Commission has taken this action in recognition of several factors.
First, principal bond trading on exchanges provides a relatively liquid market for transactions of small size. The primary market in listed bonds is over-the-counter and is characterized by large-sized transactions among financial institutions and bond dealers. Bond transactions on exchanges, on the other hand, are generally effected as principal on behalf of exchange members retail customers and often involve transactions of less than 100 bonds, which normally would be the minimum size of an institutional over-the-counter transaction.
The second reason for the Commissions adoption of an exemptive rule for bond trading is its belief that, because the primary market for listed bond trading currently is in the over-the-counter market, the exchange bond markets do not appear to offer to exchange bond traders the special "time and place" trading advantages which the Congress identified as a basis for Section 11(a). 12 Unlike other types of securities, the pricing of listed bonds on the exchanges appears to be directly related to the pricing of similar forms of indebtedness traded in the over-the-counter market. Finally, since the institutional trading market in bonds currently is conducted over-the-counter, and exemption for exchange bond trading would not appear to raise any of the problems of institutional exchange membership articulated by the Congress when it enacted Section 11(a). 13
The bond trading rule covers transactions involving any bond, debenture, or other form of indebtedness listed or admitted to trading on national securities exchanges. 14 Transactions permitted by the rule will continue to be governed by applicable exchange rules as well as provisions of the Act (other than Section 11(a)) and rules thereunder. The relief provided by that rule extends to transactions for the account of a member or its associated person, 15 but not to transactions effected by a member on behalf of a managed institutional account. 16 Transactions for managed institutional accounts are not being exempted since the potential fiduciary problems which the Congress identified with respect to such accounts would not appear to be substantially less significant in debt securities than they were perceived to be in the case of equity securities.
The Commission is adoption Rule 11a1-4(T) on a temporary basis, effective May 1, 1978, in order to avoid any disruption of the exchange bond market on and after May 1, 1978. The Commission will consider carefully commentators views on the bond trading rule and may act at any time to modify, or indeed to rescind, the rule. The commission may also need to revise the rule if exchange bond trading activities undergo a substantial change of character or begin to exhibit any substantial member trading abuses.
II. AMENDMENTS TO, AND INTERPRETATIONS UNDER, THE PROPRIETARY TRADING RULE
(TEMPORARY RULE 11a1-1(T))
The proprietary trading rule was adopted under Section 11(a)(1)(G) 17 to implement that provisions exemption for members proprietary transactions. Under Section 11(a)(1)(G), as implemented by the proprietary trading rule, a member may effect a transaction for its own account if (i) the member derives more than 50% of its gross income from certain types of business (the "business mix" test), and (ii) the transaction yields priority, parity, and precedence in execution to orders for the accounts of persons who are not members or associated with members of the exchange. Questions have been raised concerning (i) the revenues which are included within the categories of business enumerated in the "business mix" test and (ii) procedures that should be implemented by exchanges and their members concerning the identification of members orders.
A. Treatment of Revenues Derived from Transactions Exempted under Section 11(a)(1)
The "business mix" test contained in Subparagraph (G)(i) of Section 11(a)(1) is intended to limit the Section 11(a)(1)(G) exemption to members which are engaged in certain aspects of the securities business. 18 Specifically, that test limits the availability of the exemption to members which are "primarily engaged in the business of underwriting and distributing securities issued by other persons, selling securities to customers, and acting as broker, or any one or more of such activities, and whose gross income normally is derived principally from such business and related activities" (referred to as "eligible income").
The determination as to whether revenue derived from a particular transactions or series of transactions is eligible income turns solely on the Section 11(a)(1)(G)(i) test itself rather than on whether the transaction or series of transactions is exempted under Paragraphs (A) through (H) of Section 11(a)(1). For example, revenue from an arbitrage transaction exempt under Section 11(a)(1)(D) would not necessarily be eligible income, since the arbitrage transaction might not involve any of the activities enumerated in Section 11(a)(1)(G)(i).
The phrase "selling securities to customers" in Section 11(a)(1)(G)(i) refers to an exchange members principal transactions with its own customers. While purchasing securities from customers should be considered a "related" activity, 19 an exchange members purchase of securities from, or sale to, other broker-dealers is not a transaction with the members own customers, 20 even though the broker-dealers with whom the transactions are effected may be acting as agent for their customers. For example, an exchange specialist would derive eligible brokerage income from his book, but would derive eligible dealer income only in transactions with the specialists own non-broker-dealer "customers." 21 Similarly, an upstairs market maker would derive eligible income from effecting principal transactions with its own customers 22 but not from market-making transactions with other broker-dealers who are acting as principal or as agent for their customers.
While this result represents what the Commission believes to be a proper reading of the language of Section 11(a)(1)(G)(i), the "business mix" test in the Section 11(a)(1)(G) exemption, as so interpreted, is too restrictive. It fails to recognize a number of exchange member dealer activities which also have been considered part of a "traditional" securities business.
Accordingly, the Commission is amending Paragraph (b) of the proprietary trading rule, pursuant to its authority under Section 11(a)(1)(H), to permit members to count revenues from market-making, odd-lot dealer, and arbitrage and hedge transactions towards the satisfaction of the Section 11(a)(1)(G)(i) "business mix" test. All of these activities are expressly exempted from the prohibitions of Section 11(a)(1), in part because the Congress determined that their impact on exchange markets was beneficial, or at least not deleterious. 23
In assessing compliance with the "business mix" test under Paragraph (b) of the proprietary trading rule, an exchange may rely on a financial report prepared by independent accountants in accordance with generally accepted accounting principles. Certain classes of members, however, are not required to file such reports with exchanges under Rule 17a-5, 24 and, as a result, would not be able to supply such reports to exchanges without incurring additional costs. The Commission believes that, in the absence of a report of independent accountants under Rule 17a-5, an exchange may rely on a final report filed under Rule 17a-5(a)(4) unless the exchange knows or should know that the report is inaccurate. 25
B. Pre-May 1, 1978 Limit Orders
Under current practices on the exchanges, limit orders left with an exchange specialist or other person maintaining a limit order book may be designated as not expiring if unfilled at the end of the trading day on which they were entered. 26 In view of those practices, the Commission understands that limit orders entered before May 1, 1978 generally will not have been marked, for purposes of the proprietary trading rule, to indicate whether they must yield to non-members orders if effected on or after May 1, 1978. 27
In order to avoid undue burdens with respect to those orders, the Commission has adopted, effective May 1, 1978, a new Paragraph (c) to the proprietary trading rule. The Paragraph, adopted pursuant to Sections 11(a)(1)(G) and (H), provides that any limit order which was left with a specialist or any other person maintaining a limit order book on a national securities exchange before May 1, 1978, and not executed before that date, shall be deemed, if executed before January 1, 1979, to be an order for the account of a person who is not, and is not associated with, a member.
C. Identification of Orders
Subparagraph (G)(ii) of Section 11(a)(1) requires all members proprietary orders effected thereunder to comply with Commission rules assuring that such orders yield priority, parity, and precedence in execution to orders for the accounts of persons which are not members or associated with members of the exchange (collectively referred to as "yielding orders"). Paragraph (a) of the proprietary trading rule implements that provision by requiring (i) that a members proprietary order be identified at all steps in the process of effecting the order and (ii) that, notwithstanding exchange yielding rules otherwise applicable, such order yields to any non-member order at the same price regardless of size or the time when entered. Members yielding orders under the proprietary trading rule are not required to yield to other members yielding orders, or to other members or associated persons proprietary orders otherwise exempt under Section 11(a)(1).
The proprietary trading rule sets forth an order identification requirement only with respect to yielding orders. In order for the yielding requirement of the proprietary trading rule to work properly, however, it would appear necessary for all members of the trading crowd to identify all orders, including those not required to yield, as to whether they are (i) non-member orders, (ii) members or associated persons yielding orders, or (iii) members or associated persons non-yielding orders. 28
III. INTERPRETATIONS UNDER THE LOOK-THROUGH RULE (RULE 11a1-2)
The look-through rule permits a member to effect a transaction for the account of its associated person or the public customers of its associated person if, assuming such account were carried on the same basis by a member, the member itself would have been permitted under Section 11(a) and the rules thereunder to effect the transaction. The look-through rule is based on the principle that there should be no difference between transactions for the account of a member allowed under Section 11(a)(1) and transactions for the account of a person associated with that member, provided that these transactions are effected in the same manner and are subject to the same conditions. 29
The look-through rule provides that a member proposing to effect a transaction for the account and benefit of an associated person in reliance on Section 11(a)(1)(G) and the proprietary trading rule thereunder may do so if the associated person, during its preceding fiscal year, met the "business mix" test of Paragraph (G)(i). While the associated persons order must yield to public orders to satisfy the conditions of Section 11(a)(1)(G)(ii), the member effecting such a transaction for its associated person is not itself required to satisfy the "business mix" test.
IV. AMENDMENT TO, AND INTERPRETATIONS UNDER, THE EFFECT VERSUS EXECUTE RULE
(TEMPORARY RULE 11a2-2(T))
The effect versus execute rule was adopted by the Commission in the March 1978 Release. It provides an exemption for all member transactions for covered accounts that are referred to other members for execution and are executed in accordance with certain conditions. The effect versus execute rule was designed to put members and non-members on the same footing, to the extent practicable, in light of the purposes of Section 11(a). 30
A. Effective Date
The effect versus execute rule was adopted pursuant to the Commissions rulemaking authority under Sections 11(a)(1)(H) and 11(a)(2). 31 Pursuant to Section 11(a)(3), the provisions of Section 11(a)(1) will not become effective until May 1, 1978 with respect to persons who were exchange members on May 1, 1975. Section 11(a)(3), however, also provides that the Commission is not prohibited from exercising its Section 11(a)(2) rulemaking authority to adopt regulations prior to May 1, 1978 prohibiting or regulating the kinds of transactions subject to Section 11(a)(1). Consequently, the Commission is authorized under Sections 11(a)(2) and 11(a)(3) to apply the prohibition of Section 11(a)(1) to exchange members who were members on May 1, 1975 and otherwise not subject to Section 11(a)(1) until May 1, 1978.
The House of Representatives 32 and the Senate 33 recently passed legislation to extend the "grandfather" provision of Section 11(a)(3). The effect versus execute rule, because it was adopted in part under Section 11(a)(2), might be construed to become effective on May 1, 1978 as to all exchange members, notwithstanding any legislative extension of Section 11(a)(3). If the delay legislation is enacted into law, however, the Commission does not intend the effect versus execute rule to be effective with respect to those grandfathered members. Accordingly, the Commission today is amending the effect versus execute rule by the addition of a new Paragraph (f), to eliminate any uncertainty as to the Commissions intention in that regard.
B. Participation of Members Floor Employees
Paragraph (a)(2)(iii) of the effect versus execute rule prohibits the initiating member or an associated person thereof from participating in the execution in the transaction at any time after the order for the transaction has been transmitted. The prohibition would thus extend to any order-handling function performed by the initiating broker (or one of its associated persons) after the order was transmitted. Accordingly, the Commission wishes to make it clear that the participation prohibition in Paragraph (a)(2)(ii) would not allow a member to transmit a covered account order from off the exchange floor to its employee on the floor for the purpose of having that employee refer the order to an unaffiliated member. That employee is an associated person of the member and is prohibited from participating in the execution of any transaction pursuant to the effect versus execute rule after transmission of the order by the member from its facilities off the exchange floor. That application of the prohibition on participation helps to ensure that members do not retain any special trading advantages not available to non-members in connection with effecting orders for covered accounts under the effect versus execute rule.
V. APPLICATION OF THE NATURAL PERSON
EXEMPTION UNDER SECTION 11(a)(1)(E)
TO CERTAIN ACCOUNTS
Section 11(a)(1)(E) 34 exempts from the prohibition of Section 11(a)(1) any transaction for the account of a "natural person, the estate of a natural person, or a trust (other than an investment company) created by a natural person for himself or another natural person." That exemption was discussed in earlier releases. 35 The application of that exemption as to certain kinds of customer accounts requires clarification.
One reading of Section 11(a)(1)(E) might lead to the conclusion that accounts of two or more natural persons are excluded from its coverage, even though many such accounts are substantially similar to individual natural person accounts. The Commission believes that exemption should be available to certain accounts which, in light of the purposes of Section 11(a), may be considered "natural person accounts," provided that such accounts are not established for the purpose of avoiding Section 11(a) or the rules thereunder; (i) husband and wife joint accounts and other joint tenancies where the tenants are related by blood or marriage or are members of the same household; (ii) accounts of family trusts with one or more beneficiaries who are related to the settlor by blood or marriage, or who are members of the settlors household; and (iii) an individual retirement account established by a natural person. 36
An account established by an entity with a separate legal existence (e.g., an unincorporated business association, a general or limited partnership, a joint venture, a professional association, a personal holding company, or a corporation) would not qualify for the natural person exemption. A personal holding company established under the laws of another country, however, may be a "natural person" for purposes of Section 11(a)(1)(E) if the company is able to demonstrate that: (i) it is established under the laws of a country which does not recognize or permit the equivalent of a common law joint tenancy or trust; (ii) the company is established for the benefit of persons who are related by blood or marriage, or who are members of the same household; and (iii) the company is not established for the purpose of avoiding Section 11(a) or the rules thereunder.
VI. RELATIONSHIP OF EXEMPTIONS UNDER
SECTION 11(a) TO ONE ANOTHER
Section 11(a)(1) prohibits a member of a national securities exchange from effecting a transaction for any covered account in the absence of a statutory exemption or one created by rule. In many cases, a member may be able to effect a transaction pursuant to more than one statutory or rule exemption. As the Commission observed in the March 1978 Release, 37 each exemption under Section 11(a), whether provided by the Section or by rule, is independent of each other exemption under that provision. 38 The number of questions, however, received by the Commissions staff with respect to the interaction of exemptions under Section 11(a) suggests that further explanation of this matter would be appropriate.
A member effecting a transaction that could fall within more than one statutory or rule exemptions is only required to satisfy the terms of one exemption. For example, a member which qualifies for the exemption for members proprietary transactions under Section 11(a)(1)(G) or one of the other statutory exemptions may properly decide to rely instead upon the provisions of the effect versus execute rule to effect a proprietary transaction. If the member chooses to rely upon the provisions of the effect versus execute rule, it need comply only with the conditions of that rule and need not comply with the conditions of any other available statutory or rule exemption.
VII. STATUTORY BASIS
The Securities and Exchange Commission, acting pursuant to the Securities Exchange Act of 1934, and particularly Sections 2, 3, 6, 10, 11, 11A, 15, and 23 thereof (15 U.S.C. 78b, 78c, 78f, 78j, 78k, 78k-l, 78o, and 78w), hereby adopts Temporary Rule 11a1-4(T), amendments to Temporary Rule 11a1-1(T), and an amendment to Temporary Rule 11a2-2(T). The Commission has determined that Temporary Rule 11a1-4(T), the amendments to Temporary Rule 11a1-1(T), and the amendment to Temporary Rule 11a2-2(T) are consistent with the purposes of Section 11(a), the protection of investors, and the maintenance of fair and orderly markets.
With respect to the adoption of Temporary Rule 11a1-4(T), the Commission believes that failure to adopt this rule prior to May 1, 1978 would be likely to disrupt exchange trading in bonds and other forms of indebtedness without furtherance of the purposes of Section 11(a). Such a disruption could interfere with the execution of transactions for retail customer orders in exchange-listed bonds and other forms of indebtedness. 39 In view of the foregoing discussion and the May 1, 1978 effective date of Section 11(a), the Commission finds that notice and public procedures in accordance with Section 4(b) of the Administrative Procedure Act ("APA") 40 would be impracticable and contrary to the public interest. Accordingly, the Commission finds, pursuant to 5 U.S.C. 553(b)(B), that good cause exists to adopt Temporary Rule 11a1-4(T) without notice and public procedures in connection therewith. For the same reasons, the Commission finds good cause to make Temporary Rule 11a1-4(T) effective less than 30 days after its adoption, in accordance with Section 4(d) of the APA. 41 In addition, publication of notice is not required because Temporary Rule 11a1-4(T) grants an exemption under Section 11(a). 42
With respect to the amendments to Temporary Rule 11a1-1(T), the Commission believes that the amendment should eliminate unjustifiable distinctions between classes of securities transactions, will avoid anticompetitive discrimination in various aspects of the securities business, and will avoid unnecessary disruptions of exchange markets. In view of the May 1, 1978 effective date of Section 11(a), the Commission finds that notice and public procedures in accordance with Section 4(b) of the APA would be impracticable and contrary to the public interest and that good cause exists to adopt the amendments to Temporary Rule 11a1-1(T) without notice and public procedure in connection therewith. In addition, the Commission finds good cause to make the amendments to Temporary Rule 11a1-1(T) effective less than 30 days after its adoption in accordance with Section 4(d) of the APA, 43 in view of the foregoing and the fact that the amendment broadens an existing exemption under Section 11(a).
With respect to the amendment to Temporary Rule 11a2-2(T), the Commission finds that the amendment is interpretive in nature, and that notice and public procedure under Section 4 of the APA 44 are unnecessary in connection therewith, and that 30 days notice of its effective date is likewise unnecessary.
The Commission finds that the rule and rule amendments being adopted today will not impose any burdens on competition that are not necessary or appropriate in furtherance of the purposes of the Act. The adoption of Temporary Rule 11a1-4(T) will establish an exemption for members exchange proprietary transactions in listed bonds and other forms of indebtedness, and may increase competition on exchanges. The amendment to Temporary Rule 11a1-1(T) which concerns the "business mix" test may increase competition by broadening the availability of the exemptions under Section 11(a)(1)(G). The second amendment to Temporary Rule 11a1-1(T) relieves problems with respect to the handling of certain limited price orders and will not impose any unnecessary or inappropriate burdens on competition. The amendment to Rule 11a2-2(T) is interpretive in nature and does not impose any burden on competition.
Part 241 of Chapter II of Title 17 of the Code of Federal Regulations is amended, effective immediately, by the inclusion of this Release therein. Part 240 of Chapter II of Title 17 of the Code of Federal Regulations is amended, effective May 1, 1978, as follows:
§240.11a1-4(T) Bond transactions on national securities exchanges.
A transaction in a bond, note, debenture, or other form of indebtedness effected on a national securities exchange by a member for its own account or the account of an associated person thereof shall be deemed to be of a kind which is consistent with the purposes of section 11(a)(1) of the Act, the protection of investors, and the maintenance of fair and orderly markets.
§240.11a1-1(T) Transactions yielding priority, parity and precedence.
* * * * *
(b) A member shall be deemed to meet the requirements of section 11(a)(1)(G)(i) of the Act if during its preceding fiscal year more than 50 percent of its gross revenues was derived from one or more of the sources specified in that section. In addition to any revenue which independently meets the requirements of section 11(a)(1)(G)(i), revenue derived from any transaction specified in paragraph (A), (B), or (D) of section 11(a)(1) of the Act shall be deemed to be revenue derived from one or more of the sources specified in section 11(a)(1)(G)(i). A member may rely on a list of members which are stated to meet the requirements of section 11(a)(1)(G)(i) if such list is prepared, and updated at least annually, by the exchange. In preparing any such list, an exchange may rely on a report which sets forth a statement of gross revenues of a member if covered by a report of independent accountants for such members to the effect that such report has been prepared in accordance with generally accepted accounting principles.
(c) Any limited price order which was left with a specialist or any other person maintaining a limit order book on a national securities exchange before May 1, 1978, and not executed before that date, shall be deemed, if executed before January 1, 1979, to be an order for the account of a person who is not, and is not associated with, a member.
§240.11a2-2(T) Transactions effected by exchange members through other members.
* * * * *
(f) The provisions of this section shall not apply to transactions by exchange members to which, by operation of section 11(a)(3) of the Act, section 11(a)(1) of the Act is not effective.
By the Commission
George A. Fitzsimmons
Secretary
Three commentators on the March 1978 Release objected to the contractual modification and disclosure provisions of the effect versus execute rule on the ground that those provisions were inconsistent with the purposes of Section 11(a). Responses of the American Council of Life Insurance (April 14, 1978) and the American Insurance Association (April 13, 1978), File No. S7-613. One of those commentators suggested that compliance with those provisions would put exchange members at a competitive disadvantage with respect to non-member money managers. Response of Sanford C. Bernstein & Co., Inc. (April 13, 1978), File No. S7-613. But see Report of the House Comm. on Interstate and Foreign Commerce, Together with Additional Views, to Accompany H.R. 11567, H.R. Rep. No. 95-1010, 95the Cong., 2d Sess. 4 (1978); 121 Cong. Rec. H2431 (daily ed. Apr. 4, 1978) (remarks of Congressman Moss).
1 15 U.S.C. 78k(a)(1).
2 15 U.S.C. 78k(a)(3).
3 The Commission has rulemaking authority under Section 11(a)(2), 15 U.S.C. 78k(a)(2), to extend the prohibitions of Section 11(a)(1) to (i) members transactions (other than market maker and odd-lot dealer transactions) exempted thereunder; (ii) over-the-counter transactions (other than market maker transactions); and (iii) non-members exchange transactions (other than market maker transactions). The Commissions authority under that Section is complemented by Sections 11(b) and 15(c)(5) of the Act, 15 U.S.C. 78k(b) and 78o(c)(5). In addition, under Section 11(a)(1)(H), 15 U.S.C. 78k(a)(1)(H), the Commission is authorized to exempt from Section 11(a)(1) any transaction of a kind which the Commission, by rule, determines is consistent with the purposes of Section 11(a)(1), the protection of investors, and the maintenance of fair and orderly markets.
4 Securities Exchange Act Release No. 14563 (Mar. 14, 1978) (the "March 1978 Release"), 43 FR 11542 (Mar. 17, 1978).
5 17 CFR 240.11a1-1(T). The proprietary trading rule was adopted in Securities Exchange Act Release No. 12055 (Jan. 27, 1976) (the "January 1976 Release"), 41 FR 8075 (Feb. 24, 1976).
6 17 CFR 240.11a1-2.
7 17 CFR 240.11a2-2(T).
8 42 FR 16345 (Mar. 29, 1977).
9 Responses of Asiel & Co. (June 14, 1976, June 30, 1977, and April 14, 1978); Cowen and Company (April 7, 1978); Lehman Brothers Kuhn Loeb (April 14, 1978); Mabon, Nugent & Co. (April 19, 1976, May 10, 1977, and April 14, 1978); Merrill Lynch, Pierce, Fenner and Smith Incorporated (April 13, 1978); the New York Stock Exchange, Inc. (June 25, 1976, undated response received July 25, 1977, and April 20, 1978); and the Securities Industry Association (July 14, 1977), Securities Exchange Commission File No. S7-613 (hereinafter "File No. S7-613").
10 Letter from James E. Buck to Andrew M. Klein (Dec. 23, 1977), File No. S7-613.
11 March 1978 Release, at text following note 80.
12 Securities Reform Act of 1975, Report of the House Comm. on Interstate and Foreign Commerce, Together with Minority Views, to Accompany H.R. 4111 (the "House Report"), H.R. Rep. No. 94-123, 94the Cong., 1st Sess. 54-57 (1975).
13 House Report, at 55-57; Securities Acts Amendments of 1975, Report of the Senate Comm. on Banking, Housing and Urban Affairs to Accompany S.249 (the "Senate Report"), S. Rep. No. 94-75, 94the Cong., 1st Sess. 60-69 (1975). In 1964, the Commission concluded that floor trading activities in bonds did not pose serious problems. The Commission permitted the NYSE and the American Stock Exchange, Inc. (the "Amex"), to amend their floor trading plans under Rule 11a-1, 17 CFR 240.11a-1, to exempt bond trading from all of the prohibitions contained in that rule and in the plans adopted by the exchanges thereunder. In that connection, the Commission concluded that (i) bond trading on the NYSE and the Amex comprises a minimal part of the business transacted on those exchanges; (ii) the low volume of activity in the exchange markets for bonds, coupled with the fact that the principal market for bonds exists in the over-the-counter market, eliminates the possibilities of harm which the Commission had earlier identified as arising from floor trading in equity securities; (iii) the floor trader in bonds does not have a significant competitive advantage over the public and, in fact, must adjust his own quotations to meet those he receives from off the floor; and (iv) because of the limited activity in bonds, there is considerable doubt whether the exchanges could continue making markets in bonds if the restrictions in Rule 11a-1 and the plans of the exchanges were to apply to the activities of members trading bonds on the floor. Securities Exchange Act Release No. 7375 (July 13, 1964).
14 The phrase "other form of indebtedness" would include, for example, notes, obligations of the United States, foreign government obligations, guaranteed loan certificates, equipment trust certificates, and convertible debt securities. It would not, of course, include any equity security other than a convertible debt security. See Rule 3a11-1 under the Act, 17 CFR 240.3a11-1.
15 The Commission continues to believe that, for purposes of Section 11(a), there should be no difference between transactions for the account of a member allowed under Section 11(a)(1) and transactions for the account of a person associated with that member, provided that those transactions are effected in the same manner and are subject to the same conditions. March 1978 Release, at text following note 56.
16 Such transactions may, of course, be effected pursuant to an available statutory or rule exemption under Section 11(a)(1), such as the effect versus execute rule (Rule 11a2-2(T)). In that regard, a member (the "initiating member") entering transactions into the NYSE Automated Bond System for execution should be regarded as meeting the off-floor transmission requirement contained in Paragraph (a)(2)(ii) of the effect versus execute rule regardless of the location of the terminal at which the order is entered. See also March 1978 Release, note 41. If the order is matched by that system with an order on the contra side also entered by the initiating member and the transaction is thereafter effected under the conditions and limitations built into that system, the transaction will nevertheless comply with Paragraph (a)(2)(iii) of the effect versus execute rule even though the initiating members orders were so effected as a cross transaction.
17 15 U.S.C. 78k(a)(1)(G).
18 The "business mi. test is derived from a comparable provision in Section 3(c)(2) of the Investment Company Act of 1940, 15 U.S.C. 80a-3(c)(2). See Securities Acts Amendments of 1975, Report of the Committee on Conference to Accompany S.249, H.R. Rep. 94-229, 94the Cong., 1st Sess. 105 (1975). The Commissions interpretations and actions with respect to Section 11(a)(1)(G)(i) should not, however, be viewed as implying any necessary interpretation or action with respect to that Section of the Investment Company Act of 1940.
19 Income derived from activities "related" to such business would include income from activities which are directly incidental to one of the activities enumerated in Section 11(a)(1)(G)(i). For example, activities "related to" the sale of securities to customers or brokerage would include clearance and settlement, custodial services, and the extension of credit to customers.
20 The term "customer" is generally used to refer to persons other than registered broker-dealers. See, e.g., Rule 15c1-1 under the Act, 17 CFR 240.15c1-1.
21 NYSE Rule 113, for example, permits NYSE specialists to carry accounts for certain types of non-institutional customers. New York Stock Exchange Guide.
22 Investment advisory activities would not, however, represent activities "related" to those set forth in Section 11(a)(1)(G)(i). March 1978 Release, note 65.
23 Senate Report, at 68. Market-making transactions are exempted under Section 11(a)(1)(A), odd-lot dealer transactions under Section 11(a)(1)(B), and arbitrage and hedge transactions under Section 11(a)(1)(D).
24 17 CFR 240.17a-5.
25 The proprietary trading rule does not define the procedures to be followed in the case of new members which have not been in business long enough to have financial statements for the preceding fiscal year. The Commission believes that it would be appropriate for exchanges to permit a new member to use the Section 11(a)(1)(G) exemption if the new member represents to the exchange its bona fide intention to conduct a business meeting the "business mix" text in Section 11(a)(1)(G)(i). Thereafter, the exchange should obtain unaudited quarterly statements from the member (until such time as its audited financial statement for the preceding fiscal year is available) and allow the new member to use the Section 11(a)(1)(G) exemption only if its revenues in each quarter meet the "business mix" test. See Nadell-Lodge, Inc. 76-77 Transfer Binder Fed. Sec. L. Rep. (CCH) 80,964 (Jan. 3, 1977).
26 See, e.g., NYSE Rule 13, New York Stock Exchange Guide (CCH) 2013; Amex Rule 131, American Stock Exchange Guide (CCH) 9281.
27 Response of the New York Stock Exchange, Inc. (April 20, 1978), File No. S7-613.
28 For example, if upstairs member firm A transmits an order for the account and benefit of its associated person or its managed institutional account to floor member B pursuant to the effect versus execute rule, it would appear necessary for member B to identify the class of its order to the trading crowd immediately prior to execution in order to facilitate operation of the yielding requirement.
29 March 1978 Release, at text following note 56.
30 See March 1978 Release, at text accompanying notes 24-52.
31 Under Section 11(a)(2) and other provisions of the Act, the Commission has general authority to extend, by rule, the Section 11(a) prohibition to non-member, exempt, and over-the-counter transactions. See note 3 supra.
32 H.R. 11567, 95the Cong., 2d Sess., Section 2(a) (1978).
33 S.8331, 95the Cong., 2d Sess., Section 19 (1978).
34 15 U.S.C. 78k(a)(1)(E).
35 See January 1976 Release, at text accompanying notes 26-27 and note 27; March 1977 Release at text accompanying notes 86-123; March 1978 Release, at text following note 67.
36 Group retirement accounts, such as group Keogh plans and so-called "master IRA" accounts maintained by a member or its associated person, would not be included within the ambit of the natural person exemption.
37 March 1978 Release, note 10.
38 The look-through rule, however, does not provide any exemption that would not separately be available to a member trading for its own account, one which it managed, or the account of an unaffiliated public customer.
39 See, e.g., NYSE Rule 396, New York Stock Exchange Guide (CCH) .
40 5 U.S.C. 553(b).
41 5 U.S.C. 553(d).
42 Id.
43 5 U.S.C. 553(d).
44 5 U.S.C. 553.
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