Release No. 34-40760

63 Fed. Reg. 70843 - Dec. 22, 1998

Regulation of Exchanges and Alternative Trading Systems

ACTION: Final rules.
 

IV. Regulation of Alternative Trading Systems

B. Registration as a National Securities Exchange

Trading systems that fall within Rule 3b-16 are only required to comply with Regulation ATS if they wish to be exempt from the definition of ''exchange.'' Such systems may choose instead to register as national securities exchanges. The Commission expects that some trading systems will find that registration as a national securities exchange provides attractive benefits that make this option more suitable to their business objectives. In particular, registered exchanges enjoy more autonomy in their daily operations than do broker- dealers that are members of SROs. Because any trading system that registers as an exchange would be an SRO, it would not be subject to oversight by a competing national securities exchange or national securities association.³²² Similarly, as a national securities exchange, a trading system would be able to establish its own rules of conduct, trading rules, and fee structures for access. An alternative trading system registered as a broker-dealer, on the other hand, would have to comply with the rules of the SRO to which it belongs, including any rules regarding fees or the automatic execution of orders.

In addition, systems that elect to register as exchanges may benefit from the added prestige and investor confidence associated with status as a registered exchange. Registered exchanges are also able to establish listing standards, which may promote investor confidence in the quality of the securities traded on the exchange. Registered exchanges may also become direct participants in the national market system mechanisms, such as the ITS, Consolidated Tape Association (''CTA''), and the Consolidated Quotation System (''CQS''). Direct participation in these systems may provide a higher degree of transparency and execution opportunities for subscribers to a trading system. As direct participants in the national market system mechanisms, registered exchanges are also entitled to share in the revenues generated by the national market system systems, such as revenue from CTA fees. Moreover, as the Commission noted in the Proposing Release, only registered exchanges are eligible to be participants of the Options Clearing Corporation (''OCC'').³²³ Consequently, any trading system that wants to trade standardized options issued by the OCC would have to register as an exchange and become a member of the OCC.

Finally, if a trading system chooses to register as an exchange, it could allow broker-dealers that are members of exchanges with off-board trading restrictions to trade certain securities on the trading system pursuant to unlisted trading privileges. The Commission believes that if a trading system is registered and regulated as an exchange, it should be considered to be an exchange, rather than an over-the-counter market, for purposes of exchange off-board trading.³²⁴

As discussed in the Proposing Release, the Commission views certain obligations of exchanges as fundamental to fair and efficient operation in the marketplace and critical for the protection of investors. The Commission did not propose any relief from the current obligations of registered exchanges under the Exchange Act. Nevertheless, the Commission requested comment on whether any exemptions from exchange regulatory provisions would be necessary or appropriate to enable alternative trading systems to register as exchanges. Commenters, however, generally thought that any trading system that chooses to register as an exchange should be subject to the same requirements as currently registered exchanges and cautioned the Commission against relieving registered exchanges from any requirements because of their for-profit structure. Consequently, at this time the Commission has determined that those trading systems choosing to register as exchanges should satisfy all requirements that apply to national securities exchanges under the Exchange Act.³²⁵

Many, if not all, alternative trading systems currently operating are proprietary, rather than not-for-profit entities. The Commission does not believe that there is any overriding regulatory reason to require exchanges to be not-for-profit membership organizations, and believes that alternative trading systems may retain their proprietary structure even if they choose to register as exchanges. The Exchange Act does not require national securities exchanges to be not-for-profit organizations. As the Commission stated in the Proposing Release, it believes that Congress clearly intended the 1975 Amendments to encourage innovation by exchanges and recognized that future exchanges may adopt diverse structures.³²⁶ The Commission believes that it is possible for a for-profit exchange to meet the standards set forth in section 6(b) of the Exchange Act.

Any system meeting the definition set forth in Rule 3b-16 may apply for registration as a national securities exchange by filing an application with the Commission on Form 1.³²⁷ The Commission, in Rule 6a-1, set forth the procedure for filing such an application.³²⁸ All Exhibits must accompany Form 1, including audited

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financial statements prepared in accordance with United States Generally Accepted Accounting Principles.

The Commission has adopted an amendment to its rules of practice regarding the processing of filings. Applications for registration as a national securities exchange, as well as applications for exemption from registration due to the limited volume of transactions, will not be considered filed until all necessary information, including financial statements and other required documents, have been furnished in the proper form.³²⁹ Further, under section 6(b) of the Exchange Act, the Commission must make certain determinations before registering an exchange.³³⁰ In reviewing applications for registration as a national securities exchange, the Commission will not register an exchange unless it is satisfied that the exchange meets the requirements discussed below.

1. Self-Regulatory Responsibilities

As a prerequisite for the Commission's approval of an exchange's application for registration, the exchange must be organized and have the capacity to carry out the purposes of the Exchange Act. Specifically, an exchange must be able to enforce compliance by its members, and persons associated with its members, with the federal securities laws and the rules of the exchange.³³¹ The Commission believes that the self-regulatory role of registered exchanges is fundamental to the enforcement of the federal securities laws. Congress has delegated to the SROs certain quasi-governmental functions and responsibilities, and has charged the Commission with overseeing the SROs to make sure they have the ability and resources to comply with those obligations. In this regard, the Commission believes that persons responsible for operating an SRO should not have a disciplinary history, and will seriously question the ability of an exchange to carry out its SRO functions if the founders or prospective managers of an applicant for registration as a national securities exchange are subject to a statutory disqualification, as that term is defined in section 3(a)(39) of the Exchange Act.³³² The Commission believes that persons who, for example, have willfully violated the federal securities laws or have been convicted within the past ten years of a felony or misdemeanor involving misappropriation of funds, or securities fraud, larceny, theft, robbery, extortion, or other related crimes would be inappropriate selections to fill the role of director, officer, or manager of an exchange.

An alternative trading system wishing to register as a national securities exchange may choose to set listing standards for its system. If an applicant chooses to set listing standards, it must have written listing and maintenance standards, as well as an adequate regulatory staff to apply those standards.³³³ The applicant must also have rules restricting the listing of securities issued in a limited partnership rollup transaction.³³⁴ The ability to carry out these functions must be adequately represented on an exchange's application for registration before the Commission will register the exchange.

An applicant for registration as an exchange must also have rules designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and to refrain from imposing any unnecessary or inappropriate burdens on competition, among other things.³³⁵ For example, an exchange must maintain procedures to surveil for securities law violations, such as insider trading and manipulation on the exchange. The Commission understands that surveillance procedures can vary and will depend on the nature of, and types of securities traded, on a particular exchange. Thus, while the Commission will require all applicants for registration as an exchange to have adequate measures in place, they will not have to use the same procedures. The Commission will also require an applicant for registration as a national securities exchange to show that it has sufficient resources, including both staff expertise and capital, to support its surveillance function.³³⁶ Consistent with these requirements, an applicant should, at a minimum, demonstrate that the officers charged with day-to-day management of the exchange are familiar with the federal securities laws and the role of a registered exchange as an SRO. In addition, an applicant for registration as a national securities exchange must demonstrate that it has the capability to maintain an audit trail of the transactions on its system. Furthermore, an applicant must establish rules providing for the allocation of fees for the use of its system.³³⁷

An exchange must also have general conflict of interest rules regarding, for example, trading on the exchange by its employees, owners, or exchange officials. Moreover, an exchange must have rules that ensure that no member's order is unfairly disadvantaged. For example, if an exchange has priority rules, those rules need to treat all exchange members fairly. Finally, an exchange must have rules establishing procedures for the clearance and settlement of trades effected on the exchange. Alternatively, an exchange must have rules requiring members to make their own arrangements for clearance and settlement of trades.

While exchanges are required to enforce compliance by their members, and persons associated with their members, with applicable laws and rules, the Commission has used its authority under sections 17 and 19 of the Exchange Act to allocate to particular SROs oversight of broker-dealers that are members of more than one SRO (''common members'').³³⁸ For example, in order to avoid unnecessary regulatory duplication, the Commission appoints a single SRO as the designated examining authority (''DEA'') to examine common members for compliance with the financial responsibility requirements.³³⁹ When an SRO has been named as a common member's DEA, all other SROs to which the common member belongs are relieved of the responsibility to examine the firm for compliance with applicable

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financial responsibility rules.³⁴⁰ Consistent with past Commission action, the Commission may continue to designate one SRO, such as the NASD or the NYSE, as the primary DEA for common members of exchanges.

In addition, the Commission has previously permitted existing SROs to contract with each other to allocate non-financial regulatory responsibilities.³⁴¹ Rule 17d-2 under the Exchange Act permits SROs to establish joint plans for allocating the regulatory responsibilities imposed by the Exchange Act with respect to common members.³⁴² An SRO participating in a regulatory plan is relieved of regulatory responsibilities with respect to a broker-dealer member of such SRO, if those regulatory responsibilities have been designated to another SRO under the regulatory plan. Alternative trading systems registered as exchanges would also be able to establish joint plans with respect to common members.

A registered exchange would also be expected to maintain an audit trail of trading. A fully automated exchange, however, can produce comprehensive, instantaneous automated records that can be monitored remotely. Therefore, fully automated exchanges might be able to contract with other SROs to perform certain oversight activities, while retaining ultimate responsibility for ensuring that these activities are performed.

Further, the Commission also believes that the ultimate responsibility for enforcement and disciplinary actions for violations relating to transactions executed in an SRO's market or rules unique to that SRO should continue to be retained by that SRO. In addition, these exchanges must establish a disciplinary process including appropriate sanctions for violations of the rules and a fair procedure for administering the disciplinary process.³⁴³ Existing exchanges generally employ personnel and establish extensive programs to fulfill this responsibility. However, it may be possible for an exchange to contract with another SRO to perform its day-to-day enforcement and disciplinary activities. Nevertheless, a registered exchange would retain ultimate responsibility for this function.³⁴⁴ In considering an exchange's application for registration the Commission will consider whether allowing the exchange to contract with another SRO to perform its day-to-day enforcement and disciplinary activities would be consistent with the public interest.

2. Fair Representation

Section 6(b)(3) of the Exchange Act requires that registered exchanges have rules that: (1) Provide that one or more directors is representative of issuers and investors, and not associated with a member of the exchange, or with any broker-dealer; and (2) ''assure a fair representation of its members in the selection of its directors and administration of its affairs.'' ³⁴⁵

(i) Public Directors

Congress adopted the requirement that at least one director be representative of issuers and investors because of the public's interest in ensuring the fairness and stability of significant markets.³⁴⁶ Public representation on an exchange's board of directors helps to achieve this goal. The Commission believes that, under this structure, representation of the public on an oversight body that has substantive authority and decision making ability is critical to ensure that an exchange actively works to protect the public interest and that no single group of investors has the ability to systematically disadvantage other market participants through use of the exchange governance process.³⁴⁷ Therefore, the Commission would expect alternative trading systems that apply for registration as exchanges to have public representation on their boards of directors.

(ii) Fair Representation of Exchange Members

The second requirement, that of fair representation of an exchange's members, also serves to ensure that an exchange is administered in a way that is equitable to all market members and participants. Because a registered exchange is not solely a commercial enterprise, but also has significant regulatory powers with respect to its members, competition between exchanges may not be sufficient to ensure that an exchange carries out its regulatory responsibilities in an equitable manner. The fair application of an exchange's authority to bring and adjudicate disciplinary procedures may be particularly important, because these actions can have significant and far-reaching ramifications for broker-dealers.

Historically, the fair representation requirement was one of the major obstacles to the regulation of alternative trading systems as exchanges because of the concern that it would be incompatible with their proprietary structures.³⁴⁸ In the Proposing Release,

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however, the Commission proposed to allow non-membership, for-profit alternative trading systems that choose to register as exchanges some flexibility in satisfying this ''fair representation'' requirement.

The Delta system cannot register as an exchange because the statute requires that an exchange be controlled by its participants, who in turn must be registered brokers or individuals associated with such brokers. So all the financial institutions that trade through the Delta system would have to register as brokers, and (the system sponsors) would have to turn over the ownership and control of the system to the institutions. The system would be kaput.

Id. at 1272-73.

The Commission notes that it has not, in the past, interpreted an exchange's obligation to provide fair representation of its members to mean that all members must have equal rights. Instead, the Commission has allowed registered SROs a degree of flexibility in complying with this requirement. For example, PCX ''electronic access members'' (''ASAP Members'') do not have voting rights, and therefore are not represented on the board of that exchange.³⁴⁹

More recently, the Commission approved the merger between the Amex and the NASD. As a result of the merger, Amex, reorganized as New Amex LLC (''New Amex''), is now a subsidiary of the NASD. In reviewing the merger, the Commission considered several fair representation issues. Specifically, the Commission considered, among other things, Amex member representation on the Board of Governors of New Amex, Amex member representation on the Board of the NASD, the voting rights of the Amex membership, and representation of the Amex membership in the disciplinary process.

The Commission found that the composition of the New Amex Board satisfied the fair representation requirement by providing the Amex membership with the opportunity to nominate four Amex floor governors to the New Amex Board.³⁵⁰ Further, the Commission found that the inclusion of one New Amex floor governor on the NASD Board ³⁵¹ helped to fulfill the fair representation requirement by providing for New Amex input on the parent Board.³⁵² In addition, the Commission believes that the fair representation requirement was furthered by the corporate governance provisions of New Amex's constitution that require the consent of either Amex (through a Membership vote), the Amex Committee (a committee designed specifically to represent the interests of the Amex membership), or both, in situations impacting certain membership interests or material market changes to New Amex. Lastly, the Commission found that the disciplinary procedures of New Amex met the fair representation requirement by providing for review of all disciplinary matters by a committee composed of both Amex members and public representatives. Specifically, the Amex Adjudicatory Council, which is empowered to act for the full New Amex Board in reviewing appeals from disciplinary proceedings, is composed of three Public Members and three Floor Governors, all of whom are nominated by the Amex Nominating Committee (or by petition signed by twenty-five Members) and elected by a full Amex Membership vote.³⁵³

In addition, with respect to clearing agencies, the Commission has stated that registered clearing agencies may employ several methods to comply with the fair representation standard.³⁵⁴ The Commission believes that other structures may also provide independent, fair representation for an exchange's constituencies in its material decision making processes if the exchange is not owned by its participants. For example, a proprietary alternative trading system that registers as an exchange might be able to fulfill this requirement by establishing an independent subsidiary that has final, binding responsibility for bringing and adjudicating disciplinary proceedings and making rules for the exchange, and ensuring that the governance of such subsidiary equitably represents the exchange's participants.³⁵⁵ As another possibility, certain directors appointed to the board to represent the interests of trading members or participants could be limited to considering certain topics relating to system use and rules, while consideration of ownership issues could be restricted to board members representing the interests of the owners or stockholders.³⁵⁶

Some commenters expressed concern that the flexibility afforded alternative trading systems in complying with their ''fair representation'' requirement not extend so far as to result in unequal regulation of alternative trading systems registered as exchanges and traditional exchanges. In addition, these commenters expressed concern that the efficiency of the markets not be compromised.³⁵⁷ American Century also expressed its support for structures in which an alternative trading system's board included both owners and participants.³⁵⁸ On the other hand, several commenters stated that members (or participants) of a proprietary exchange should not have any right to participate in the governance of the exchange and that imposing constraints on the manner in which alternative trading systems are governed may undermine the factors that lead to their efficiency and innovativeness.³⁵⁹

The Commission believes alternative trading systems should be required to assure fair representation of their members if they choose to register as exchanges. As discussed above, registered exchanges have special responsibilities under the Exchange Act, regardless of whether they are not-for-profit or for-profit. Accordingly, the Commission continues to believe that exchange participants--including

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participants in a for-profit exchange--need to have substantive input into disciplinary and other key processes to prevent these processes from being conducted in an inequitable, discriminatory, or otherwise inappropriate fashion.

The NASD asked the Commission to provide more specific guidance on the details of the flexibility the Commission proposes to allow alternative trading systems applying for registration as exchanges.³⁶⁰ The Commission has provided several examples of ways in which fair representation requirements can be met in non-traditional ways and believes that there may be other acceptable ways. The Commission, however, does not believe it is necessary to specify in greater detail what types of structures would be acceptable to it. What constitutes fair representation for a particular exchange will be determined in the context of that system's application for registration under sections 6(a) and 19(a) of the Exchange Act. Under section 19(a) of the Exchange Act, notice of an application for registration as an exchange is published for comment before approval.³⁶¹ This will provide interested persons with notice of, and an opportunity to comment on, the manner in which a particular exchange proposes to meet its fair representation obligations.³⁶²

3. Membership on a National Securities Exchange

An applicant for registration as a national securities exchange must have rules to admit members and persons associated with those members.³⁶³ Section 6(c)(1) of the Exchange Act ³⁶⁴ prohibits exchanges from granting new membership to any person not registered as a broker-dealer, or associated with a broker-dealer. In the Concept Release, the Commission solicited commenters' views on whether to allow institutional membership on national securities exchanges. Because most commenters were opposed to institutional membership on exchanges, the Commission did not propose to exempt registered exchanges from the limitations in section 6(c)(1). Nevertheless, in the Proposing Release, the Commission asked for comment on whether institutions should be permitted to be members of national securities exchanges.

Most commenters expressing a view on institutional membership on registered exchanges agreed that such exchanges should be prohibited from having non-broker-dealer members.³⁶⁵ One commenter, however, believed that direct institutional access to exchanges is a choice that would benefit market participants by providing lower execution costs for the shareholders of institutional funds. Although this commenter noted the Commission's concerns about the regulatory burden an institution might face if it chose to be a direct member of an exchange, it thought that membership should be a choice available to those institutions that feel they have the economies of scale to warrant direct access or believe that anonymity is worth the regulatory cost of membership.³⁶⁶

As discussed in the Proposing Release, the Commission believes that, in order to ensure the central goals of exchange regulation, direct institutional members or participants in exchanges would have to be subject to the majority of rules and regulations to which broker- dealers are currently subject.³⁶⁷ Moreover, because institutions that were granted exchange membership or direct access to exchanges would likely need to become members in one or more of the national clearance and settlement corporations in order to clear and settle their trades, these institutions would need to demonstrate and maintain financial creditworthiness. Insufficient net capital and incomplete books and records could compromise financial soundness, audit trails, and other general risk management objectives that are critical to sound markets and clearance and settlement systems. Consequently, the Commission would need to require non-broker-dealer institutions to comply with financial responsibility obligations, including the requirements to maintain certain minimum levels of net capital and appropriate books and records.³⁶⁸ Without such requirements, institutional membership on an exchange may also conflict with an exchange's obligation to have rules that foster the efficient clearance and settlement of securities transactions.

The Commission believes that non-broker-dealer institutions essentially would be required to comply with the same requirements imposed on registered broker-dealers and, therefore, undermine most benefits an institution receives by virtue of not registering as a broker-dealer.³⁶⁹ Thus, the Commission does not believe that allowing institutional membership on exchanges would be any less costly to an institution than establishing a broker-dealer affiliate, which can become a member in a registered exchange. At the same time, it would impose ad-hoc regulatory burdens on the Commission and the exchanges as they tried to impose critical rules and regulations on institutions. Further, the Commission does not believe that it is currently practical or serves the best interests of investors or the markets generally to allow non-broker-dealers to be members of national securities exchanges, because of the potential lack of regulatory oversight the Commission would have over these entities. Therefore, just as currently registered exchanges are required to limit membership to broker- dealers, alternative trading systems that choose to register as exchanges would be prohibited from extending membership to non-broker- dealers.

Accordingly, the Commission believes that exchange membership should continue to be limited to registered broker-dealers and persons associated with registered broker-dealers in accordance with section 6(c)(1) of the Exchange Act.³⁷⁰ Institutions, however, would be able to access alternative trading systems registered as exchanges through a registered broker-dealer member of such a trading system, including an affiliate of the institution. Institutions currently have efficient access to the NYSE through SuperDOT

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terminals given to them by NYSE members,³⁷¹ and the OptiMark System ³⁷² will enable institutions to directly enter orders in the OptiMark System through use of an exchange member give-up. Access of this nature should not impose significant costs or burdens on institutions or on broker-dealers providing the access. The Commission believes if institutions continue to have indirect access to exchanges, their needs can be met without compromising important regulatory objectives.

Finally, while the NASD agreed with the Commission's views that institutions should not be ''members'' of registered exchanges, it asked the Commission to provide guidance on whether a registered exchange may set up a broker-dealer subsidiary to provide sponsored access to retail and institutional customers. Further, the NASD asked whether the registered exchange could be the SRO for its broker-dealer subsidiary. The NASD believes that there is an inherent conflict of interest in such an arrangement and that the Commission should explain its views and provide SROs with guidance on the responsibilities for oversight of the broker-dealer in such circumstances.³⁷³

In this regard, a registered exchange is not explicitly prohibited from establishing a broker-dealer subsidiary through which it can provide sponsored access to its non-broker-dealer customers. Nonetheless, the Commission recognizes concerns about the potential conflict of interest if a registered exchange were the SRO for its subsidiary, and believes that it may be difficult for an exchange to fulfill its obligations under sections 6(b)(6), 6(b)(7), and 19(g) with respect to such a subsidiary.³⁷⁴

4. Fair Access

Sections 6(b)(2) ³⁷⁵ and 6(c) ³⁷⁶ of the Exchange Act prohibit registered exchanges from denying access to, or discriminating against, members. The obligation to ensure fair access for members does not, however, restrict the authority of a national securities exchange to maintain reasonable standards for access.³⁷⁷ The securities industry and the general public need access to exchanges to ensure the best execution of orders. Exchanges are venues for trading that should be open to all qualified persons. The Commission stated in the Proposing Release that alternative trading systems that register as exchanges would be required to comply with section 6(b)(2) and section 6(c) of the Exchange Act. IBEX was the only commenter to express a view on this requirement and its comment was favorable.³⁷⁸ Thus, the Commission would require any alternative trading system registered as an exchange to ensure the fair access of registered broker-dealers.

In a similar vein, exchanges are prohibited from adopting any anti- competitive rules.³⁷⁹ To further emphasize the goal of vigorous competition, Congress requires the Commission to consider the competitive effects of exchange rules,³⁸⁰ as well as the Commission's own rules.³⁸¹ The fair access and fair competition requirements in the Exchange Act are intended to ensure that national securities exchanges treat investors and their participants fairly, consistent with the expectations of the investing public. For example, as discussed above, an exchange's rules, including its rules of priority, must treat all members fairly. Accordingly, before granting an application for registration as an exchange, the Commission would review the exchange's rules for compliance with these requirements.

5. Compliance With ARP Guidelines

All national securities exchanges are expected to maintain sufficient systems capacity to handle foreseeable trading volume. Applicants for registration as a national securities exchange must have adequate computer system capacity, integrity and security to support the operation of an exchange. The Commission believes that adequate capacity is vital to the efficient operation of exchanges, particularly during periods of high volume or volatility, such as have been experienced in the past year. To this end, all exchanges and the NASD currently participate in the Commission's automation review program (''ARP'').³⁸² Given the highly automated nature of most alternative trading systems, the Commission stated in the Proposing Release that it would expect any exchange applying for registration as a national securities exchange to comply with the policies and procedures outlined by the Commission in its policy statements concerning the automation review program, including cooperation with any reviews conducted by the Commission. In this regard, the Commission would consider the resources and ability of an applicant for registration as an exchange to meet the standards set forth in the automation review program. In particular, the Commission would consider whether the applicant had sufficient capital to maintain its automated systems, and staff with technical expertise.

The Commission received one comment letter addressing this issue. The PCX commented that registered exchanges should only have to comply with the ARP guidelines if they reach the threshold level that triggers these requirements for alternative trading systems registered as broker-dealers. The PCX noted that, although many exchanges do not account for twenty percent, or even ten percent, of the trading in ITS eligible equity securities, all exchanges are required to comply with the ARP guidelines. The PCX commented that these regulatory requirements impose substantial costs on exchanges and that there is no basis for imposing these types of requirements on exchanges when such requirements are not imposed on alternative trading systems registered as broker-dealers that have substantially greater trading volume.³⁸³

The Commission notes that today it is adopting a requirement that alternative trading systems with twenty percent or more of the volume in any equity security, or certain categories of debt, comply with certain systems capacity, integrity, and security requirements. While some registered exchanges may have less than twenty percent of the volume in similar securities, the Commission nevertheless believes that these exchanges' direct participation in the national market system necessitates

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participation in the automation review program. Moreover, while there are costs associated with capacity planning and testing, contingency planning, stress testing, and independent reviews, as well as ensuring that automated systems have sufficient capacity, these are costs that all highly automated business must bear and not merely regulatory costs.³⁸⁴ The Commission's ARP guidelines are intended only to ensure that short-term cost cutting by registered exchanges does not jeopardize the operation of the securities markets.

6. Registration of Securities

Under the Exchange Act, securities traded on a national securities exchange must be registered with the Commission and approved for listing on the exchange.³⁸⁵ In addition, national securities exchanges are permitted to trade securities listed on other exchanges and Nasdaq pursuant to unlisted trading privileges (''UTP'').³⁸⁶ These requirements ensure that investors have adequate information and that all relevant trading activity in a security is reported to, and surveilled by, the exchange on which it is listed. The Commission discussed in the Proposing Release that an alternative trading system choosing to register as an exchange would be subject to these requirements and would be required to have rules for trading the class or type of securities it seeks to trade pursuant to UTP.³⁸⁷ Moreover, to trade Nasdaq NM securities, such a system would have to become a signatory to an existing plan governing such trading.³⁸⁸

With regard to these securities registration requirements, OptiMark commented that they would preclude, as a practical matter, those alternative trading systems that trade privately placed securities or unregistered foreign securities from choosing to register as exchanges. In addition, the various conditions and limited scope of the Nasdaq/ National Market System/Unlisted Trading Privileges (''OTC-UTP'') plan ³⁸⁹ would impair the ability of alternative trading systems that offer competing facilities for securities listed on existing exchanges to register as exchanges. For example, UTP may be extended for Nasdaq NM securities, but this does not include Nasdaq SmallCap securities or other over-the-counter securities. Moreover, formally amending the OTC- UTP plan to admit any new member and to allocate expenses and revenues among competing market centers is a time-consuming process.

Consequently, OptiMark recommended that the Commission exercise its exemptive authority to reduce the differences in regulatory treatment between alternative trading systems registered as exchanges and those registered as broker-dealers. In particular, OptiMark suggested that, regardless of whether they are registered exchanges or broker-dealers, alternative trading systems that limit their screen availability to certain qualified persons be permitted to trade unregistered securities, including private placements and foreign securities. Similarly, OptiMark believed that alternative trading systems that seek to compete for order flow with existing exchanges should be able to do so in all securities listed on those exchanges, regardless of the alternative trading system's registration status.³⁹⁰

The issue of trading unregistered securities, and in particular unregistered foreign securities, on exchanges raises many difficult issues. Registration of securities provides public information for investors that is prepared in accordance with U.S. accounting and auditing standards. This assures that the issuer's disclosures are consistently presented and can be easily compared to the information provided by other issuers. For this reason, the Exchange Act requires securities to be registered if they trade on national securities exchanges.

The Commission has maintained the current structure in the final rules: continuing to require registered exchanges to trade only registered securities, but not extending this requirement to alternative trading systems not registered as exchanges. The Commission is continuing to review on a broader basis the issuing and trading of unregistered foreign securities in the U.S. and, as part of that review, will specifically consider whether unregistered foreign securities should continue to be freely traded on alternative trading systems that are not registered as exchanges.

7. National Market System Participation

As discussed in the Proposing Release, any alternative trading system that elects to register as a national securities exchange would also be expected to become a participant in the market-wide transaction and quotation reporting plans currently operated by registered exchanges and the NASD. These plans--the CQS,³⁹¹ the CTA,³⁹² the ITS,³⁹³ the Options Price Reporting Authority (''OPRA''),³⁹⁴ and OTC-

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UTP ³⁹⁵--link trading, quotation, and reporting for all registered exchanges and the NASD and are responsible for the transparent, efficient, and fair operation of the securities markets. These plans form the backbone of the national market system and participation in these plans by all registered exchanges is vital to the success of the national market system.

Participation in effective quote and transaction reporting plans and procedures would, therefore, be mandatory for any newly registered exchange, as it is now for currently registered exchanges.³⁹⁶ The CTA and the CQS, which make quote and transaction information in exchange- listed securities available to the public,³⁹⁷ both have provisions governing the entry of participants to the plans,³⁹⁸ and allow any national securities exchange or registered national securities association to become a participant.³⁹⁹ New participants are required to pay certain entry fees to the existing participants.⁴⁰⁰ Participants in these plans share in the income and expenses associated with the plans' operations.⁴⁰¹ Because national securities exchanges are required to participate in an effective quote and transaction reporting plan, the Commission expects the participants of existing plans to include them in the plans under reasonable conditions adapted to the situations of the new exchanges.

The OPRA plan also provides for the collection and dissemination of last sale and quotation information with respect to options that are traded on the participant exchanges. Under the terms of this plan, any national securities exchange whose rules governing the trading of standardized options have been approved by the Commission may become a party to the OPRA plan. The plan provides that any new party, as a condition of becoming a party, must pay a share of OPRA's start-up costs. It also provides for revenue sharing among all parties. The OPRA plan was approved pursuant to Section 11A of the Exchange Act and Rule 11a3-2 thereunder. See Securities Exchange Act Release No. 17638 (Mar. 18, 1981) (''OPRA plan'').

In addition to requiring participation by newly registered exchanges in quote and transaction reporting plans, the Commission would expect newly registered exchanges to participate in ITS,⁴⁰² or an equivalent system if one were developed. ITS provides trading links between market centers and enables a broker or dealer who participates in one market to execute orders, as principal or agent, in an ITS security at another market center, through the system.⁴⁰³ The ITS plan requires that the members of participant markets avoid initiating a purchase or sale at a worse price than that available on another ITS participant market (''trade-throughs'').⁴⁰⁴ Participation in ITS would give users of these new exchanges access to other ITS participant markets. Moreover, participation in ITS would require new exchanges to adopt rules to comply with other applicable ITS plan provisions and policies on matters such as, for example, trade-throughs, locked markets,⁴⁰⁵ and block trades.⁴⁰⁶ As with the quote and transaction reporting plans, alternative trading systems that register as exchanges would have to be integrated into ITS, or another system that links markets for trading purposes would have to be created to accomplish full integration of the newly registered exchanges into the national market system.

The Commission solicited comment on what issues were raised by the possible integration of new exchanges into ITS. One commenter strongly believed that the current voting structure of ITS establishes barriers to entry, which leads to barriers to innovation. This commenter was concerned that the network supporting ITS may not be strong enough to handle sharply higher volumes of securities transactions and that, in an environment with multiple exchanges, the failure of these linkages would impede market participants' quest for best prices.⁴⁰⁷ Another commenter, similarly, expressed concern that the means of access to, and participation in, the national market system plans more generally was not clearly defined and, therefore, provided the current participants in these plans an opportunity to delay and to set unreasonable terms and conditions for entry of new participants.⁴⁰⁸ The Commission realizes that integrating new exchanges into the national market system plans may require amendments to these plans and notes that national market system plans may be amended

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either by vote of the participants, or by Commission action.⁴⁰⁹

The Commission also requested comment on whether any changes were necessary to incorporate alternative trading systems registered as exchanges into the national market system plans. In this regard, the Chicago Board Options Exchange (''CBOE'') and the NYSE stated that they did not believe that there would need to be significant changes to these plans, and that any changes that would be necessary to accommodate alternative trading systems registered as exchanges into ITS would be relatively easy to resolve.⁴¹⁰ The CBOE, however, did state that alternative trading systems registered as exchanges should be subject to the same requirements regarding access to the national market system plans as are applicable to traditional exchanges, including payment of participation entry fees.⁴¹¹

The NASD suggested that, before the Commission approves an alternative trading system's application for registration as an exchange, the Commission address more completely the manner in which such an alternative trading system registered as an exchange may participate in national market system plans. The NASD noted three areas in which the Proposing Release was silent. First, the Commission did not address what mechanism would be used for access among any new exchange and other exchanges or markets. For example, in the context of Nasdaq securities, the NASD thought it was unclear whether the existing approach to linkage and execution should continue to occur through Nasdaq's SelectNet system or its successor, or whether there should be a new ITS-like entity formed with a completely new approach to access. The NASD expressed a preference for using the current approach to linkages. Second, the NASD noted that the Commission did not address whether alternative trading systems registered as exchanges could continue to charge an access fee, and believed strongly that such alternative trading systems should not be allowed to charge for another market accessing displayed interest. Third, the Commission did not address the intermarket linkage issues raised by access to traditional exchanges by non-broker-dealers that have indirect access to alternative trading systems registered as exchanges.⁴¹²

OptiMark asked the Commission to consider the effect of an alternative trading system's ability to charge an execution fee on its choice to register as an exchange or as a broker-dealer. OptiMark noted that the Proposing Release only contemplated that alternative trading systems operating as broker-dealers would be able to charge a fee to non-subscribers; alternative trading systems registered as exchanges and participating in ITS would not.⁴¹³

Susquehanna Investment Group (''Susquehanna'') expressed concern about potentially integrating many alternative trading systems registered as exchanges into the national market system mechanisms. Susquehanna commented that integrating new exchanges' quotations into the national market system should be done only with careful consideration for the preservation of the ITS trade-through rule.⁴¹⁴ Instinet also stated that in order for an alternative trading system to make a determination about the feasibility of registering as an exchange, the Commission needs to address those unresolved issues relating to ITS, including the rules governing time/price priority within a multiple exchange structure. In addition, Instinet stated that inter-exchange rules need to be set forth for both the listed and over- the-counter securities markets.⁴¹⁵

The Commission agrees that access to national market system systems is of key importance. It currently has outstanding proposals for incorporation of one linkage into ITS of an alternative trading system--OptiMark--and a traditional exchange--PCX--and has sought comment on organizational and other changes to ITS to make it more responsive to changing conditions.⁴¹⁶ The precise arrangements for inclusion of new exchanges into these plans depends on the structure of these exchanges, and will be addressed when an applicant seeks registration as an exchange.

8. Uniform Trading Standards

In addition to participation in national market system mechanisms, an alternative trading system that registers as an exchange would be required to comply with any Commission-instituted trading halt relating to securities traded on or through its facilities.⁴¹⁷ Newly registered exchanges would be required in some instances to adopt trading halt rules to comply with certain Commission rules.⁴¹⁸ A newly registered exchange would also have the authority and be expected to impose trading halts for individual securities, for classes of securities, and for its system as a whole under the appropriate circumstances.⁴¹⁹ The Commission does not believe that this requirement would present any undue burden for alternative trading systems that elect to register as national securities exchanges because most alternative trading systems are already subject to the imposition of trading halts as members of the NASD.

In addition, to promote the orderly operation of the securities markets in accordance with Section 6 of the Exchange Act,⁴²⁰ the Commission would expect all newly registered national securities exchanges to implement circuit breaker rules to temporarily halt trading during periods

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of extraordinary market volatility or unusual market declines. The Commission believes that for circuit breakers to be effective, all markets must impose corresponding circuit breakers.⁴²¹

9. Proposed Rule Changes

Under Section 19(b)(1) of the Exchange Act, SROs are required to file all proposed rule changes with the Commission.⁴²² Thus, once registered as an exchange, an alternative trading system would have to submit copies of any proposed rule changes to the Commission for approval.

C. Application for Registration as an Exchange

The Commission proposed to revise Rules 6a-1, 6a-2 and 6a-3 under the Exchange Act ⁴²³ to clarify the requirements for registration as an exchange and to accommodate the registration as exchanges of automated and proprietary trading systems. Additionally, the Commission proposed to revise Form 1, the application used by exchanges to register or to apply for an exemption based on limited volume, and to repeal Form 1-A. After considering the comments, the Commission is adopting the amendments to Rule 6a-1, Rule 6a-2, Rule 6a-3 and Form 1 as proposed.

1. Revisions to and Repeal of Form 1-A

The Commission is adopting the revisions to Form 1 and repealing Form 1-A as proposed. Form 1 is revised by reorganizing and redesignating the Statements and the exhibits. Because the Commission expects most future applicants for registration as an exchange to be fully or partially automated, the Commission revised some of the information requested in Form 1 to be more applicable to automated exchanges. Specifically, the Commission is adding two new exhibits requiring an applicant for registration as an exchange to describe the way any of its electronic trading systems operate, and the criteria used by the exchange in admitting members.⁴²⁴ In addition, the Commission is adding a new exhibit to Form 1 to reflect the possibility that an exchange is owned by shareholders, rather than members.⁴²⁵ The Commission is also adopting other changes to the information requested on Form 1 to reflect the fact that a for-profit exchange would have participants or subscribers trading, rather than members.

Both the NYSE and the Amex expressed concern that these new Exhibits would require new and additional information.⁴²⁶ Exhibits E and L, however, need only accompany the application for registration as an exchange and, therefore, are inapplicable to currently registered exchanges. In addition, Exhibit K applies only to non-member owned exchanges. Therefore, because all currently registered exchanges are member-owned, new Exhibit K does not apply to them. The Commission has clarified that Exhibit K exclusively applies to non-member owned exchanges. If, however, a currently registered, member-owned exchange were to convert to a for-profit structure, it would have to comply with the requirement to update Exhibit K.

Exchanges currently registered with the Commission are required to use amended Form 1 in complying with Rules 6a-2 and 6a-3. The information registered exchanges are required to update under Rules 6a- 2 and 6a-3 is not substantially different from what registered exchanges are required to update today. The Commission has provided the chart below to assist currently registered exchanges in complying with the filing obligations under amended Rules 6a-2 and 6a-3.

2. Amendments to Rules 6a-1, 6a-2, and 6a-3 Under the Exchange Act

In order to reduce some of the filing burdens for exchanges and to allow exchanges to comply with the filing requirements by posting information on an Internet web page, the Commission is amending Rules 6a-1, 6a-2, and 6a-3 under the Exchange Act. a. Rule 6a-1 Application for Registration as an Exchange or Exemption Based on Limited Volume of Transactions

The Commission proposed to amend Rule 6a-1 to clarify that Form 1 should only be used by an exchange to apply for registration as a national securities exchange or for an exemption from registration under section 5 of the Exchange Act based on such exchange's limited volume of transactions. The Commission received no comments on these proposed changes and is adopting them as proposed. b. Rule 6a-2 Periodic Amendments

Paragraph (a) of amended Rule 6a-2 requires an exchange to file an amendment to Form 1 within 10 days of changes to: (1) Information filed on the Execution Page of Form 1, or amendment thereto; (2) information regarding all affiliates and subsidiaries (Exhibit C); (3) application for membership, participation or subscription to the exchange or for a person associated with a member, participant, or subscriber of the exchange (Exhibit F); (4) financial statements, reports or questionnaires required of members, participants or subscribers (Exhibit G); (5) listing applications, any agreements required to be executed in connection with listing and a schedule of listing fees (Exhibit H); ⁴²⁷ (6) officers, governors, members of all standing committees, or persons performing similar functions, who presently hold or have held their offices or positions during the previous year (Exhibit J); (7) persons with direct ownership and control for non- member owned exchanges (Exhibit K); and (8) any members, participants, subscribers or other users and the information pertaining thereto (Exhibit M).⁴²⁸ Additionally, rather than exchanges filing these changes in the form of a notice, as is currently required under paragraph (a) of Rule 6a-3, the changes will be filed in the form of an amendment on Form 1.

These amendments to Rule 6a-2 relieve exchanges from some of the filing requirements to which exchanges are currently subject. Specifically, a registered exchange no longer has to file notice within 10 days of changes to: (1) Its constitution, articles of incorporation or association, or by-laws (Exhibit A); (2) written rulings or settled practices of any governing board or committee of the exchange that have the effect of rules or interpretations (Exhibit B); and (3) the schedule of securities listed on the exchange (Exhibit N).

Paragraph (b) of amended Rule 6a-2 requires an exchange to file annually an amendment to Form 1 with the following information: (1) Unconsolidated financial statements for each subsidiary or affiliate or the exchange for latest fiscal year (Exhibit D); (2) audited consolidated financial statements for last fiscal year of the exchange prepared in accordance with, or reconciled to, United States generally accepted accounting principals (Exhibit I); ⁴²⁹ (3) a list of persons with direct ownership and control for non-member exchanges (Exhibit K); (4) a list of all members, participants, subscribers or other users and the information pertaining thereto (Exhibit M); and (5) a schedule of securities listed on the exchange, securities admitted to unlisted trading privileges and securities admitted to trading on the exchange which are exempt from registration under Section 12(a) of the Act (Exhibit N).⁴³⁰ These amendments remove exchanges' obligations to include the following as part of the annual amendment: (1) The exchange's affiliates and subsidiaries (Exhibit C) and (2) a list of officers, governors, and members of standing committees be

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included as part of an annual amendment (Exhibit J).

Paragraph (c) of amended Rule 6a-2 requires an exchange to file an amendment to Form 1 every three years with the following information: (1) A copy of the constitution, articles or incorporation or association and by-laws (Exhibit A); (2) a copy all written rulings, settled practices having effect of rules and interpretations of any governing board or committee of the exchange (Exhibit B); (3) information regarding all affiliates and subsidiaries (Exhibit C); and (4) a list of officers, governors, members of all standing committees, or persons performing similar functions, who presently hold or have held their offices or positions during the previous year (Exhibit J).⁴³¹

Paragraph (d) of amended Rule 6a-2 provides exchanges with alternatives to the annual filing requirement for Exhibits K, M, and N, and to the three year filing requirement for Exhibits A, B, C, and J. Pursuant to Rule 6a-2(d) exchanges have the following options, in lieu of paper filing: (1) To publish or cooperate in the publication of this information on an annual or more frequent basis, and to certify to the accuracy of the information; (2) to keep the information up to date, and certify that the information is up to date and available to the Commission and the public upon request; or (3) to make the information available continuously on an Internet web site controlled by an exchange, indicate the location of the Internet Web site where such information may be found, and to certify that the information available at such location is accurate as of its date.⁴³²

Comments from the NYSE and the Amex suggested that the amendments to Rule 6a-2 and Form 1, as adopted, reimpose some of the annual filing requirements previously eliminated.⁴³³ As discussed above, Rule 6a-2 and Form 1, as adopted, relax the current filing burdens without reimposing any filing requirements. The technical modifications to the amendments to Rule 6a-2 clarify the operation of the rule, as adopted.

c. Rule 6a-3 Supplemental Material

Paragraph (b) of Rule 6a-3 currently requires registered exchanges, or exchanges exempt from registration based on their limited volume of transactions, to furnish to the Commission copies of all materials issued or made available to members. The Commission proposed to continue to require exchanges to provide the Commission with the information currently required under the rule. However, as an alternative to filing such information on paper, the Commission proposed to permit exchanges to make the information available on an Internet web site and provide the Commission with the location of the web site. The Commission did not receive comments addressing these proposed changes, and is adopting the amendments to Rules 6a-3(b) as proposed.⁴³⁴

D. National Securities Exchanges Operating Alternative Trading Systems

National securities exchanges could, under the rules the Commission is adopting today, form subsidiaries or affiliates that operate alternative trading systems registered as broker-dealers.⁴³⁵ If a national securities exchange chose to form such a subsidiary or affiliate, the exchange itself could remain registered as a national securities exchange, while the subsidiary or affiliate operated as a broker-dealer. Such subsidiaries or affiliates would of course be required to become members of a national securities association or another national securities exchange.⁴³⁶ In addition, any subsidiary or affiliate of a registered exchange could not integrate, or otherwise link the alternative trading system with the exchange, including using the premises or property of such exchange for effecting or reporting a transaction, without being considered a ''facility of the exchange.'' ⁴³⁷

³²² Alternative trading systems that continue to be regulated as broker-dealers would remain subject to oversight by national securities exchanges and the NASD, in their self-regulatory capacities. See supra Section IV.A.2.a.

³²³ Options Clearing Corporation By-laws, Art. VII, Sections 1 and 4. Registered exchanges that are members of the OCC determine such matters as listing, registration, clearance, issuance and exercise of options contracts. Exchange members of the OCC are also able to use registration and disclosure materials tailored for standardized options.

³²⁴ The Commission has the authority to review final disciplinary sanctions imposed by SROs on members or associated persons of members, including sanctions imposed for violations of SRO rules. The Commission may only affirm a sanction imposed by an SRO on one of its members, participants or associated persons of its members for a violation an SRO's rules, if the Commission finds that: (1) The member, participant, or associated person of the member engaged in the acts or practices that the SRO found were engaged in; (2) such acts or practices are in violation of the SRO's rules; and (3) the SRO's rules, and the application by the SRO of its rules, are consistent with the purposes of the Exchange Act. Sections 19(d)(2) and 19(e) of the Exchange Act, 15 U.S.C. 78s(d)(2) and 78s(e).

³²⁵ 15 U.S.C. 78f.

³²⁶ See S. Rep. No. 75, supra note 107.

³²⁷ Section 6(a) of the Exchange Act, 15 U.S.C. 78f(a).

³²⁸ 17 CFR 240.6a-1.

³²⁹ 17 CFR 202.3(b)(2). The Commission is not required to propose changes to its Rules of Practice prior to adoption. See 5 U.S.C. 553(b)(3)(A).

³³⁰ Section 6(b) of the Exchange Act, 15 U.S.C. 78f(b).

³³¹ Section 6(b)(1) of the Exchange Act, 15 U.S.C. 78f(b)(1).

³³² 15 U.S.C. 78c(a)(39). See also 15 U.S.C. 78o(b).

³³³ See Section 12(d) of the Exchange Act, 15 U.S.C. 78l(d); Rule 12d2-2, 17 CFR 240.12d2-2 (requiring national securities exchanges to file an application with the Commission to strike a security from listing and registration).

³³⁴ See 15 U.S.C. 78f(b)(9).

³³⁵ Section 6(b)(5) of the Exchange Act, 15 U.S.C. 78f(b)(5). See also Section 6(b)(8) of the Exchange Act, 15 U.S.C. 78f(b)(6).

³³⁶ The Commission notes that, according to the audited financial statements for 1997, the NYSE had total assets of $1,174,887,000 and total expenses of $488,811,000; the Amex had total assets of $195,547,000 and total expenses of $173,742,000; the PCX had total assets of $67,622,000 and total expenses of $60,636,000; the CSE had total assets of $13,124,585 and total expenses of $5,343,403; and the Boston Stock Exchange (''BSE'') had total assets of $33,339,961 and total expenses of $16,106,837.

³³⁷ Section 6(b)(4) of the Exchange Act, 15 U.S.C. 78f(b)(4).

³³⁸ 15 U.S.C. 78q and 78s. See also 17 CFR 240.17d-2; 17 CFR 240.19g2-1.

³³⁹ With respect to a common member, section 17(d)(1) of the Exchange Act authorizes the Commission, by rule or order, to relieve an SRO of the responsibility to receive regulatory reports, to examine for and enforce compliance with applicable statutes, rules, and regulations, or to perform other specified regulatory functions. 15 U.S.C. 78q(d)(1).

³⁴⁰ See Securities Exchange Act Release No. 23192 (May 1, 1986) 51 FR 17426 (May 12, 1986). Moreover, section 108 of NSMIA, supra note 7, adds a provision to section 17 of the Exchange Act that calls for improving coordination of supervision of members and elimination of any unnecessary and burdensome duplication in the examination process.

³⁴¹ For example, the Commission has approved a regulatory plan filed by the Amex, CBOE, NASD, NYSE, PCX, and the Philadelphia Stock Exchange (''Phlx'') that divides the oversight responsibilities among these SROs for common members, by designating each participating SRO as the options examination authority for a portion of the common members. This designated SRO has sole regulatory responsibility for certain options-related trading matters. See Securities Exchange Act Release No. 20158 (Sept. 8, 1983), 48 FR 41265 (Sept. 14, 1983). The SRO designated under the plan as a broker-dealer's options examination authority is responsible for conducting options-related sales practice examinations and investigating options-related customer complaints and terminations for cause of associated persons. The designated SRO is also responsible for examining a firm's compliance with the provisions of applicable federal securities laws and the rules and regulations thereunder, its own rules, and the rules of any SRO of which the firm is a member. Id.

³⁴² 17 CFR 240.17d-2. Securities Exchange Act Release No. 12935 (Oct. 28, 1976), 41 FR 49093 (Nov. 8, 1976). In addition to the regulatory responsibilities it otherwise has under the Exchange Act, the SRO to which a firm is designated under these plans assumes regulatory responsibilities allocated to it. Under Rule 17d-2(c), the Commission may declare any joint plan effective if, after providing notice and opportunity for comment, it determines that the plan is necessary or appropriate in the public interest and for the protection of investors, to foster cooperation and coordination among the SROs, to remove impediments to, and foster the development of, a national market system and a national clearance and settlement system, and in conformity with the factors set forth in Exchange Act section 17(d). 15 U.S.C. 78q(d). The Commission has approved plans filed by the equity exchanges and the NASD for the allocation of regulatory responsibilities pursuant to Rule 17d-2. See, e.g., Securities Exchange Act Release Nos. 13326 (Mar. 3, 1977), 42 FR 13878 (Mar. 14, 1977) (NYSE/Amex); 13536 (May 12, 1977), 42 FR 26264 (May 23, 1977) (NYSE/BSE); 14152 (Nov. 9, 1977), 42 FR 59339 (Nov. 16, 1977) (NYSE/CSE); 13535 (May 12, 1977), 42 FR 26269 (May 23, 1977) (NYSE/CHX); 13531 (May 12, 1977), 42 FR 26273 (May 23, 1977) (NYSE/PSE); 14093 (Oct. 25, 1977), 42 FR 57199 (Nov. 1, 1977) (NYSE/ Phlx); 15191 (Sept. 26, 1978), 43 FR 46093 (Oct. 5, 1978) (NASD/BSE, CSE, CHX and PSE); and 16858 (May 30, 1980), 45 FR 37927 (June 5, 1980) (NASD/BSE, CSE, CHX and PSE).

³⁴³ See section 6(b)(6) of the Exchange Act, 15 U.S.C. 78f(b)(6). See also section 6(b)(7) of the Exchange Act, 15 U.S.C. 78f(b)(7).

³⁴⁴ See, e.g. section 19 of the Exchange Act, 15 U.S.C. 78s

³⁴⁵ Section 6(b)(3) of the Exchange Act, 15 U.S.C. 78f(b)(3).

³⁴⁶ Id.

³⁴⁷ See NASD 21(a) Report, supra note 4.

³⁴⁸ See Delta Release, supra note 32, at 1900. In Board of Trade of the City of Chicago v. Securities and Exchange Commission, 923 F.2d 1270 (7th Cir. 1991) (''Delta II''), the court stated that:

³⁴⁹ See Securities Exchange Act Release No. 28335 (Aug. 13, 1990), 55 FR 34106 (Aug. 21, 1990) (order approving rule change establishing electronic access memberships on the PCX).

³⁵⁰ The New Amex Board consists of eighteen total governors. Floor governor nominees will be proposed by either the Amex Nominating Committee (consisting of three floor members and two public members) or a petition signed by twenty five members and will be selected by a plurality of the Amex Regular and Options Principal members voting together as a single class. The Amex membership elects the members of the Amex Nominating Committee.

³⁵¹ The Chief Executive Officer of New Amex will also be a governor on the NASD Board.

³⁵² The New Amex Floor Governor is nominated by the Amex Membership and will be able to directly express the Amex members' viewpoint and concerns within the NASD Board forum. In addition, the Chief Executive Officer of New Amex will be able to provide information about, and communicate the needs of, New Amex to the NASD Board.

³⁵³ See Securities Exchange Act Release No. 40622 (Oct. 30, 1998), 63 FR 59819 (Nov. 5, 1998).

³⁵⁴ 15 U.S.C. 78q-1(b)(3)(c). These methods include: (1) Solicitation of board of directors nominations from all participants; (2) selection of candidates for election to the board of directors by a nominating committee which would be composed of, and selected by, the participants or representatives chosen by participants; (3) direct participation by participants in the election of directors through the allocation of voting stock to all participants based on their usage of the clearing agency; or (4) selection by participants of a slate of nominees for which stockholders of the clearing agency would be required to vote their share. See Securities Exchange Act Release No. 14531 at 24 (Mar. 6, 1978), 43 FR 10288 (Mar. 10, 1978). See also Securities Exchange Act Release No. 16900 (June 17, 1980), 45 FR 41920 (June 23, 1980).

³⁵⁵ The proprietary foreign exchange Easdaq, a recognized secondary market in Belgium, has established a ''regulatory authority'' that has a degree of independence from Easdaq's board of directors.

³⁵⁶ The Commission in the past has approved exchange rules limiting the voting rights of ''special access'' or non-equity members as consistent with section 6(b)(3) of the Exchange Act, 15 U.S.C. 78f(b)(3). See, e.g., Securities Exchange Act Release No. 22959 (Feb. 28, 1986), 51 FR 8060 (Mar. 7, 1986) (approving rule change by NYSE establishing ''electronic access membership'' with restricted voting rights).

³⁵⁷ See CBOE Letter at 5-6; NASD Letter at 4-5.

³⁵⁸ American Century Letter at 6.

³⁵⁹ See Ashton Letter at 4 (for-profit exchanges should be afforded considerable flexibility in their formative business stages in meeting fair representation obligations); OptiMark Letter at 3-4 (users of alternative trading systems should be treated fairly, but are not entitled to exercise any formal rights in regard to the management of the system, and are adequately protected through a combination of regulatory safeguards and market forces); Lee Letter at 1-2 (owners of exchanges already have incentives to create suitable governance structures).

³⁶⁰ NASD Letter at 4-5.

³⁶¹ 15 U.S.C. 78s(a).

³⁶² 15 U.S.C. 78f(a) and 78s(a). See NASD Letter at 4-5 (commenting that the public should have an opportunity to comment on the proposed governance structure of an exchange before the Commission approves its application for registration).

³⁶³ 15 U.S.C. 78f(b)(3)-(4) and 78f(c).

³⁶⁴ 15 U.S.C. 78f(c)(1). Section 6(c)(1), adopted in 1975, prohibits exchanges from granting new memberships to non-broker- dealers. At the time this Section was adopted, one non-broker-dealer maintained membership on an exchange. This non-broker-dealer was not affected by the prohibition and continues to maintain its membership.

³⁶⁵ CBOE Letter at 6 (''it would be difficult, if not impossible, for the Commission to adequately regulate or oversee the array of non-broker-dealer institutions that currently are, or may become, participants on (alternative trading systems)''); NASD Letter at 8 (institutions should not be members of alternative trading systems that register as exchanges); IBEX Letter at 13 (institutional and individual investors should be granted exchange access through the sponsorship of discount or full-service broker- dealers).

³⁶⁶ American Century Letter at 4.

³⁶⁷ Sections 6(f) and 15(e) of the Exchange Act, 15 U.S.C. 78f(f) and 78o(e), would permit the Commission to subject institutional members to all exchange rules and relevant Exchange Act provisions.

³⁶⁸ The Commission could adopt such requirements pursuant to its authority under Section 15(c) of the Exchange Act, 15 U.S.C. 78o(e).

³⁶⁹ The Commission notes that institutions currently have the option to establish a broker-dealer affiliate, which can become a member in an exchange. The institution can then direct its order flow through its affiliated entity. Many investment companies already have affiliated broker-dealers.

³⁷⁰ 15 U.S.C. 78f(c)(1).

³⁷¹ Exchange members are subject to regulatory action by the NYSE for violations of NYSE rules by their customers entering orders through the members' SuperDOT terminals.

³⁷² See infra note 452.

³⁷³:NASD Letter at 8.

³⁷⁴ 15 U.S.C. 78f(b)(6)-(7) and 15 U.S.C. 78s(g). These provisions require that a registered exchange be able to enforce compliance by its members with the federal securities laws, appropriately discipline its members for violations of such laws, and provide a fair disciplinary procedure. The Commission notes, however, that unless a broker-dealer effects transactions in securities solely on a national securities exchange of which it is a member, it must become a member of a national securities association or another national securities exchange. Section 15(b)(8) of the Exchange Act, 15 U.S.C. 78o(b)(8).

³⁷⁵ 15 U.S.C. 78f(b)(2).

³⁷⁶ 15 U.S.C. 78f(c).

³⁷⁷ A denial of access would be reasonable, for example, if it were based on objective standards, such as capital and credit requirements, and if these standards were applied fairly.

³⁷⁸ IBEX Letter at 13-14.

³⁷⁹ Section 6(b)(8) of the Exchange Act, 15 U.S.C. 78f(b)(8); section 15A(b)(9) of the Exchange Act, 15 U.S.C. 78o-3(b)(9).

³⁸⁰ Section 6(b)(6) of the Exchange Act, 15 U.S.C. 78f(b)(6).

³⁸¹ Section 23(a) of the Exchange Act, 15 U.S.C. 78w(a).

³⁸² See supra notes 269-273 and accompanying text.

³⁸³ PCX Letter at 7-8.

³⁸⁴ In this regard, those exchanges applying for registration in 1999 should also be prepared to demonstrate that their systems are year 2000 compliant.

³⁸⁵ Section 12(a) of the Exchange Act makes it unlawful for any member, broker, or dealer to effect any transaction in any security (other than an exempted security) on a national securities exchange unless a registration statement has been filed with the Commission and is in effect as to such security for such exchange in accordance with the provisions of the Exchange Act and the rules and regulations thereunder. 15 U.S.C. 78l(a). Section 12(b) of the Exchange Act, 15 U.S.C. 78l(b), contains procedures for the registration of securities on a national securities exchange. Section 12(a) does not apply to an exchange that the Commission has exempted from registration as a national securities exchange. See, e.g., Securities Exchange Act Release No. 28899 (Feb. 20, 1991), 56 FR 8377 (Feb. 29, 1991). See also Securities Exchange Act Release No. 37271 (June 3, 1996), 61 FR 29145 (June 7, 1996).

³⁸⁶ Section 12(f) of the Exchange Act, 15 U.S.C. 78l(f). Under section 12(f) of the Exchange Act, 15 U.S.C. 78l(f), exchanges cannot trade securities not listed on an exchange or classified as Nasdaq NM securities (such as Nasdaq SmallCap or OTC securities) without Commission action. Section 12(f) of the Exchange Act authorizes the Commission to permit the extension of UTP to any security listed otherwise than on an exchange. The OTC-UTP plan which provides UTP for Nasdaq NM securities, is the only extension to date approved by the Commission. See OTC-UTP plan, infra note 401. Thus, registered exchanges cannot currently trade Nasdaq SmallCap securities or exempted securities that are not separately listed on the exchange.

³⁸⁷ Rule 12f-5, 17 CFR 240.12f-5.

³⁸⁸ See OTC-UTP plan, infra note 401 and accompanying text.

³⁸⁹ The OTC-UTP plan provides for the collection, consolidation, and dissemination of quotation and transaction information for Nasdaq NM securities by its participants. Any registered Exchange where Nasdaq NM securities are traded may become a full participant in the OTC-UTP plan. See infra note 401. See also Securities Exchange Act Release Nos. 24407 (Apr. 27, 1987), 52 FR 17349 (May 7, 1987); 36985 (Mar. 18, 1996), 61 FR 12122 (Mar. 25, 1996).

³⁹⁰ OptiMark Letter at 3.

³⁹¹ The CTA provides vendors and other subscribers (including alternative trading systems) with consolidated last sale information for stocks admitted to dealings on any exchange pursuant to a plan approved by the Commission (''CTA plan''). See, e.g., Securities Exchange Act Release Nos. 10787 (May 10, 1974), 39 FR 17799 (final rules approving CTA plan); 16983 (July 16, 1980), 45 FR 49414 (July 24, 1980); 37191 (May 9, 1996), 61 FR 24842 (May 16, 1996).

³⁹² The CQS gathers quotations from all market makers in exchange-listed securities and disseminates them to vendors and other subscribers pursuant to a plan approved by the Commission (''CQ plan''). Securities Exchange Act Release No. 16518 (Jan. 22, 1980), 45 FR 6521 (final rules approving CQ plan); 37191 (May 9, 1996), 61 FR 24842 (May 16, 1996).

³⁹³ The ITS is a communications system designed to facilitate trading among competing markets by providing each market participating in the ITS pursuant to a plan approved by the Commission (''ITS plan'') with order routing capabilities based on current quotation information. See, e.g. Securities Exchange Act Release Nos. 37191 (May 9, 1996), 61 FR 24842 (May 16, 1996); 17532 (Feb. 10, 1981), 46 FR 12919 (Feb. 18, 1981); 23365 (June 23, 1986), 51 FR 23865 (July 1, 1986) (CSE/ITS linkage); 18713 (May 6, 1982) 47 FR 20413 (May 12, 1982) (NASD's CAES/ITS linkage); 28874 (Feb. 12, 1991), 56 FR 6889 (Feb. 20, 1991) (CBOE/ITS linkage).

³⁹⁴ See infra note 401 and accompanying text for a description of the OPRA plan.

³⁹⁵ See infra note and accompanying text for a description of the OTC-UTP plan.

³⁹⁶ See Rules 11Ac1-1(b)(1) and 11Aa3-2(c), 17 CFR 240.11Ac1- 1(b)(1) and 240.11Aa3-2(c).

³⁹⁷ Both the CTA and the CQS are presently operated by the eight national securities exchanges and the NASD.

³⁹⁸ The CTA plan also contains a provision for entities other than participants to report directly to the CTA as ''other reporting parties.'' Pursuant to this provision, parties other than a national securities exchange or association may be permitted to provide transaction data directly to the CTA. Alternative trading systems that do not elect to register as exchanges would be eligible for participation in the CTA plan pursuant to this provision; however, as non-member participants, these systems would neither be obligated to pay the required fees and expenses to the plan, nor able to share in the plan's profits.

³⁹⁹ See Securities Exchange Act Release No. 37191 (May 9, 1996), 61 FR 24842 (May 16, 1996).

⁴⁰⁰ These fees represent the ''tangible and intangible assets'' provided by the plans to the new participant. See Proposing Release, supra note 3 at nn.342-43 (discussing entry fees for the CTA, CQS, and ITS plans).

⁴⁰¹ Similar to the CTA and CQ plans, the OTC-UTP plan governing trading of Nasdaq NM securities provides for the collection, consolidation, and dissemination of quotation and transaction information for Nasdaq NM securities by its participants. Any national securities exchange where Nasdaq NM securities are traded may become a full participant of the OTC-UTP plan. The plan also provides that new participants pay a share of development costs, share ongoing operating costs, and are entitled to share in the plan's profits. See Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation and Dissemination of Quotation and Transaction Information for Exchange- listed Nasdaq/National Market System Securities and for Nasdaq/ National Market System Securities Traded on Exchanges on an Unlisted Trading Privilege Basis (''OTC-UTP plan''). Securities Exchange Act Release No. 24407 (Apr. 29, 1987), 52 FR 17349 (May 7, 1987). See also Securities Exchange Act Release No. 36985 (Mar. 18, 1996), 61 FR 12122 (Mar. 25, 1996).

⁴⁰² To become a participant in ITS, an exchange or association must subscribe to, and agree to comply and to enforce compliance with, the provisions of the plan. See ITS plan, supra note 393, at section 3(c).

⁴⁰³ ITS also establishes a procedure that allows specialists to solicit pre-opening interest in a security from specialists and market makers in other markets, thereby allowing these specialists and market makers to participate in the opening transaction. Participation in an opening transaction can be especially important when the price of a security has changed since the previous close.

⁴⁰⁴ A trade-through occurs when an ITS participant purchases securities at a lower price or sells at a higher price than that available in another ITS participant market. For example, if the NYSE is displaying a bid of 20 and an offer of 20\1/8\ for an ITS security, the prohibition on trade-throughs would prohibit another ITS participant market from buying that security from a customer at 19\7/8\ or selling that security to a customer at 20^1/2. In addition, each participant market has in place rules to implement the ITS Trade-Through Rule. See, e.g. NASD Rule 5262. The plan also provides a mechanism for satisfying a market aggrieved by another market's trade-through.

⁴⁰⁵ A locked market occurs when an ITS participant disseminates a bid for an ITS security at a price that equals or exceeds the price of the offer for the security from another ITS participant or disseminates an offer for an ITS security at a price that equals or is less than the price of the bid for the security from another ITS participant. The plan provides a mechanism for resolving locked markets.

⁴⁰⁶ The ITS block trade policy provides that the member who represents a block size order shall, at the time of execution of the block trade, send or cause to be sent, through ITS to each participating ITS market center displaying a bid (or offer) superior to the execution price a commitment to trade at the execution price and for the number of shares displayed with that market center's better priced bid (or offer).

⁴⁰⁷ American Century Letter at 3 (citing instances of downtime on alternative trading systems that are attributable to SelectNet, rather than the alternative trading system).

⁴⁰⁸ Ashton Letter at 4 (also stating that the Commission should be sensitive to the ''veiled anti-competitive motives'' of the existing plan participants and be prepared to direct any new qualified exchanges to be accepted into all national market system plans).

⁴⁰⁹ Securities Exchange Act Release No. 40204 (July 15, 1998), 63 FR 390306 (July 22, 1998) (proposal providing for the linkage of the PCX application of the OptiMark system to the ITS system); Securities Exchange Act Release No. 40260 (July 24, 1998), 63 FR 40748 (July 30, 1998) (proposal expanding the ITS/CAES linkage to all listed securities, including non-Rule 19c-3 securities).

⁴¹⁰ See CBOE Letter at 4-5; NYSE Letter at 8-9. The NYSE also stated that consideration of this issue can be better evaluated at the time an alternative trading system registers as an exchange and seeks to become a member of ITS. Id. But see CHX Letter at 7 (expressing concern about a for-profit exchange becoming a full participant in the national market system plans because such exchanges would be subject to pressures not to expend significant resources on maintaining surveillance and enforcement capability and would not have the same commitment to the public interest and the investing public as traditional not-for-profit exchanges).

⁴¹¹ CBOE Letter at 4-5.

⁴¹² NASD Letter at 7.

⁴¹³ OptiMark Letter at 4-5 (also asking that the Commission consider how members of exchanges, other than the exchange through which an alternative trading system registered as a broker-dealer disseminates its quotations, could access such alternative trading system's quotes).

⁴¹⁴ Letter from Gerald D. O'Connell, Susquenhanna Investment Group to Jonathan G. Katz, Secretary, SEC, dated July 23, 1998 (''Susquehanna Letter'') at 1-2. See also OptiMark Letter at 4 (asking the Commission to clarify that participation in national market system plans is not conditioned on any universal public display requirement).

⁴¹⁵ Instinet Letter at 1-2, 3, 6.

⁴¹⁶ See supra note 409.

⁴¹⁷ The Commission may suspend trading in any security for up to 10 days, and all trading on any national securities exchange or otherwise, for up to 90 days pursuant to sections 12(k)(1)(A) and (B) of the Exchange Act, 15 U.S.C. 78l(k)(1)(A) and (B).

⁴¹⁸ For example, a newly registered exchange would be required under Rule 11Ac1-1, 17 CFR 240.11Ac1-1, to halt trading when neither quotation nor transaction information can be disseminated.

⁴¹⁹ The Commission has found that trading halt rules instituted by a national securities exchange or a national securities association are consistent with the objectives of Section 6(b)(5) of the Exchange Act, 15 U.S.C. 78f(b)(5). See, e.g., Securities Exchange Act Release Nos. 39582 (Jan. 26, 1998), 63 FR 5408 (Feb. 2, 1998); 26198 (Oct. 19, 1988), 53 FR 41637 (Oct. 24, 1988). See, e.g., Amex Rule 117, NASD Rule 4120(a)(3), and NYSE Rules 80B and 717. There is no requirement that exchanges or associations of securities dealers employ identical trading halt rules, and these rules may vary according to the needs of the individual market.

⁴²⁰ 15 U.S.C. 78f.

⁴²¹ If circuit breakers are imposed in one market, but not in another, overall market disruptions caused by trading imbalances can migrate from one market to the next, and efforts to stabilize such imbalances during periods of heavy trading and extreme volatility would be subverted. See also Securities Exchange Act Release No. 39846 (Apr. 9, 1998), 63 FR 18477 (Apr. 15, 1998) (approving proposed changes to SRO rules regarding circuit breakers).

⁴²² Section 19(b) of the Exchange Act, 15 U.S.C. 78s(b).

⁴²³ 17 CFR 240.6a-1, 240.6a-2 and 240.6a-3.

⁴²⁴ Exhibit E requires an exchange to describe, among other things, the means of access to the electronic trading system, the procedures governing display of quotes and/or orders, execution, reporting, clearance, and settlement. Exhibit L requires an exchange to describe its criteria for membership, conditions under which members may be subject to suspension or termination, and procedures that would be involved in such suspension or termination.

⁴²⁵ Exhibit K requires non-member owned exchanges to provide a list of direct owners and control persons.

⁴²⁶ See NYSE Letter at 11; Amex Letter at 6.

⁴²⁷ A technical modification was made to the amendments as proposed to include Exhibit H in Rule 6a-2(a)(2).

⁴²⁸ Rule 6a-2(a), 17 CFR 240.6a-2(a).

⁴²⁹ A technical modification was made to the amendments as proposed to remove Exhibit I from Rule 6a-2(a)(2) and to include Exhibit I in Rule 6a-2(b)(1).

⁴³⁰ A technical modification was made to the amendments to include Exhibit N in Rule 6a-2(b)(2).

⁴³¹ A technical modification was made to the amendments to include Exhibit J in Rule 6a-2(c).

⁴³² Rule 6a-2(d), 17 CFR 240.6a-2(d).

⁴³³ Securities Exchange Act Release No. 35123 (Dec. 20, 1994), 59 FR 66692 (Dec. 28 1994).

⁴³⁴ 17 CFR 240.6a-3. This rule is now found at paragraph (c) of Rule 6a-3.

⁴³⁵ In addition, the owner of the alternative trading system would continue to be liable for securities law violations.

⁴³⁶ But see supra note 374.

⁴³⁷ Section 3(a)(2) of the Exchange Act, 15 U.S.C. 78c(a)(2). See also supra note 48 (discussing the OptiMark System as a facility of the PCX); 35030 (Nov. 30, 1994), 59 FR 63141 (Dec. 7, 1994) (discussing the Chicago Match system as a facility of the CHX); 29237 (May 24, 1991), 56 FR 24853 (May 31, 1991) (discussing the Off-Hours Trading system as a facility of the NYSE).