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Notice

Self-Regulatory Organizations; Order Approving Proposed Rule Change and Amendment No. 1 Thereto and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 3 to the Proposed Rule Change by the New York Stock Exchange, Inc. Amending Its Rules To Provide for the Trading of Exchange-Traded Funds on an Unlisted Trading Privileges Basis

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Start Preamble July 30, 2001.

I. Introduction

On April 25, 2001, the New York Stock Exchange, Inc. (“NYSE” or “Exchange”) filed with the Securities and Exchange Commission (“SEC” or “Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”),[1] and Rule 19b-4 thereunder,[2] a proposed rule change to amend certain NYSE rules and policies to accommodate the trading of certain exchange-traded funds (“ETFs”) on an unlisted trading privileges (“UTP”) basis. On May 22, 2001, the NYSE filed Amendment No. 1 to the proposed rule change.[3] The proposed rule change and Amendment No. 1 were published in the Federal Register on June 5, 2001.[4] No comments were received on the proposal, as amended. On July 18, 2001, the NYSE filed Amendment No. 2 to the proposed rule change.[5] On July 27, 2001, the NYSE filed Amendment No. 3 to the proposed rule change.[6] This order Start Printed Page 40762approves the proposed rule change, as amended. The Commission also seeks comment on Amendment no. 3 from interested persons.

II. Description of the Proposed Rule Change

The NYSE proposes to amend its rules and policies to accommodate the listing and trading ETFs on a UTP basis. These ETFs may include the NASDAQ 100 Trust (symbol QQQ), Standard and Poor's Depositary Receipts (symbol SPY) and the Dow Industrials DIAMONDS (symbol DIA).

The NYSE proposes to amend the following NYSE rules and policies: NYSE Rule 98, NYSE Rule 36, paragraph (l) of the Guidelines to NYSE Rule 105, NYSE Rule 13, NYSE Rules 104.20 and 104.21, and the NYSE's Market-On-Close/Limit-At-The-Close and Pre-Opening Price Indications Policies.

A. NYSE Rule 98

NYSE Rule 98 provides that affiliates of a specialist organization can receive an exemption from certain rules applicable to specialists, provided that they establish a system of information barriers between themselves and the affiliated specialist. One of the conditions for the NYSE Rule 98 exemption is that the specialist organization be capitalized separately and apart from any affiliate. The Exchange is proposing to delete this requirement in the case of a specialist organization that is registered solely in ETFs. However, a specialist organization that is registered only in ETFs will remain subject to the minimum capital requirements specified in NYSE Rule 104.20.

B. NYSE Rule 105

Currently, Guideline (1) to NYSE Rule 105 prohibits affiliates of specialist units from acting as a primary market marker in the option on a specialty security. The NYSE proposes to permit an affiliate of an NYSE ETF specialist to act in any market making capacity with respect to options on an ETF as long as NYSE Rule 98 information barriers are established.[7] The Exchange also proposes to permit an affiliate of the ETF specialist to act in a market making capacity, but not as a specialist, in the ETF itself on another market center, as long as NYSE Rule 98 information barriers are established.

C. NYSE Rules 36.30

NYSE Rule 36.30 governs the establishment of telephone or electronic communications between the Exchange's trading floor and any other location.[8] The Exchange proposes to permit ETF specialists to use communication devices at the post to enter proprietary orders in options [9] and futures on the ETF, on the ETF itself on another market center, or in component securities of the ETF,[10] and would permit the ETF specialist to obtain market information with respect to ETFs options, futures, and component securities.

D. NYSE Rule 13

NYSE Rule 13 currently provides that stop and stop limit orders in an ETF can be elected by a bid (in the case of an order to buy) or an offer (in the case of an order to sell), provided that the specialist obtains the prior approval of a Floor Governor or two Floor Officials. The Exchange proposes to amend this prior approval requirement for ETFs to require floor official approval only where the bid or offer that would elect a stop or stop limit order is more than 0.10 point away from the last sale and is made for the specialist's dealer account.[11]

E. NYSE Rules 104.20 and 104.21

The Exchange proposes to amend NYSE Rules 104.20 and 104.21 to provide a capital requirement of $500,000 per ETF. A specialist registered only in an ETF would be subject to the $1,000,000 minimum capital requirement of NYSE Rule 104.20.

F. NYSE's Market-on-Close/Limit-At-The-Close Policy

The Exchange proposes that orders in ETFs will not be subject to the Exchange's Market-on-Close (“MOC”)/Limit-At-The-Close (“LOC”) policy concerning order entry limitations, cancellation of orders during a regulatory halt, imbalance publications, and any other limitations or procedures with respect to MOC/LOC procedures. A MOC/LOC order in an ETF could be permitted to be entered at any time without regard to the limitations of the Exchange's MOC/LOC policies. In addition, the closing price of an ETF will not be subject to publication of imbalances under the Exchange's MOC/LOC policy. Furthermore, ETFs will trade until 4:15 p.m.[12]

G. NYSE's Pre-Opening Price Indications Policy

Similarly, the Exchange proposes that its policies regarding mandatory dissemination of pre-opening price indications (other than ITS pre-opening notifications) in the case of significant order imbalances and potentially large price dislocation from the prior close will not apply to ETFs.

The Exchange will inform its members and member organizations of these proposed changes to its policies by publication of an Information Memo.

III. Discussion

After careful review, the Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.[13] In particular, the Commission believes that the proposal is consistent with Section 6(b)(5) of the Act,[14] which requires, among other things, that the rules of an exchange be designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market, and to protect investors and the public interest. The Commission notes that the Start Printed Page 40763proposed amendments to NYSE rules and policies are designed to facilitate the introduction of ETFs trading on the Exchange on a UTP basis.

NYSE Rule 98 provides that, as long as certain information barriers are in place between a specialist and its affiliates, the affiliates of a specialist organization can receive an exemption from certain rules applicable to specialist organization that is registered only in the ETFs, the Exchange has proposed to eliminate the requirement for the NYSE Rule 98 exemption that a specialist organization be capitalized separate and apart from any affiliate. The Commission notes that this amendment merely removes the requirement that specialists and their affiliates keep their capital separate and does not diminish the amount of capital required of the ETF specialists will still be required to be adequately capitalized pursuant to NYSE Rule 104. Further, the Exchange will continue to monitor the adequacy of capital of its ETF specialists through its special allocation committee. The Commission also notes that all other NYSE Rule 98 requirements must be satisfied as a condition to an NYSE Rule 98 exemption.

In addition, the Exchange proposes to revise NYSE Rules 104.20 and 104.21 to provide for a capital requirement of $500,000 per ETF.[15] The Commission finds that the amendments to eliminate the separate capitalization requirement in the limited context noted above and to establish a capital requirement of $500,000 per ETF are consistent with the Act.

Currently, Guideline (1) to NYSE Rule 105 provides that affiliates of a specialist may not act as primary market makers in the options overlying its specialty security. The NYSE proposes to amend Guideline (1) to allow an affiliate of an NYSE specialist to act in any market making capacity in options overlying an ETF, subject to the condition that NYSE Rule 98 information barriers are in place. In addition, the Exchange proposes to allow an affiliate of an ETF specialist to act in any market capacity, other than as a specialist in the ETF itself, on other market centers, as long as NYSE Rule 98 information barriers are in place. The Commission finds that the revision to Guideline (1) of NYSE Rule 105 is consistent with the Act.

The Commission also finds the amendment to NYSE Rule 36.30 to allow ETF specialists to maintain telephone lines at their off-floor offices or clearing firm, to members of options and futures exchanges, and to maintain order entry terminals to be consistent with the Act. ETF specialists will be permitted to enter proprietary options [16] and futures orders, proprietary orders in the ETF on other market centers, and in component securities of the ETF. In addition, specialists will be permitted to obtain market information regarding the ETF, options, and futures on the ETF, and component securities of the ETF.[17] The Commission notes that the specialist entering proprietary orders in a component security of the ETF with the upstairs clearing firm for execution on the floor of the Exchange must enter and execute the orders in accordance with Rule 11a2-2(T) under the Act [18] and NYSE Rule 112.20 and must enter such orders only for the purpose of hedging a position in the ETF.[19]

The NYSE proposes to amend NYSE Rule 13 to remove the requirement that the specialist obtain the prior approval of a Floor Governor or two Floor Officials before electing a stop order or a stop limit order by a quotation. The specialists, however, must obtain Floor Official approval in the situation where the bid or offer that would elect a stop or stop limit order is more than 0.10 point away from the last sale and is made for the specialist's dealer account.[20] The Commission believes that the amendment to NYSE Rule 13 is consistent with the Act.

The Commission notes that, pursuant to the proposed rule change, ETFs will not be subject to the NYSE's MOC/LOC policy regarding order entry limitations, cancellation of orders during a regulatory halt, imbalance publications, and any other limitations or procedures with respect to MOC/LOC procedures. Moreover, ETFs will trade until 4:15 p.m., except on the last business day of each month.[21] ETFs will not be subject to the NYSE's policies concerning mandatory pre-opening price indications and notifications in cases of order balances because ETF prices are based on the values of the underlying component securities, notwithstanding any other imbalance. The Exchange will publish Information Memos to notify member organizations of the foregoing policies. The Commission finds that these policies, as revised, are appropriate in the context of ETFs.

Finally, the Commission, pursuant to Section 19(b)(2) of the Act,[22] finds good cause for approving Amendment No. 3 to the proposed rule change prior to the thirtieth day after the date of publication in the Federal Register. In Amendment No. 3, the NYSE withdrew the proposed amendment to NYSE Rule 111; revised the rule text of NYSE Rule 36 to clarify that if an order in a component security of an ETF is executed on the Exchange floor, the order must be in compliance with NYSE Rule 112.20 and Rule 11a2-2(T) under the Act,[23] and must be for the purpose of hedging a position in the ETF; and revised its proposed amendment to NYSE Rule 13 to require Floor Official approval in a situation where the bid or offer that would elect a stop or stop limit order is more than 0.10 point away from the last sale and is made for the specialist's dealer account. The Commission finds these changes are necessary to clarify the rules governing the ability of specialists to execute trades for their own account on the Exchange. Therefore, accelerated approval of Amendment No. 3 is appropriate.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and arguments concerning the whether Amendment No. 3 to the proposed rule change is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written Start Printed Page 40764communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the NYSE. All submissions should refer to File No. SR-NYSE-2001-08 and should be submitted by August 24, 2001.

V. Conclusion

for the foregoing reasons, the Commission finds that the NYSE's proposal to amend its rules and policies to accommodate the trading of certain ETFs on a UTP basis, as amended, is consistent with the requirements of the Act and rules and regulations thereunder.

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,[24] that the proposed rule change (SR-NYSE-2001-08), as amended, is approved.

Start Signature

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[25]

Jonathan G. Katz,

Secretary.

End Signature End Preamble

Footnotes

3.  See letter from James E. Buck, Senior Vice President and Secretary, NYSE, to Nancy Sanow, Assistant Director, Division of Market Regulation (“Division”), Commission, dated May 21, 2001 (“Amendment No. 1”). In Amendment No. 1, the NYSE amended the proposed rule text to reflect the correct wording of current NYSE Rule 36.

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4.  See Securities Exchange Act Release No. 44352 (May 25, 2001), 66 FR 30256 (“Notice”).

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5.  See letter from James E. Buck, Senior Vice President and Secretary, NYSE, to Nancy Sanow, Assistant Director, Division, Commission, dated July 18, 2001 (“Amendment No. 2”). The NYSE withdrew Amendment No. 2 on July 27, 2001.

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6.  See letter from James E. Buck, Senior Vice President and Secretary, NYSE, to Nancy Sanow, Assistant Director, Division, Commission, dated July 27, 2001 (“Amendment No. 3”). In Amendment No. 3, the NYSE withdrew the proposed amendment to NYSE Rule 111; revised the rule text of NYSE Rule 36 to clarify that if an order in a component security of an ETF is executed on the Exchange floor, the order must be in compliance with NYSE Rule 112.20 and Rule 11a2-2(T) under the Act, 17 CFR 240.11a2-2(T), and must be for the purpose of hedging a position in the ETF; and revised its proposed amendment to NYSE Rule 13 to require Floor Official approval in a situation where the bid or offer that would elect a stop or stop limit order is more than 0.10 point away from the last sale and is made for the specialist's dealer account.

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7.  As discussed above, the NYSE proposes to eliminate the separate capital requirement with respect to ETF specialists. See also Securities Exchange Act Release No. 44175 (April 11, 2001), 66 FR 19825 (April 17, 2001).

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8.  Currently, NYSE Rule 36.30 allows specialists to have telephone lines to its off-floor office or its clearing firm for the purpose of entering options or futures hedging orders. The specialist also is permitted to transmit such orders through a member on the floor of the options or futures exchange.

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9.  Any proprietary order for an option based on an ETF for which the specialist is registered must comply with the requirements of NYSE Rule 105.

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10.  See Amendment No. 3, supra note 6. Any order in a component security of the ETF that is to be executed on the NYSE floor must be entered and executed in accordance with the principles of Exchange Rule 112.20 and Rule 11a2-2(T) under the Act, 17 CFR 240.11a2-2(T), and must be for the purpose of hedging a position in the ETF.

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11.  See Amendment No. 3, supra note 6. This amendment parallels the specialist's responsibility to obtain floor official approval under NYSE Rule 123A.40 in situations where the specialist is the party to the electing trade.

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12.  But see Securities Exchange Act Release No. 44595 (July 26, 2001), which amended the time of close for ETFs to 4:05 p.m. on the last business day of each month.

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13.  In approving this proposal, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

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15.  The Commission notes that specialists registered only in an ETF are subject to the $1,000,000 minimum capital requirement of NYSE Rule 104.20.

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16.  Any proprietary options order must be executed in compliance with NYSE Rule 105, which generally restricts specialist's specialty options transactions to hedging transactions.

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17.  The Commission notes that the specialist will only be able to gain public market information from other market centers. See, e.g., NYSE Rule 115.

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19.  See Amendment No. 3, supra note 6. NYSE Rule 112.20 states, in relevant part, that a member using a communication facility located on the Floor of the Exchange to enter an order for his own account will be deemed to be initiating an off-Floor order if such order is routed through a clearing firm's order room, where a time-stamped record of the order is maintained, before such order re-transmitted to the Floor for execution. However, an off-Floor order for an account in which a member has an interest is to be treated as an on-Floor order if it is executed by the number who initiated it. Rule 11a2-2(T) under the Act relates to conditions surrounding a member's ability to trade for his own account or for the account of an associated person on the floor of the Exchange.

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20.  The Commission notes that the amendment to NYSE Rule 13 parallels the specialist's responsibility to obtain floor official approval under NYSE Rule 123A.40 in situations where the specialist is a party to the electing trade.

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21.  See supra note 12.

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[FR Doc. 01-19436 Filed 8-2-01; 8:45 am]

BILLING CODE 8010-01-M