The report by the NYSE's Special Committee on Market Structure, Governance and Ownership - a panel of the Exchange's public directors - rejects proposals for a consolidated limit-order book (CLOB), saying a CLOB would divide liquidity and impair competition, among other detriments. In addition, the report says technology exists today that would provide more direct and efficient access to the markets than electronic intermarket linkages.
"With our board's endorsement, the report gives us an important blueprint for building "Network NYSE"-a market built on customers' choice in how they access and utilize the unparalleled liquidity, transparency and depth of the New York Stock Exchange," said NYSE Chairman and Chief Executive Officer Richard A. Grasso.
"I thank the committee for assessing the rapid and far-reaching changes in the marketplace, and applying the most important litmus test - asking the question of what is best for the investor," added Mr. Grasso. "I also want to express our appreciation to the many commentators who provided the committee with a broad range of candid and insightful viewpoints. Theirs is a valuable contribution to our ongoing process of responding to the dynamically changing needs of our customer base."
The Exchange's board had called on its public directors last October to evaluate and make recommendations on issues related to market structure, governance and ownership in light of dramatic changes in the securities industry. During the past six months, the committee heard presentations from individual and institutional investors, specialists and floor brokers, broker-dealers, listed companies and industry experts. "The response to the committee's request for input was remarkable in its breadth and depth," said NYSE Director and Committee Co-Chairman Alex Trotman, former chairman, president and CEO of Ford Motor Corp. (NYSE: F). "The testimony from presenters was wide-ranging, thoughtful and provocative."
"As public directors, the committee sought to identify structural improvements that would achieve fairness, stability, efficiency, true price discovery and, above all, meet the needs of large and small investors," said NYSE Director and Committee Co-Chairman Clifton R. Wharton Jr., former chairman and CEO of TIAA-CREF. The committee's market-structure recommendations are outlined below. The full report is available at nyse.com. Governance and ownership issues will be addressed in the near future. Market-Structure Recommendations of the Special Committee:
The NYSE should continue to develop and implement systems for: (a) electronic order execution, and (b) electronic dissemination of market information from the point of sale, to meet customer demand. These systems should be designed to both enhance and take advantage of the liquidity of the NYSE trading-floor crowd.
The NYSE should retain positive aspects of its current market structure, including: (a) integrated agency-auction trading of large and small customer orders for best price discovery and (b) the specialists' affirmative and negative obligations for fair and orderly trading.
The NYSE should not support implementation of a central limit-order book (CLOB): (a) none of the proposed CLOB platforms meets the needs of all investors-individual and institutional; (b) the CLOB proposal would reduce liquidity rather than increase it; and © a CLOB would likely destroy intermarket competition and innovation, running contrary to the policy mandated by Congress in the Securities Act Amendments of 1975.
The NYSE should implement the new multi-platform structure it has announced as soon as possible: (a) the multi-platform structure meets investor needs by giving investors a range of execution choices and by enhancing liquidity; and (b) the multi-platform structure does not sacrifice vigorous intermarket competition and does not have any of the disadvantages of a CLOB.
The NYSE should not facilitate internalization of customer orders in the absence of price improvement, and should continue to urge adoption of an industry-wide rule to such effect.
The NYSE should seek elimination of intermarket order-routing linkages in light of technological developments since the passage of the 1975 Securities Act Amendments and the adoption of the Intermarket Trading System Plan.
The NYSE should develop a communications plan designed to educate investors about order-execution and market-structure issues.
Network NYSE
In its report, the committee encourages reengineering the NYSE's trading model - in the manner that Mr. Grasso called "Network NYSE"-citing that many institutions want to be closer to the point of sale, to reduce the market impact of large orders, and to improve market transparency. In addition, some individual investors seek certainty and speed of execution-even at the expense of possible price improvement.
The NYSE is implementing a number of such initiatives, including: Institutional XPress TM, an information and execution product that provides member firm-sponsored electronic communication links between institutional investors and the trading floor; NYSeDirect+ TM, an enhanced ECN that allows customers to specify limit orders of 1,099 shares or less to receive automatic execution; e-Broker, a wireless, hand-held order-management system that enables NYSE floor brokers to be in constant contact with their customers, sending customers market information and receiving orders back based on that information, all in a matter of seconds; Virtual Trading Floor, a new information product that will enable individual and institutional customers of member firms to "fly" through a virtual depiction of the NYSE and click-on real-time news and proprietary information about listed stocks.
The committee believes these initiatives expand the order-execution choices NYSE member firms can make available to customers and exemplify the types of market-structure improvements its recommendations are designed to support.
Committee Takes Stand on CLOB, Internalization, ITS
The report rejects proposals for a consolidated limit-order book (CLOB) and discourages internalization of orders. The CLOB, the report states, segments the market between large and small orders and therefore significantly impairs price discovery. It also works to the advantage of some industry participants at the expense of others and eliminates the specialists' affirmative obligation, thereby increasing volatility.
The committee also recommends vigorous opposition to current payment-for-order-flow practices and internalization, or the process by which a member firm executes as a dealer against a customer agency order or directs the order to an affiliated dealer for execution. While such orders may at times receive some degree of price improvement, they do not interact with other public orders and are often denied the opportunity to receive the full degree of price improvement available at the NYSE, where orders are frequently price improved. These internalized orders do not contribute to, or participate in, optimum price discovery.
In addition, the committee believes that advances in communications technology have introduced more direct and efficient means of routing orders among markets than intermarket linkages. The committee's report notes that such technology could enable broker-dealers to fulfill their best-execution obligations with their own information and order-routing systems rather than through exchange linkages. If the SEC does not adopt a similar position, then the committee believes that all ITS participants must be required to link to ITS only as, or through, a self-regulatory organization to prevent an unfair advantage over other broker-dealers as well as prevent fragmentation.
Investor Information
The report recommends that the NYSE develop an informational initiative to heighten public awareness of order-execution and market-structure issues. "The informational program is an important component to implementing the new initiatives," said NYSE Senior Vice President Robert McSweeney, who has supported the committee throughout the fact-gathering process. "Our Individual Investors Advisory Committee conducted a survey that indicated that, unlike institutional investors, most individual investors are not aware of how their orders are being executed, or whether their orders in NYSE-listed stocks are being internalized. It's extremely important to empower individual investors in the decision-making process, because order-routing decisions certainly impact their costs."
Members of Special Committee on Market Structure, Governance and Ownership
In addition to Co-Chairmen Trotman and Wharton, the NYSE public directors serving on the Special Committee are: Philip Morris Companies Chairman and CEO Geoffrey C. Bible; America Online Chairman and CEO Stephen M. Case; American International Group Chairman and CEO Maurice R. Greenberg; CBS Corp. President and CEO Mel Karmazin; Time Warner Chairman and CEO Gerald M. Levin; British Airways Chairman Lord Marshall; New York State Comptroller H. Carl McCall; Leon E. Panetta of The Leon & Sylvia Panetta Institute for Public Policy;The Warnaco Group Chairman, President and CEO Linda J. Wachner; and Kathryn Whitmire of the James MacGregor Burns Academy of Leadership, University of Maryland.
