[12954]
December 20, 2000
TO: EQUITY MARKETS ADVISORY COMMITTEE No. 64-00
RE: PROPOSED RULE CHANGE ESTABLISHING THE ARCHIPELAGO EXCHANGE
The Securities and Exchange Commission has published for comment a proposed rule
change filed by the Pacific Exchange (“PCX”), through its subsidiary, PCX Equities (“PCXE”), to
create a new electronic trading facility of the PCXE called the Archipelago Exchange (“Arca”).1
Arca, which would be operated by Archipelago Exchange, L.L.C., would provide automatic
order execution capabilities for the equity securities listed or traded on the PCXE and would
operate in the place of the PCXE's traditional floor trading environment. Under the proposal,
the PCX and PCXE would maintain responsibility for all regulatory functions related to Arca
and Archipelago Exchange, L.L.C. would be responsible for the business of the trading facility.
The SEC’s proposed rule change describing Arca and the text of the proposed Arca rules
are attached. In addition, attached is (1) a summary prepared by Archipelago of the most
significant aspects of the Arca rules including trading on Arca, access to Arca, and qualifications
and obligations of Arca market makers; and (2) a description prepared by Archipelago of the
types of orders that can be placed on Arca and of Arca’s order execution processes.
SEC Solicitation of Comments
The Proposing Release contains several items on which the SEC specifically requests
comments. In particular, the SEC requests comments on: (1) “Discretionary Orders,” (2) the
minimum price improvement level for Directed Orders, (3) the priority of customer orders, and
(4) the Arca trading sessions.
Discretionary Orders
The proposal would enable users to submit “Discretionary Orders” for execution on
Arca. The proposed rules define a Discretionary Order as “an order to buy or sell a stated
amount of a security at a specified, undisplayed price (the ‘discretionary price’), in addition to
at a specified, displayed price (‘displayed price’).” For example, as the Proposing Release
illustrates, an Arca user could submit a Discretionary Order to buy 5000 shares of XYZ at a price
1 Securities Exchange Act Release No. 43608 (November 21, 2000), 65 FR 78822 (December 15, 2000) (“Proposing
Release”).
2of $20, with discretion to buy up to a price of $20.25. In that case, the Arca user represents a
displayed price of $20 but is willing to buy the 5000 shares at a price up to the discretionary
price of $20.25.
The SEC requests general comments on the proposed availability of Discretionary
Orders in the light of the Quote Rule, which requires each responsible broker or dealer to
promptly communicate to its exchange or association, pursuant to the procedures established
by that exchange or association, its best bids, offers, and quotation sizes for any subject security.
In addition, the SEC seeks specific comments on the potential advantages or disadvantages of
Discretionary Orders with regard to: (1) price discovery; (2) market transparency; and (3)
transaction costs for investors. Finally, the SEC requests comments on whether a distinction
should be made between Discretionary Orders placed on behalf of public customers and
Discretionary Orders placed by PCXE market makers trading for their own accounts.
Minimum Price Improvement Level
The proposed rules would establish a minimum price improvement increment of $.01 or
10% of the spread, whichever is greater, with regard to the execution of Directed Orders. The
SEC notes that the minimum price improvement increment for these orders therefore would not
be less than $.01 but that under the proposal, the minimum price variation for equity securities
traded on Arca would be 1/64 of $1.00 for securities that are quoted in fractions and $.01 for
equity securities that are quoted in decimals. The SEC therefore specifically requests comment
on whether the PCX’s proposed minimum price improvement interval that may be greater than
the minimum price variation for internalized or otherwise preferenced orders is appropriate.
Customer Order Priority
The SEC states that historically securities exchanges have adopted rules that give
priority to the agency orders of public customers over the proprietary trades of member firms,
in recognition that traders on the floor of an exchange generally possess an informational
advantage over public customers. The Proposing Release states, however, that because the PCX
seeks to establish Arca as a purely electronic facility that would not employ a trading floor, they
do not believe that its users would possess any informational advantage over public customers
and that the Arca Book would therefore not give precedence to agency orders over principal
orders and would rank orders based upon price/time priority.2 The SEC therefore specifically
requests comment on the order execution priority of the Arca Book, including whether market
makers’ orders should have priority equal to orders of the same type placed by public
customers.
Trading Sessions
The PCX proposes to operate three distinct trading sessions for Arca: an opening
session, a core trading session, and a late trading session. The opening session, which would
begin at 8:00 a.m. Eastern Time and run until the start of the core trading session, would include
an Opening Auction at the start of the opening session and a Market Order Auction that would
2 The proposed rules would, however, prohibit a market maker from trading for its proprietary account on Arca
ahead of its own customer’s limit order at the same price.
3begin at 9:30 a.m. Eastern Time. The core trading session for each security would begin
immediately after conclusion of the Market Order Auction for that security. The SEC
specifically requests comments about the opening session, particularly the opening procedures
and the transition from the opening session to the core trading session.
The PCX also proposes to operate a late trading session that would begin when the core
trading session ends and conclude at 8:00 p.m. Eastern Time. The Proposing Release notes that
currently after-hours trading sessions for listed securities end at 6:30 p.m. Eastern Time. The
SEC therefore requests comments about the PCX’s proposed late trading session, including the
possible extension of the late trading session to 8:00 p.m. Eastern Time.
Comments on the proposed rule change are due to the SEC no later than January 5,
2001. If you have any comments you would like the Institute to consider including in a
possible comment letter, please provide them to the undersigned by phone at (202) 371-5408,
by fax at (202) 326-5839, or by e-mail at aburstein@ici.org no later than December 29.
Ari Burstein
Associate Counsel
Attachment (in .pdf format)