Ray Garrett had been a strong chairman, willing to take responsibility for unfixing commission rates and to accept the charge from Congress to create a national market system. But Garrett stepped down by the end of 1975. During the two years that Roderick Hills served, he generally deferred to the Congressionally appointed National Market Advisory Board, which explored the issues but reached no consensus. It fell to the Commission under Harold Williams to effectuate the Congressional mandate. And to be sure, it was a confusing mandate. As Commissioner Roberta Karmel, who served with Williams, explained, the 1975 Act was “rather schizophrenic in terms of mandating that on the one hand the National Market System should be based on the principle of competition, and on the other hand specifying that this was supposed to be an integrated marketplace.” 27 Williams believed that the SEC need not choose between allowing unbridled competition and serving as architect of a new market structure. He set the precedent that endured for a generation in which the SEC allowed competition to reshape the markets, but intervened, sparingly, with rules intended to guarantee transparency and ensure linkages between markets so that competition would result in better prices to investors. 29
When it came to transparency and linkage, there was nothing as fundamental as consolidation of all transaction reporting and quotes onto a single “tape” so that investors could seek the best deal across markets. It was fairly easy to achieve the former. Planning for a “composite tape” (created by SIAC) was begun even before the 1975 legislation was passed. Because the SEC did not want to give NYSE control of the tape, a Consolidated Tape Association was created. There were two goals, recalled Mark Fitterman. "One, it was consolidated so that you got to see all the trades from all the markets on a single data stream. The second was to create what we call a high speed line." The Consolidated Tape Association got transaction reporting up and running by the spring of 1976. Rule 17a-15, noted Market Regulation director Lee Pickard, required that “any transaction in an equity security of any magnitude has to be recorded on the tape within ninety seconds. It doesn’t matter whether it’s traded on the New York Stock Exchange, Philadelphia Exchange, over-the-counter, upstairs at Merrill Lynch’s trading desk, it has to be reported.” 29
Far more difficult to achieve was a composite quote system. This was not surprising because quote transparency threatened to divert business away from the NYSE and the AMEX. "The primary issues," Fitterman recalled, "were revenue issues with respect to the tape." Every exchange and brokerage "asserted proprietary interest and collected revenue," Fitterman said. "That is still the case." But passage of the 1975 Act amendments confirmed that the SEC could insist upon such a system, and the Commission went to work. In 1978, Rule 11Ac1-1, or the “Quote Rule” (the industry called it the “trade-through” rule), required that throughout the trading day, all exchanges and market makers had to provide best bid and offer information. Market makers and specialists could still trade through other markets, but they would be required to make up the price difference if a customer complained. Some on the SEC staff had hoped to do more, implementing a central limit order book, or CLOB, which would allow for automatic execution and nationwide price/time priority. But, with fierce opposition from those concerned about reduced competition and the systemic risk created with a single point of failure in the national market system, as George Simon, former associate director of the Division of Market Regulation, put it, “it was a political impossibility. And therefore, the concept of nationwide price protection, which is trade-through, although less thorough or less fair, seemed more politically feasible.” 30
Still, the Quote Rule was important because it required the NASDAQ to do away with the “representative bid and ask” and to make its prices consistent with those of the exchanges. It also brought the NYSE one step closer to losing its monopoly on listed stock trading. George Simon believed that this was intentional, crediting Director of Market Regulation Andy Klein with employing the strategy, “propose something really draconian, and then step back.” 31 The ploy appears to have worked—the creation of the Intermarket Trading System was a direct result of the SEC’s insistence that the NYSE provide transparency of their quotes.
ITS may have appeared to many to be a suitable compromise on the part of the Exchange, but when it came to the NYSE’s most powerful feature for protecting its market power, Rule 390 and its off-board trading restrictions, there was less room for compromise. In 1977, the SEC proposed Rule 19c-2, which would have allowed members of the Exchange to trade NYSE listed stocks in any market. The NYSE enlisted the City of New York in its defense, which warned, “there will be grass growing on Wall Street” should Rule 390 fall. Compromise followed: Rule 19c-3 allowed new listings after April 26, 1979 to be traded off the exchange, grandfathering the old blue chips into the monopoly. Adopted in 1980, Rule 19c-3, for the first time, allowed broker-dealers to make markets in direct competition with NYSE specialists. 32
Ironically, even as the NYSE yielded a share of its market dominance and the regionals and the NASDAQ began to appear to be components in a national market system, the new developments worked to collapse the third market. By 1978, third market volume fell to less than 3 percent of NYSE. It was the distortion of the market created by NYSE’s fixed commission rates that opened the way for the third market: by knocking out that prop, the SEC ended up hurting the NYSE’s old nemesis more than the exchange itself.
(27) November 18, 2005 Interview with Roberta Karmel, 31.
(28) Richard Ketchum emphasizes the Commissions “combination of rule making and linkages” in April 17, 2008 Interview with Richard Ketchum, 5.
(29) April 16, 2009 Interview with Lee Pickard, 31.
(30) February 23, 2009 Interview with George Simon, 11.
(31) February 23, 2009 Interview with George Simon, 14.
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