The New York Stock Exchange's interpretation of its Rule 108 will either add depth and liquidity to its proposed hybrid market plan or is a sop to specialists that will hurt floor brokers and institutional investors. That's the debate about specialist parity rules dividing specialists and institutional investors, who are supported by some floor brokers. The dispute is partly to blame for the Securities and Exchange Commission's inability to approve the Big Board's hybrid plan. The debate has been raging for months now and does not appear close to being settled.

The NYSE, in recent filings and in the fifth amendment to its hybrid plan, has repeatedly tried to win SEC approval for a proposal that allows specialists to trade on parity with the crowd when it is building a position. This feature, which exists under limited circumstances today, will provide a more efficient market, NYSE officials maintain. This new interpretation "benefits the market by encouraging specialists to add depth and liquidity by initiating proprietary transactions on the Floor of the Exchange," the NYSE wrote in a December 13th rule change filing with the SEC. Big Board officials argued in recent filings that, since there is no prohibition on specialist parity, "it is entirely consistent with the rule, as well as Commission precedent, to state that even if they are not entitled, specialists nevertheless may trade on parity under certain circumstances. But both floor brokers and institutional traders contend that the NYSE is distorting the rule, which is designed to protect the public investor. Critics of the NYSE rule interpretation include the Investment Company Institute (ICI) and the NYSE's Independent Broker Action Committee (IBAC), both of which have filed SEC comment letters. "Exchange rules," the ICI wrote, "currently prohibit specialists from trading for their proprietary account on parity with the crowd when the specialist is establishing or increasing its position." IBAC, in its letter, wrote that the rules contain no specialist privilege for parity acquisition trading. "The current rules do not provide such an entitlement, and this limits the ability of specialists to use their information and speed advantages vis-a-vis other market participants." Joe Gawronski, chief operating officer of floor broker Rosenblatt Securities, opposed the new interpretation. "It's bad for public policy and it's bad for institutions," Gawronski told Traders Magazine. He said that giving the specialist parity when one is acting as an agent is fine. "When Rule 108 applies, they're saying they should get parity all the time. We don't like that," he said. George Rutherfurd, a Chicago-based consultant to two trading organizations and a fierce Big Board critic, said the NYSE has been distorting the rule. The NYSE has been failing to enforce Rule 108 properly, and has been permitting "clearly illegal activity" to occur, Rutherfurd wrote in recent comment letters. The NYSE, in a December filing and in an information memo to members last fall, explained how a technical interpretation of the rule allows specialists sometimes to achieve parity in the crowd. The memo stated the interpretation allows "a specialist to be on parity with orders in the Crowd when the specialist is establishing or increasing his or her position..." But in the next phrase of the memo says that specialists must allow the brokers in the crowd "a reasonable opportunity to object." In his December 11th letter to the SEC, Rutherfurd writes that the NYSE has been "permitting parity trading for any number of years (as it had permitted other practices that led to two SEC enforcement actions) without focusing on the fact that it was specifically forbidden by Rule 108." The NYSE was embarrassed by "inadvertent admissions" in hybrid plan amendment five, Rutherfurd charged. "Deluding themselves that they could split hairs regarding the meaning of entitle," Rutherfurd's letter continued, "the NYSE staff imagined that they could project back in time their bogus linguistic exercise and assert that the drafters of Rule 108 must also have split the same hairs." Gawronski said that, if the SEC approves the NYSE view of Rule 108, 10,000 shares offered would have to be split between the public investor and the specialist. "Parity means the specialists can share any bid print," he added. Still, the NYSE said its interpretation of the Rule 108 is not setting a regulatory precedent. "This is consistent with other rules that permit a specialist to trade on parity with the Crowd, such as Rule 123A-30, which expressly authorizes Floor brokers to permit a specialist to go along with brokers' convert-and-parity ("CAP") orders, regardless of the specialist's proprietary position," according to the NYSE. The trading war began with hybrid plan amendment five filed last summer. Critics contend that it was revised in response to specialist complaints about the first four amendments. In amendment five, the NYSE said that a proposed amendment to Rule 108 "comports with existing practice on the floor where brokers may voluntarily allow specialists to be on parity with them."

Gregory Bresiger

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