Thompson, Samuel C., Jr.

English

PennState, The Dickinson School of Law: Penn State Law eLibrary

Penn State Law eLibraryJournal Articles Faculty Works1-1-1994Foreward and Impact of Market 2000 StudySamuel C. Thompson Jr.Penn State LawFollow this and additional works at: http://elibrary.law.psu.edu/fac_worksPart of the Tax Law CommonsThis Article is brought to you for free and open access by the Faculty Works at Penn State Law eLibrary. It has been accepted for inclusion in JournalArticles by an authorized administrator of Penn State Law eLibrary. For more information, please contact ram6023@psu.edu.Recommended CitationSamuel C. Thompson Jr., Foreward and Impact of Market 2000 Study, 12 UCLA Pac. Basin L.J. vii (1994).SPECIAL SECTION: SECURITIESFOREWORD AND IMPACT OF MARKET2000 STUDYSamuel C. Thompson, Jr.tThis issue of the Pacific Basin Law Journal contains threearticles dealing separately with securities regulation in Taiwan',Singapore, 2 and China3. These articles are being publishedshortly after the January 27, 1994 release by the Division of Mar-ket Regulation of the United States Securities and ExchangeCommission of its report on the U.S. equity markets: Market2000: An Examination of Current Equity Market Developments.4t Professor, UCLA School of Law.1. Jeffrey H. Chen & Jack J.T. Huang, Taiwan's Evolving Stock Market Policyand Regulatory Trends, 12 UCLA PAC. BASIN L.J. 34 (1993).2. Michael S. Bennett, Securities Regulation in Singapore: The City-State As AnInternational Financial Center, 12 UCLA PAC. BASIN L.J. 1 (1993).3. Andrew Xuefeng Qian, Riding Two Horses: Corporatizing Enterprises andthe Emerging Securities Regulatory Regime in China, 12 UCLA PAC. BASIN L.J. 62(1993).4. DIVISION OF MARKET REGULATION, U.S. SECURITIES AND EXCH. COMM'N,MARKET 2000: AN EXAMINATION OF CURRENT EQUITY MARKET DEVELOPMENTS(1994) [hereinafter MARKET 2000 STUDY]. The Securities and Exchange Commis-sion's published its last comprehensive study of the equity markets in 1971. INSTrTU-TIONAL INVESTOR STUDY REPORT OF THE SECURITIES AND ExcH. COMM'N, H.R.Doc. No. 64, 92nd Cong., 1st Sess. 1 (1971). In response to that study and to Con-gressional hearings, in 1975 Congress enacted Section 11A of the Securities Ex-change Act of 1934. 15 U.S.C. § 78k-1 (1992). Section 11A(a)(1) sets forth certain"findings" of Congress to the following effects:(1) the securities markets are an important national asset,(2) new technological developments create the opportunity for moreefficient and effective market operations,(3) the linking of markets will contribute to the best execution of or-ders, and(4) it is in the public interest to assure economically efficient execu-tion of securities transactions, fair competition among brokers, theavailability of information with respect to quotations in securities,the execution of investors' orders at the best market price, andwhere appropriate, the execution of investors' orders without par-ticipation of a dealer.PACIFIC BASIN LAW JOURNALThe U.S. equity markets are the most "efficient and liquid inthe world."' 5 Questions have arisen, however, concerning the"fairness, competitiveness, and efficiency" of these markets.6The rapid advances in technology, the development of new finan-cial products, and the accelerating pace of global economic ex-pansion have led Congress, investors, and the markets to raise"concerns about possible market fragmentation, inadequate dis-closure of market information, and uneven regulation amongcompetitors."'7 The purpose of the Market 2000 Study is to "ad-dress these issues to "ensure that U.S. equity markets remain vi-brant and efficient." 8As the United States seeks to make necessary adjustmentsin its own equity markets, the Market 2000 Study should providehelpful guidance to Taiwan, Singapore, and China, as well asother countries, in developing appropriate approaches to securi-ties regulations. For that reason, this Foreword briefly discussessome of the more significant points raised in the Study that couldhave a bearing on the problems addressed in the articles con-tained in this issue.In addressing these regulatory issues it is important to re-member that the purpose of equity markets is to "raise capital,provide investment opportunities, and promote entrepreneur-ship." 9 As pointed out in the Statement by the U.S. Securitiesand Exchange Commission that accompanies the Market 2000Study, the promotion of these goals can be facilitated by main-taining a "fair field of competition" and by pursuing the follow-ing three broad themes:First, that arrangements between customers and broker-deal-ers should be as clear as possible. Second, that markets shouldhave as much information about supply and demand as is con-sistent with customer interests. Third, that competition andSection 11A(a)(2) directs the Commission to "facilitate the establishment of a na-tional market system for securities ... in accordance with the [above stated] findingsand to carry out the [above stated] objectives..." Although Congress did not definethe term "national market system," in Section 11A(a)(3), Congress authorized theCommission in furtherance of the directive to establish a national market system to(1) create advisory committees, (2) require self regulatory organizations (SROs),such as the exchanges and the NASD, to act jointly, and (3) conduct studies andmake recommendations to Congress. The Market 2000 Study is the latest studypromulgated pursuant to the Commission's authority under Section i1A(a)(3).5. MARKET 2000 STUDY, supra note 4, at 1.6. Id.7. Id.8. Id.9. Id.[Vol. 12:viiFOREWORDinnovation in the provision of trading services should beencouraged. 10These three broad themes are addressed in four separatesections of the Market 2000 Study dealing with (1) the fair treat-ment of investors, (2) the timely and comprehensive disclosure ofmarket information (i.e., transparency), (3) fair competitionamong markets and market participants, and (4) the expansion ofopen access." The recommendations contained in each of thesesections will be considered below.Before reviewing the specific recommendations of the Mar-ket 2000 Study, however, two comments should be made. First,conclusions reached in the Study are based on a detailed analysisof the U.S. equity markets pursuant to the directives and author-ity set forth in Section 11A. While these conclusions may be ofassistance in designing regulatory schemes in other countries,there is, of course, no substitute for a directed study of eachcountry's securities markets. Indeed, it would be prudent forother countries to follow the lead of the United States in givingtheir securities regulators directives and authority to develop theequivalent of the national market system now employed in theUnited States.Second, the Market 2000 Study reaches the conclusion thatthe "Commission best fulfills its statutory mandate when it con-centrates on protecting investors, facilitating fair competition andpromoting full disclosure" and that the "equity markets are toodynamic to conclude that the government could once and for allestablish the 'ideal' way to trade equity securities."'1 2 Effectivelythe study calls for principled supervision rather than rigid regula-tory control, an observation which may prove invaluable toevolving equities markets forced to contend with diverse issuessuch as the ratio of institutional investors in the market 13 and thewisdom of stock option trading.1 4Fair Treatment of InvestorsOne of the "cornerstones" of U.S. "market integrity" is therequirement under the securities laws that a broker-dealer seekto obtain the best execution for the orders of its customers. 15Automated systems have increased the speed involved in han-10. Statement by the Securities and Exchange Commission, Upon Release ofthe Market 2000 Report, Jan. 27, 1994.11. MARKET 2000 STUDY, supra note 4, at 2.12. Id. at 15.13. See, e.g., Chen & Huang, supra note 1, at parts II, III.14. Bennett, supra note 2, at 215.15. Id. at 21. The "best execution" principal requires that the customer be pro-vided with the best price available in the market.1993]PACIFIC BASIN LAW JOURNALdling individual orders and automated routing of small orderscan facilitate best execution, but there are possible defects insuch systems. Consequently, the Market 2000 Study recommendsthat broker-dealers regularly monitor such systems to ensure thatorder flow is directed to markets that provide best execution.16The Study additionally recommends that automated systems forlisted stocks be modified to offer "some possibility of price im-provement" by adoption of order exposure principles similar tothose that apply in auction markets.' 7In addition to monitoring of automated systems, the Market2000 Study calls for greater disclosure with respect to a variety ofpayment practices engaged in by brokers, dealers, specialists, andinvestment advisors. This emphasis on fiduciary disclosure, couldpotentially interfere with the customers right to best execution,but is illustrative of the importance of both the sanctity of thebest execution concept and benefits that are expected to flowfrom full disclosure. In less well developed markets, it may beappropriate to simply prohibit practices that could interfere withbest execution rather than relying on disclosure. However, it isimportant for governments to promote full disclosure and thefree-flow of financial information. This principle may not yethave taken root in the Asian equity markets as evidenced by theSingapore government's reluctance to "place[] a high value onthe free flow of information."' 8The best execution principle may also be adversely effectedby the practice of market makers "trading ahead" of customerorders. This involves a market maker trading for its own accountat prices better than a customer's limit order price without firstexecuting the customer's order.' 9 The Market 2000 Study con-cludes that this practice should be flatly prohibited.20 Prohibi-tions on "trading ahead" have apparently not been adopteduniformly in the Asian equity markets as indicated by the Chi-nese practice of allowing persons with inside connections withthe issuing company or stock exchanges to have their orders exe-cuted before those of the general public.2'16. Id. at 24.17. Id.18. Bennett, supra note 2, at 223.19. MARKET 2000 STUDY, supra note 4, at 24.20. Id. at 25.21. Qian, supra note 3, at 72.[Vol. 12:viiFOREWORDTransparencyThe Market 2000 Study explains that transparency is the"real-time dissemination of information about prices, volumeand trades."22 The Study further explains:[T]ransparency plays a fundamental role in the fairness andefficiency of the secondary markets. Transparency ensuresthat stock prices fully reflect information and lowers tradingcosts by improving investors' ability to assess overall supplyand demand. It also contributes to the fairness of the marketsby offering all investors timely access to market information.23Transparency in the U.S. markets has been facilitated by the cre-ation of a consolidated stock reporting tape and last sale report-ing of NASD securities. 24In an effort to further promote both fair competition be-tween markets and an efficient price discovery mechanism, theMarket 2000 Study makes the following five recommendationsfor enhancing market transparency. These recommendations areclearly specific to the U.S. equity exchanges but may provide auseful framework for reform of Asian equity markets which areengaged in their own struggle for transparency.25First, the Study recommends that the SROs consider requir-ing the display of customer limit orders in certain cases. 26Second, the Study recommends that the current pricing sys-tem, which is based on a minimum variation for bids and offersof one-eighth (12.5 cents), be modified to possibly adopt a deci-mal pricing system in which prices are set in pennies.27 This typeof change could eliminate the artificially wide spreads that canoccur under the present system and also promote quotecompetition.28Third, the Study recommends that the NASDAQ's SelectNettrading system be modified to eliminate the selective display oforders. 29 Such orders should be displayed on an equal basis with-out differentiation among market makers. 30 In addition to en-hancing transparency, this proposal should also increasecompetition.Fourth, to promote the full and accurate reporting of trades,the Study recommends that the SROs develop systems for the22. MARKET 2000 STUDY, supra note 4, at 17.23. Id.24. Id.25. See, e.g., Qian, supra note 3, at 72.26. MARKET 2000 STUDY, supra note 4, at 17.27. Id. at 18.28. Id.29. Id. at 19.30. Id.1993]PACIFIC BASIN LAW JOURNALreporting of trades in U.S. securities occurring after regular trad-ing hours in the U.S. (after-hour trading) and on foreign markets(off-shore trading).31Fifth, the Study recommends that the SROs consider theadoption of an order exposure rule. Such a rule would require a"market maker to stop (i.e., guarantee execution of) a customerorder at the proposed price and, through the Consolidated Quo-tation System, to publicly bid or offer the order at a better pricebefore executing the order as principal. '32 The Study acknowl-edges, however, that adoption of such a rule may cause marketmakers, who generally make their income on the spread, to beginto charge commissions.Fair Market CompetitionThe Market 2000 Study recommends four changes needed topromote fair competition among the markets. These recommen-dations will be reviewed below although their application to theAsian equity markets is somewhat premature as most of thesemarkets have not diversified to include over-the-counter trading.First, the Study recommends that the NASD promulgaterules to provide maximum oversight of the "third market" (i.e.,OTC trading of exchange listed stocks) and to set forth tradingprinciples for such a market.33 The Study explains that there hasbeen a great debate over whether an auction or dealer systembest promotes liquidity, stability and fairness. The Commission'sview is that each system has "specific advantages and disadvan-tages, and it would be contrary to the Commission's mission toimpose a particular design."34 Although this conclusion seemssound for the U.S. market, it might not be appropriate for acountry with less well developed markets.Second, although the Market 2000 Study rejects the argu-ment of the exchanges that proprietary trading systems (PTSs)should be regulated as exchanges rather than broker-dealers, theStudy recommends enhanced record-keeping and reporting re-quirements for broker-dealers operating automated systems,much as PTSs. 35Third, the Study recommends that the transaction fees cur-rently imposed on listed stocks be expanded to apply also toOTC stocks.36 The Study explains: "Given the intense competi-31. Id. at 20.32. Id. at 21.33. MARKET 2000 STUDY, supra note 4, at 26.34. Id.35. Id. at 27.36. Id. at 27.[Vol. 12:viiFOREWORDtion for listing among the OTC and exchange markets, disparateapplication of such fees provides the OTC market with an unin-tended competitive advantage that is not justifiable. '37Fourth, the Study rejects the arguments of the equity ex-changes that filing requirements unique to the equity marketsplace them at a competitive disadvantage with PTSs and thirdmarket dealers. 38 The Study argues that PTSs do not perform thesame functions as exchanges and, therefore, do not need thesame level of regulation.39 The Study does recommend, however,that the Commission accelerate its review of proposed rulechanges.40Open Market AccessThe Market 2000 Study explains that "[p]ast experience hasshown that competitive interests can cause an SRO to take ac-tions to disadvantage competitors, while cloaking these activitieswith regulatory purpose."'41 Consequently, the Commission mustbe certain that market participants do not "impose restriction onwhere the users of the markets can conduct transactions, and[that] the restrictions on professionals are consistent with notionsof fair competition. '42 In furtherance of these objectives, theMarket 2000 Study makes three recommendations.First, the Study recommends that NYSE remove restrictionson off-board trading occurring after-hours. 43 These restrictionshave the effect of forcing NYSE members who desire to engagein after-hour trading to do so overseas. The Study explains:[T]he anti-competitive effect of the after-hours restrictionwithin the United States is absolute. NYSE Member firmssimply have no choice: they must trade overseas or be forcedto use the NYSE's [after-hours] crossing sessions, which arelimited in time and scope.44Second, the Study recommends that the procedures for de-listing stocks on the NYSE and the AMEX be modified. NYSERule 500 requires a 66.6% vote of outstanding shares for delist-ing. AMEX Rule 18 gives the Exchange the authority to deter-mine whether a board's proposal for delisting is granted with orwithout shareholder notification. On the other hand, the NASDrules permit certain issuers to delist upon written notice to the37. Id. at 27-28.38. Id. at 28.39. Id.40. Id.41. Id. at 29.42. Id.43. Id. at 29-30.44. Id. at 30.1993]PACIFIC BASIN LAW JOURNALNASD. 45 The Study concludes that the NYSE delisting rule istoo onerous and the AMEX rule is too vague.46 Consequently,the Study recommends that these rules be modified to grant tothe board of directors and independent directors the power tomake such a decision.47Third, the Study recommends that intermarket trading in ex-change listed securities, which allows a broker-dealer in one mar-ket for a security to send orders to another market for the samesecurity, be enhanced to further promote intermarket access.48This additional access should facilitate the best executionprinciple.ConclusionWhile the Market 2000 Study purports to provide a detailedstudy of the U.S. equity markets, many of its recommendationsreach far beyond the boundaries of the United States. The studyconcludes by noting four dominant trends in the U.S. equity mar-kets. It is worth considering these trends as they are likely to bereflected in evolving equity markets world-wide. First, thegrowth and dominance of institutional trading requiring regula-tors to accommodate the needs of both institutional and retailcustomers.49 Second, a growth in global trading forcing compe-tition with foreign markets offering a variety of regulatory stan-dards.50 Third, the development of derivative markets, whichpermit users to "re-create" synthetically virtually any asset ortrading strategy," thus "challeng[ing] the Commission to controlrisk and promote fair competition among markets. 51 Finally,persistent technological advances making it possible for publicinvestors to obtain direct access to the markets.52These trends inform the Market 2000 Study's recommenda-tion of fair treatment of investors, transparency, fair market com-petition, and market access, and provide sound guidance forsecurities regulators in Taiwan, Singapore, China, and the rest ofthe world.45. Id.46. Id. at 31.47. Id.48. Id. at 31.49. Id. at 32.50. Id.51. Id.52. Id.[Vol. 12:vii

Foreward and Impact of Market 2000 Study

https://elibrary.law.psu.edu/cgi/viewcontent.cgi?article=1339&amp;context=fac_works

Foreward and Impact of Market 2000 Study

Abstract

Similar works

Full text

Available Versions

PennState, The Dickinson School of Law: Penn State Law eLibrary