exist with respect to foreign nonmember access, since the nonmember discount is intended to be limited to agency orders for unaffiliated customers.

In view of these potential regulatory problems, and the general paucity of data and expertise in this area, the Commission feels that it is necessary and appropriate to study and analyze the terms and conditions, if any, upon which foreign participation in our securities markets should be permitted. To assist the Commission in studying the subject of foreign access, we contemplate issuing a release in the near future requesting public comments on a variety of issues. Rule 394

Much has been said and written about Rule 394 of the

New York Stock Exchange.

67/

The House Subcommittee concluded:

In a central market system whose
objectives are that customers should
receive the best possible execution
of their orders in any market wherever
situated and that such orders be

transacted at the lowest possible cost,
Rule 394 has no justification.

Accordingly, the New York Stock Exchange

67/ Generally, the Rule prohibits the execution of transactions in listed securities other than on an exchange floor unless a complex procedure, sufficiently onerous to discourage its use in most cases, is followed.

should immediately rescind the rule.
If this is not done the Subcommittee
will introduce legislation which will
have the effect of abrogating the rule.68/

Subsequently, the House Subcommittee introduced legislation

to abrogate Rule 394.7

69/

The Commission's 1965 staff study of Rule 394, however, recognized certain beneficial results flowing from a policy of centralizing execution on an exchange floor. As was

pointed out in the report:

Regulatory supervision is present on
Exchange transactions. The highest
bids and lowest offers are accorded
priority. Public orders can often
cross without the intervention of a
professional dealing for his own
account. Publicity is accorded to
individual transactions by tape prints
and to the collection of transactions
by the stock tables.70/

Nevertheless, the report concluded:

Whatever are the advantages which these
aspects offer the public, they must be
balanced against the disadvantages as
well as considered from the point of
view of whether the same advantages
could be preserved with certain adjustments
in the Rule. On balance, the disadvantages
seem to outweigh the advantages, and neither
the Rule nor the current interpretations

68/

69/

House Study, n. 1 above, at 127. The Senate Study
recommended amending Rule 394 "to permit exchange members
to deal net with third market makers, without prior
permission of the Exchange, subject to a requirement
that public orders be given priority in the

actual consummation of the transaction." See Senate
Study, n. 1 above, at p. 105.

H. R. 5050, n. 7 above, Sec. 209.

One of the basic reasons for creating a central market system is to enable the investing public to have the benefits of rules designed to centralize trading without impairing a broker's ability to obtain best execution. In order to achieve this centralization, all transactions in listed securities, or at least those in which a broker-dealer is involved, will have to be subject to the system's trading rules and reporting requirements. In other words, under a central market system Rule 394 would be replaced by a broader rule confining virtually all trading in listed securities to the system. The important distinction, however, is that the current disadvantages of Rule 394 would not be present.

The principal objection to Rule 394 is that it can have the effect of restricting the ability of a member firm to obtain the best execution of an order for its customer by limiting its ability to execute the order in a market away from the exchange. Since all market centers would be part of the central market system, a rule which required all

71/

Id., at 207. The procedure which permits transactions to be executed "off-board" (Section 394(b)) was added to the Rule following the staff report. As noted in footnote 67, however, this procedure has been less than a total success in achieving its intended purpose of facilitating best

transactions to be executed within that system could never work to prohibit a broker from obtaining best execution.

The broker would simply execute an order wherever in the system the best price was obtainable, subject to the

system's trading rules, and report his completed transactions through the composite reporting system.

By the same token, once a composite quotation system

is in effect retention of Rule 394 would create serious

problems for brokers seeking expeditiously to discharge their duty to obtain best execution.

Accordingly, it seems likely

that the NYSE will find it in its member's best interest

to rescind the Rule not later than the time when the composite

quotation system is implemented.

If this does not occur, the

Commission will request its rescission.

VI.

Conclusion

At the heart of the central market system we have described herein will be an efficient and comprehensive communications linkage between market centers consisting of a real-time composite transaction reporting system and a composite quotation system displaying the bids and offers of all qualified market makers in listed securities. The necessary steps which have to be taken to achieve the composite reporting system already are well under way. The next step will be to demonstrate a similar commitment to making the

end, the Commission intends to republish proposed Securities Exchange Act Rule 17a-14 in the near future.

It is clear to the Commission that the implementation of an operational communications system, without more, would necessarily precipitate some restructuring of the way securities are traded today. Rather than let such restructuring occur without rational direction, the Commission, in this policy statement, has attempted to anticipate some of the problem areas and to sketch out a broad regulatory framework within which this communications system could efficiently operate. For example, a broker will have the opportunity, for the first time, to see bids and offers in many different markets at once. To the extent the broker must execute his customer's order in a market to which he does not have the ability to negotiate economic access, he would be unfairly penalized in discharging his duty of best execution. This state of affairs would not be tolerable for long to a well-managed brokerage firm. In addition, with transactions from all markets appearing on the composite transaction reporting system, brokers must have some way of protecting their customers against transactions away from the current price which are executed in other markets. Accordingly, the Commission has suggested some approaches in this policy statement which would permit brokerage firms to accommodate their business to the realities