September 1, 1998 Jonathan G. Katz Secretary Securities and Exchange Commission Mail Stop 6-9 450 Fifth Street, N.W. Washington, D.C. 20549 Re: File No. 4-208 Dear Mr. Katz: This letter responds to the Securities and Exchange Commission's request for comment on the above referenced rule proposal. The Pacific Exchange (PCX) has previously written at length on the issues addressed therein. We are writing now simply to summarize our views. Let me begin by expressing our appreciation for the Commission staff's responsiveness to our petition, which is reflected in this initiative. The Commission requested comment on specific issues presented in the proposal to link the PCX Application of the OptiMark System (OptiMark) to the Intermarket Trading System (ITS), including: - "whether the PCX Application, in light of PCX's requirement [that all specialists on its floor enter their quotes into the OptiMark System prior to a matching session], complies with the `reasonable' probing aspect of Section 8(a)(v) of the [ITS Operating] Plan"; - "whether the PCX's or the [New York Stock Exchange's] version of the Description Amendment better meets the objectives of Section 11A of the Exchange Act, or whether an alternative that combines features of each version should be adopted"; - "on the alternative formula amendments"; and - "whether it is necessary to amend the Plan to include a percentage formula in order to satisfy the requirements of Section 8(a)(v), or whether it should be sufficient for PCX to integrate OptiMark without limitation on the amount of outgoing ITS commitments that are sent from the PCX Application to another marketplace for execution." We will address each set of issues in turn. Compliance with the reasonable probing aspects of the ITS Plan As noted in the proposal, the PCX intends to require its specialists to enter their quotes into OptiMark prior to a matching session, and recently filed changes to its rules with the SEC to effectuate that mandate (see Exchange Act Release No. 40348 (August 20, 1998), 63 FR 45892 (August 27, 1998) (notice of filing of SR-PCX-98-36)). Fulfillment of that requirement amply meets the standards of "reasonable probing," and the second, 15-second probe following an OptiMark matching session requested by the New York Stock Exchange (NYSE) is unnecessary, duplicative, and counterproductive. It is unlikely a specialist's indications of interest will substantially change in the time it takes to enter that interest in OptiMark, wait three seconds for the completion of a matching session, and be re-exposed to the specialist for an additional 15 seconds. Those indications, as incorporated in OptiMark, will be "displayed to the market" more comprehensively and transparently than any other market architecture currently provides. PCX specialists will be entering their best bids and offers for each traded security, as well as orders carried in their limit order books. With the linkage to ITS, the best bids and offers from competing specialists at other markets will also be incorporated into each OptiMark cycle. Furthermore, the manual processing requirements of the NYSE's suggested second probe are antithetical to the fully electronic environment OptiMark is designed to maintain. PCX's Description Amendment better meets the objectives of Section 11A The more markets are integrated, the closer we come to the ideals of a National Market System. The more restrictions we place on integration, the further we move away from those ideals. In a perfect world, no restrictions whatsoever would be placed on OptiMark-generated commitments. The Pacific's amendment proposes fewer restrictions than the NYSE's, and therefore better meets the Section 11A objectives. Alternative formula amendments As discussed below, the PCX does not believe any percentage formula is needed to satisfy the requirements of Section 8(a)(v) of the ITS Plan. Should the Commission deem otherwise, we believe the higher upper bound (at 20 percent, as proposed by the PCX) should be adopted and enforced, at least until such time as there is actual data available from the use of OptiMark. Absent that data, any cap on trading activity would be an arbitrary exercise. The NYSE's proposal of five percent (5%) is too low to be taken seriously. Any capping of trading commitments would artificially limit the potential effectiveness to a new, more efficient market mechanism. Is a percentage formula necessary? The PCX Application of OptiMark is neither designed nor intended to be "an order delivery system," as defined in Section 8(a)(v) of the ITS Plan. In the interests of pragmatism, the desirability of consensus, and the overwhelmingly positive response of potential users to OptiMark's promise, we offered to set a minimum ceiling of 20 percent for "trade-at" commitments, in order to avoid undue delays in the launch of this innovation. Philosophically, however, we find the notion of any artificial, arbitrary caps on ITS commitments to trade to be inappropriate and fundamentally at odds with basic principles of open markets and fair competition. The PCX, other ITS participating market centers, and the SEC can monitor the use and effects of OptiMark, once the system is implemented. If, in practice, the PCX Application of OptiMark shows signs of becoming an order delivery system, the ITS Operating Committee, with Commission oversight, can propose appropriate measures aimed at returning OptiMark to its original, intended purpose. Conclusion More than 25 years ago the SEC envisioned a National Market System "in which all buying and selling interest . . . could participate and be represented under a competitive regime . . . without any impediment, such as specific restrictions against dealing in particular markets within the system." The Commission called for "negotiable economic access between market centers, so that a broker can have the opportunity to be fairly compensated for his services even though not a member of the particular center in which an order is ultimately executed." (SEC, Letter of Transmittal, "Institutional Investor Study," H.R. No. 92-64, 92nd Congress, March 10, 1971.) Such a system was mandated by Congress in 1975. The ITS was intended to meet that mandate. The New York Stock Exchange's "concerns" for OptiMark are groundless fears, rooted in hypothetical possibilities that may, in fact, have no basis whatsoever in reality. Even if eventually proven true, the effects will be not be carried by individual and institutional investors. On the other hand, if the NYSE is successful in its efforts to delay OptiMark's introduction and impair its effectiveness, it is investors who will bear the lost opportunity to realize faster executions, more liquid markets, and better prices. The NYSE asks that the SEC direct the PCX to return to the bargaining table for further negotiations. But the parties have already negotiated in good faith for months. There are honest, unresolvable differences of opinion, and the Commission must now decide what is best for the public. We urge the Commission to continue moving the exchanges, and other market participants, toward a market architecture that is more open, more efficient, and more responsive to investors' needs. Sincerely, R. Warren Langley President and Chief Operating Officer