August 12, 1998 Jonathan Katz, Secretary Securities and Exchange Commission 450 Fifth Street NW Washington, DC 20549 Re: Release No. 34-39884; File No. S7-12-98 Dear Secretary Katz, American Century Investment Management, the investment manager for the American Century family of mutual funds[1], welcomes the opportunity to comment on the proposed new regulation of exchanges and alternative trading systems (ATS) as detailed in Release No. 34-39884, File No. S7-12-98. American Century is generally supportive of this proposal as it attempts to provide better market transparency to all investors and levels the regulatory playing field for exchanges, broker dealers, and ATS's. Within the release the Commission states "...participants have an expectation regarding the manner of execution - that is, if an order is entered, it will be executed in accordance with those procedures and not at the discretion of a counterparty or intermediary." American Century agrees with that expectation and believes the most consistent, non-partial, disintermediated means of order execution is electronic execution of orders via an ATS. The innovations of ATS's over time have provided reduced transaction costs to both American Century shareholders[2] and other equity investors. Regulation of ATS's as Exchanges or Broker Dealers The proliferation of ATS's in equity markets during the last three years has produced one particularly persistent complaint: to force an ATS (formerly electronic communication networks or ECN's) to comply with the regulatory structure of various SRO's presented a conflict of interest, at least from the viewpoint of the ATS. Specifically, ATS's have complained that strongly entrenched member interests within various SRO bodies have resisted innovations in electronic trading in order to retain their competitive advantage. This has led to higher transaction costs for most equity market participants, while established market mechanisms were allowed to prosper. American Century agrees with this criticism. The proposed rule change will help prevent these seeming conflicts. If an ATS has a choice of its regulatory overseer, it is possible to avoid working under the umbrella of an SRO that is either instransigent to change or plans to offer competing systems to the ATS.[3] American Century supports offering this choice to market innovators. Regulation of ATS's as Broker Dealers American Century has long recognized the inherent conflict of interests present when a broker dealer combines either proprietary or agency trading functions with execution of participant orders on an ATS that the broker dealer operates. This unequal flow of information has many potential moral dilemmas even under the best of circumstances. As such, we support the Commission's recommendation that direct access agency broker dealer functions be separated on an operational basis from intermediated broker dealer functions that allow ATS employees to work as agent on the behalf of customers. These employees should not have access to the account activities of customers who choose to work their orders without assistance or input from ATS employees. Further, the proposed separation of regulatory responsibilities within an ATS would help ensure that the above does occur and is adhered to. An ATS should be permitted to charge access fees, as should other market participants who post -bids and offers (specifically, NASD market makers). The disparity in fees, particularly in the over-the-counter market, has created an unlevel playing field for participants in that market for some time[4]. Broker dealers are obligated to fill orders routed to them by ECN's and are not permitted to charge an access fee, while ECN's can charge those same B-D's an access fee when the ECN posts the best bid or offer and the B-D accesses the ECN quote. Those who provide liquidity should be permitted to charge a fee for that liquidity. Those who take liquidity, should be the providers of revenue. We agree, in principal, that pricing these liquidity fees into the NBBO makes for a much simpler, more transparent pricing structure of securities. We also agree, that decimalization will provide a more valid framework for this pricing structure. An ATS that consistently charges higher fees, would consistently not be in the NBBO and not generate fee revenue; participants would be making the pricing decisions on the orders disclosed at best price.[5] This assumes the participants are placing competitive bids and offers on each ATS and it is the fee structure of a participant ATS that makes its quote non-competitive. It is important that the Commission encourage an environment that allows competition to determine fee structure and not to regulate these fees. If a level playing field is provided, exchanges that provide the best technology at the lowest cost will win, and all market participants will benefit. Further, American Century remains frustrated that we are still trading equities in fractions! In a world of electronic trade execution, one in which we and many other market participants have become quite comfortable, it is amazing that not only traditional exchanges but ATS's refuse to quote stocks in decimals. With the flick of a switch, most electronic trading systems could display prices in decimal form.[6] The Year 2000 is no excuse for this lack of action. Fair Access Requirements for an ATS as broker dealer The Commission proposes that each ATS provide "equivalent access to orders displayed in the public quote". In principal, American Century agrees with this proposal, but we caution that in practice it could prove difficult to implement without risk of an ATS exposing itself to double execution. Execution obligation should be based upon time of order receipt by the ATS, not order entry. If an ATS receives two orders: one at 10:16:43:15 from a non-subscriber participant and another order at 10:16:43:16 from a subscriber participant the non- subscriber should be filled. However, if the above were reversed and the non-subscriber had entered the order (in some other system) five seconds earlier than the subscriber, the subscriber should receive the fill. An ATS cannot be held liable for slow networks it has no control over. Nor should an ATS be asked to slow down their system to accommodate substandard networks or systems. Electronic trading provides superior audit trails that will enable the Commission to monitor ATS execution and ensure that there is no disparity between subscriber and non-subscriber order execution. If a system is continually late to "the electronic post", customers will choose more efficient execution platforms. Competition will drive efficiencies. The volume levels that apply to fair access, as proposed under Regulation ATS, are subject to much variation and could lead to serious access inequities at any point in time. American Century opposes exemptions for an ATS to provide access to its quote if it has not traded twenty percent (or any volume percentage) of the average daily volume in that security over four months or any other period of time. Volume traded via any one ATS may and will be sporadic over time. In practicality, even a large institution will only do business with a limited number of ATS's, and when a participant chooses to post a bid or offer in the NBBO, other market participants should have access to this order regardless of the trading volume in that particular issue on that particular ATS. This exemption will inhibit market participants from transacting with one another.[7] Regulation of ATS's as Exchanges American Century supports the Commission's proposal that an ATS be permitted to register itself as an exchange. Innovation provides choices to consumers, and choices, in turn, encourage innovation. Continual innovation has provided lower costs of execution for securities transactions over time, and this trend will continue. SRO's are often dominated by member firms that focus solely on retaining the status quo, and these members are resistant to new technology or structure that threatens this status quo. Providing an option for innovators, by allowing an ATS to register as an exchange, is a viable alternative. American Century strongly believes that the current voting structure of ITS provides barriers to entry which, in turn, provide barriers to innovation. To allow one member of the ITS committee to have veto power on new ITS rules in effect subjects a new entrant not only to the vested interests of a member owned and dominated exchange but forces that new entrant to subject itself to many self interested exchanges! For too long the unanimity required for rule proposals within ITS has stifled innovation. One exchange pursuing its own self interest should not be permitted to force U.S. equity investors to endure inefficient markets with self interested intermediaries.[8] If we are to see a true NMS with price transparency across many markets barriers to entry must be eliminated. Although American Century does not believe the Commission should be involved in network architecture or regulation of systems, we are concerned that the network that supports ITS may not be strong enough to handle sharply higher volumes of securities transactions. Using Selectnet as anecdotal evidence, we have seen unacceptable variability in performance on that network since the explosion of volume that occurred after the order handling rules of 1997. Although the Commission is critical of ATS reliability during the last year, we have witnessed many instances of downtime on an ATS that are attributable to Selectnet and bear no relation to the systems of the ATS which remained stable throughout many Selectnet outages. We would argue that the Commission should be more concerned with the systems that provide linkages in the NMS than with individual participants within the NMS. If we move to an environment with multiple exchanges, it will be the failure of these linkages that will impede participants' quests for best price more than the problems of any one broker dealer, exchange, or ATS. Direct Institutional Access to Exchanges We have consistently argued that choice is important for both market participants and those entities that provide execution platforms for market participants. American Century believes that direct institutional access to exchanges is a choice that will benefit market participants by providing lower execution costs for the shareholders of institutional funds. Section 6(C)(1) of the Exchange Act should be amended to allow qualified institutions direct access to exchanges. The capital of many institutional investors dwarfs that of even the world's largest broker dealers. If institutions are required to maintain guaranteed letters of credit to transact in certain exempt securities (e.g. rule 144A), similar arrangements can be made to provide direct institutional access while maintaining the integrity of credit that U.S. securities markets currently enjoy. Settlement risk rises with the passage of time, but with electronic trade execution we see no reason why each trade message cannot include credit and settlement requirements creating a "virtual" settlement process.[9] This maintains institutional anonymity while allowing the institution, and the shareholders it represents, to avoid paying unnecessary fees for trade settlement guarantee. These guarantees, in today's world, are provided by broker dealers that have less capital available than the institution on either side of the trade. The Commission noted that many commenters in the recent Concept Release were concerned about the regulatory burden that an institution might face if it chose to access an exchange directly. This path may not be the correct one for all institutions, and in fact probably is not, but it does provide a choice to those institutions that feel they have the economies of scale to warrant direct access or believe that anonymity is worth the regulatory cost of achieving direct access. American Century believes that direct access should require a higher level of responsibility and scrutiny than access via a broker dealer. In the world of electronic trade execution, it becomes very difficult to differentiate how an institution that is accessing the NYSE via DOT through a member broker dealer is not really attaining direct access. The broker dealer provides only the connectivity, while all the execution skills reside on the trading desk of the institution. If an institution is willing to comply with the regulatory oversight that direct access requires, why should its shareholders be forced to pay higher fees when executing transactions? Order Disclosure by Institutions American Century supports Rule 301(b)(3) which would require disclosure of displayed orders within an ATS in the national best bid and offer (NBBO) with no exemption for institutions. Displayed orders are good for markets, and displaying all disclosed orders in the NBBO is within the spirit of the Exchange Act, which calls for a national market system (NMS) to provide a level playing field for all investors. The Commission has expressed concerns with fragmentation, and non- disclosure of displayed orders on certain ATS's interfering with the success of a true NMS. American Century shares these concerns. Clearly, this disadvantages investors who cannot access the quote of a specific ATS when searching for best price. As the ATS world expands (the Commission counts 43 ATS's in existence now, with expectations of three more each year), how is any investor going to find best price with confidence without accessing each and every ATS? Even institutional investors, with economies of scale and technology budgets that allow use of multiple ATS's, will be paralyzed in their search for best price as they are forced to go from screen to screen to screen in an attempt to fulfill their fiduciary duty. The small investor, with limited technological resources will be at an even more distinct disadvantage. The Commission expressed concern that requiring institutions to display an order on an ATS could lead to a decrease in orders displayed on that ATS and a general decrease in trading volumes on that ATS. American Century believes exactly the opposite will occur and points to the proliferation of ECN's since the order handling rules were put into effect during early 1997. By enabling institutions to post bids and offers in the NBBO, an ECN was in effect advertising to the world that it had the best price at a given moment in time. As newer ECN's became more prevalent in the NBBO, volumes expanded on those ECN's. American Century believes all displayed orders should be disclosed in the NBBO, regardless of volume representation in that security by the ATS on which the order is displayed. The Commission requested comment on certain volume levels an ATS must achieve in trading a particular security before disclosure in the NBBO is required. American Century feels these volume levels will be arbitrary over time. Trading volume in any particular security may be sporadic over time as that security falls in and out of favor with investors. To base rules upon data that will vary over time is unwise. Further, in a world with many ATS's it may become difficult for one ATS to establish the level of volume in a particular security that will result in disclosure requirement, or participants may choose to go from one ATS to another until an ATS is found that does not require disclosure. A simple rule that requires disclosure of all displayed orders in the NBBO provides a much more consistent application of regulation and will allow for a clear understanding of the NMS by all investors. The Commission requested comment on displaying institutional orders based upon the size of the order. American Century feels that any limitations along this course are unwise. Size limits in one security may mean little or nothing in another. (Requiring disclosure of 50,000 shares of WAL-MART Stores is inconsequential, while requiring disclosure of 50,000 shares of Chiquita Brands might have significant market impact). The market participant must have the election of deciding how much to disclose and when based upon factors such as market volatility, stock specific risk, and trading volume. To regulate here is to impede price discovery for institutional investors and the millions of individual investors they represent. Price, time priority of disclosed orders in combination with reserve book function obviates the need for an arbitrary order size display obligation. At the same time, it is imperative that the reserve order functionality, pioneered by Bloomberg's Tradebook system, be maintained for ATS participants. Many ATS's now provide this functionality which allows participants to display a portion of an order while putting the balance of this order in a reserve visible only to the institution that placed that order.[10] This protects larger orders from being used as a free option by other market participants while providing depth of supply and demand at a price. Shareholders of mutual funds should not be disadvantaged because they choose to pool their funds with other small investors. They deserve the same right to best price of order execution as any other market participant. Disclosure of institutional orders in the NBBO is good, but not to the point where their investors would be held hostage to market participants attempting to take unfair advantage of the information that is embedded in such orders.[11] Miscellaneous The Commission requests comment on whether Form ATS should be a public document. As a relatively non-interested party we believe this document should be kept confidential, as the proposal recommends. In an era of technological innovation, such a document will likely contain proprietary information that competitors could easily copy before the new system could even begin operation. The confidentiality of Form Pilot should also be left to the discretion of the filer. In general, American Century agrees with the Commission that all filings may be done electronically. Such filings would be less expensive and quicker. American Century is supportive of Commission proposals which allow an ATS to "outsource" compliance and regulatory responsibilities to a third party, whether it be another exchange, SRO, or consultant. Forcing all exchanges to fulfill these requirements in parallel is redundant. The Commission proposes that the board of an ATS may include both owners and participants, with participants focusing on system use and rules while board members who are owners focus on the interests of other owners or stockholders. American Century is supportive of these types of structures. An ATS that is more responsive to participants will probably be more successful over time, and structures that encourage this responsiveness should be permitted. Summary  American Century supports the proposal that provides choices to innovators. We should not permit legacy institutions to dominate and control our NMS with the result that competition and innovation are discouraged..  Orders that participants choose to display should be disclosed in the NBBO.  The reserve order functionality that allows participants to display a portion of their order while maintaining a quantity in reserve only known to the participant should be maintained.  Exemptions for access or disclosure in the NBBO by volume are arbitrary over time, and should not be encouraged. Keep the rules fair, consistent and simple.  Those who post bids and offers provide a service to markets and should be permitted to charge a fee for those quotes to participants who seek this liquidity.  Section 6(C)(1) of the Exchange Act should be amended to allow direct institutional access to U.S. exchanges.  For the U.S. to enjoy a true NMS, in the spirit of the Exchange Act, ITS governance that permits domination by entrenched interests must be changed. ITS governance should be accommodative, not stifling. American Century appreciates the opportunity to comment on the proposal and would be happy to discuss any specific issues further. Sincerely, Mike Cormack Manager, Equity Trading American Century Investments **FOOTNOTES** [1]: American Century was established in 1958 and focused its business on developing direct contact with investors through no load mutual funds. Today, American Century manages over $70 billion in retail oriented mutual funds with over two million shareholders. [2]: American Century commission data estimate that our shareholders have realized over $46 million in savings via lower commission rates by using various alternative trading systems during the last three years. The data do not account for any savings in market impact costs. [3]: Witness the recent NASD Central Limit Order Book proposal. Many of the comments to this proposal by ATS's saw the NASD, the SRO responsible for regulating them, as competing directly with them. [4]: See "The Fight Over ECN Fees", Traders Magazine, July 1998, pp. 31,95. [5]: This is best explained by an example: Let us assume the market in security XYZ is 25.10 X 25.20. A participant has a choice between an exchange and an ATS to post a bid and wishes to buy stock at 25.15. The exchange charges an access fee of .02/share while the ATS charges a fee of .01/share. If we disclose the access fee in the quote, the bidder will be more inclined to use the ATS (in this case the more competitive vehicle) since its 25.15 bid will show up as 25.14 in the NBBO. If one assumes a participant is always seeking best price of execution and technology between the exchange and ATS is equal, orders will migrate to the posting vehicle with the lowest fees. In this example, the participant who posts the bid may very well get a rebate by the sponsoring ATS for providing this liquidity, so the price paid may in actuality be less than 25.15. [6]: American Century was told by a senior executive of Instinet that Instinet could move to equity quotations in decimals in a matter of days, not weeks or months. This conversation took place in mid 1997. [7]: American Century frequently transacts in illiquid securities that we will purchase and hold for a number of years. It is only when an institution is building or moving out of such a position that the liquidity is sufficient for another institution to take the opposite side of that trade. These trading patterns may be very sporadic over time and require much patience on the part of the institution. To deny access to these orders to any participant damages the integrity of the NMS. No participant on an ATS should be inhibited from posting a bid or offer into the NBBO, nor should access be denied. [8]: The recent attempts by the Pacific Stock Exchange to introduce new rules to support Optimark and to insure other market participants received adequate representation within Optimark via ITS was met with only resistance on the part of the New York Stock Exchange. [9]: Optimark, an electronic trade execution platform in partnership with the Pacific Coast Stock Exchange, already provides much of this credit risk analysis on a pre-trade basis. Each time an institution enters a trade a "give up" broker dealer must be chosen and the system automatically checks the credit limit that broker has allotted to that particular institution. There is no reason why an electronic exchange could not process the same information on behalf of an institution that is accessing it directly. [10]: It is important to note that reserve orders have no "standing" within the ATS structure. If an order is subsequently displayed by another market participant at the same price, the second order moves ahead in priority of the non-displayed portion of the first order. [11]: See "Automation, Trading Costs, and the Structure of the Securities Trading Industry" by Ian Domowitz and Benn Steil, Tokyo Club Papers in Economics, March 1998, p. 9.