In 1964, the SECURITIES AND EXCHANGE COMMISSION (SEC) proposed and subsequently adopted its Rule 11a-1 under the SECURITIES EXCHANGE ACT OF 1934, which provides, with specified exceptions, that no member of a national securities exchange, while on the floor of such exchange, may initiate any transaction in any security admitted to trading on the exchange for an account in which such member has an interest. The rule provided exemptions for registered SPECIALISTS (and then ODD-LOT DEALERS), stabilizing activities pursuant to Rule 10b-7 under the Securities Exchange Act of 1934, bona fide arbitrage, transactions approved for the purpose of maintaining a fair and orderly market, and transactions made to offset errors. The rule also permitted floor trading transactions effected in conformity with rules adopted by an exchange and approved by the SEC, which are designed to eliminate floor trading activities not beneficial to the market.
Acting under this latter exemption, the NEW YORK STOCK EXCHANGE filed a plan with the SEC which eventually received the SEC's approval (the American Stock Exchange also filed a plan for the regulation of floor trading on that exchange, and other exchanges requested exemption from Rule 11a-1 under Sec. 11(c) of the act), and floor trading avoided outright prohibition.
Earlier drafts of the original Securities Exchange Act of 1934 contemplated complete prohibition of floor trading, based on the special advantages enjoyed by floor traders because of their presence on the floor, their tendency to trade with the trend, and the conflicts of interest involved in acting as both floor trader and commission broker. On the other hand, in defense of floor trading, it was argued that it contributed to the maintenance of more continuous and more liquid markets. The act (Sec. 11(a) merely vested responsibility in the SEC to regulate or to prohibit floor trading.
In 1935, the SEC suggested that the exchanges adopt certain rules to regulate floor trading. In 1936, the SEC evaluated the functioning of floor trading and concluded that despite the existence of exchange rules, the undesirable characteristics of floor trading persisted. It was determined, however, not to abolish floor trading but to strengthen its regulation by additional rules. One of these proposals (Report on the Feasibility and Advisability of the Complete Segregation of the Functions of Dealer and Broker, 1936) would have required a complete segregation of floor trading from the floor brokerage function. This proposal was not carried into effect.
Next, after a comprehensive study, the Division of Trading and Exchanges of the SEC filed with the commission a report made public on January 16, 1945, which found that the evils of floor trading persisted, that floor traders enjoyed a formidable advantage over the general public, that floor trading distracted brokers from their duties to the public, and that floor traders traded with the trend and were a destabilizing influence. The report also concluded that the existing exchange rules were ineffective in meeting the problem and that the only adequate solution was complete prohibition of floor trading. The SEC tentatively determined to abolish floor trading in August, 1945, but after considering the matter andholding conferences with the exchange, it determined not to abolish floor trading in light of repeated assurances that the exchanges would develop effective self-regulaiton of this activity.
Between 1945 and 1961, various commission staff studies continued to report critically upon floor trading practice. A special study (Report of Special Study of Securities Markets of the Securities and Exchange Commission, 1963) recommended that floor trading be prohibited by commission rule and that the feasibility of utilizing floor traders as auxiliary specialists be explored. The commission in a letter to Congress dated July 23, 1963, commented on the special study's recommendation as follows:
The New York Stock Exchange acted by retaining the firm of Cresap, McCormick & Paget, a management consultant firm, to make a study of floor trading and appointed a special committee of governors of the exchange to consider the subject. On March 4, 1964, the special committee presented its proposals to the SEC. The commission rejected the exchange's proposals, but instead of proceeding to abolish floor trading, it had its staff consult with the exchange during March, 1964, in several meetings and develop the gist of Rule 11a-1 as a means of preserving the benefits of floor trading while controlling and limiting its alleged harmful effects.
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