By Paul D. Cohen *
Stanford Journal of Law, Business & Finance | Winter 1999
* Duke University, B.A., 1992; Washington University School of Law, J.D., 1996; Washington University John M. Olin School of Business, M.B.A., 1997. I would like to express my appreciation to Professor John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia University School of Law, for his insights and suggestions; to Ms. Ann D. Wallace, Special Associate Director, Division of Corporation Finance, U.S. Securities and Exchange Commission, for her advice and inspiration; to Kevin Coenen, Kirkland & Ellis; and to Scott J. Golde, Greensfelder, Hempker & Gale, for their comments.
“Technology-related issues are the most important, pervasive, promising and pressing issues facing the [Securities and Exchange] Commission and the markets.”
— Steven M. H. Wallman, Securities and Exchange Commissioner 1
With the growing popularity and use of the Internet, several companies have launched their own Internet-based trading systems. These systems fall into one of two main categories: Internet-based bulletin boards and Internet-based crossing systems. Internet-based bulletin boards bring buyers and sellers of securities together by providing a place, usually the issuing company’s home page, where an individual posts an interest to purchase or sell securities. Interested parties then privately negotiate a trade. Internet-based crossing systems play a more active role in facilitating a trade. They collect trading interests from investors and, through a computerized algorithm, match buyers and sellers of securities.
Securities regulations currently categorize trading establishments as either broker-dealers or exchanges for regulatory purposes. While Internet-based bulletin boards and Internet-based crossing systems perform many of the functions of a broker-dealer and a national securities exchange, they do not fall directly within the definition of either. Due to the unique character of internet trading, regulation of Internet-based trading systems through traditional regulatory categories may hinder their integration into the National Market System, may inadequately protect investors from fraudulent and manipulative practices, and may impede other goals of the U.S. securities laws.
New technology requires a new regulatory approach. Possible alternatives include a new system-specific regulatory category, a modified broker-dealer approach, or a tiered exchange approach based on trading volume. This paper assesses the strengths and weaknesses of each proposal.
n10 David P. Brown, Why Do We Need Stockbrokers? 52 FIN. ANALYSTS J. 21 (1996). The Designated Order Turnaround (DOT), technologically updated with the SuperDOT system, permits exchange members to forward orders of up to 100,000 shares to the trading floor electronically. Nyquist, supra note 2, at 298, 318. Other markets also offer automatic routing systems. Id. at n. 86. Money managers often use electronic networks such as SuperDOT, which charge 2.5 cents per share, because of the price advantages they offer. By using these systems, money managers also reduce or avoid market impact. Use of SuperDOT accounts for 80% of the orders placed on the NYSE and more than half of the NYSE’s annual share volume that measures 74.4 billion shares. Alyssa A. Lappen, “The Cost of Inefficiency,” Money Management, [Institutional Investor] Mar. 1995, at 65. For further discussion of these systems, see LOUIS LOSS & JOEL SELIGMAN, 5 SECURITIES REGULATION 2556, 2557-58 (1990).
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