In re New York Stock Exchange

  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
UNITED STATES OF AMERICA 

                                                                     Before                                                                     the                                                                     

SECURITIES AND EXCHANGE COMMISSION 

SECURITIES EXCHANGE ACT OF 1934 
Release No. 51524 / April 12, 2005 
ADMINISTRATIVE PROCEEDING 
File No. 3-11892 
In the Matter of 

New York Stock Exchange, Inc., 

Respondent. 

ORDER INSTITUTING PUBLIC 
ADMINISTRATIVE PROCEEDINGS 
PURSUANT TO SECTIONS 19(h)(1) AND 
21C OF THE  SECURITIES EXCHANGE 
ACT OF 1934, MAKING FINDINGS, 
ORDERING COMPLIANCE WITH 
UNDERTAKINGS, AND IMPOSING A 
CENSURE AND A CEASE-AND-DESIST 
ORDER 
I. 
The Securities and Exchange Commission (“Commission”) deems it necessary and 
appropriate in the public interest and for the protection of investors that public 
administrative proceedings be, and hereby are, instituted pursuant to Sections 19(h) and 21C 
of the Securities Exchange Act of 1934 (“Exchange Act”) against the New York Stock 
Exchange, Inc. (“NYSE”). 
II. 
In anticipation of the institution of these proceedings, the NYSE has submitted an 
Offer of Settlement (the “Offer”) that the Commission has determined to accept.  Solely for 
the purpose of these proceedings and any other proceedings brought by or on behalf of the 
Commission or in which the Commission is a party, and without admitting or denying the 
findings contained herein, except as to the Commission’s jurisdiction over the NYSE and 
the subject matter of these proceedings, the NYSE consents to the entry of this Order 
Instituting Public Administrative Proceedings Pursuant to Sections 19(h)(1) and 21C of the 
Securities Exchange Act of 1934, Making Findings, Ordering Compliance with 
Undertakings, and Imposing a Censure and a Cease-And-Desist Order (the “Order”), as set 
forth below. 

  
 
 
 
 
 
 
 
  
 
   
 
 
 
  
  
 
  
                                                
 
 
III. 
On the basis of this Order and the Offer submitted by the NYSE, the Commission  
finds
1
 that: 
A.        RESPONDENT        
1. The NYSE is a New York not-for-profit corporation that is, and at all times 
relevant hereto was, registered with the Commission as a national securities exchange pursuant 
to Section 6 of the Exchange Act.  The NYSE first registered as a national securities exchange 
with the Commission on October 1, 1934.  In 2003, the NYSE had a total of 2,750 listed 
companies trading on its market with a global market capitalization of $17.3 trillion.  The total 
share volume traded on the NYSE in 2003 was 352.4 billion shares, and the average daily share 
volume was 1.4 billion shares valued at $38.5 billion.  For the year ending December 31, 2003, 
the NYSE reported total revenues of nearly $1.1 billion and net income of $49.6 million. 
B.        FACTS        
Summary 
2. This matter concerns the failure of the NYSE to properly detect, investigate, and 
discipline widespread unlawful proprietary trading by specialists on the floor of the NYSE.  Section 
19(g)(1) of the Exchange Act obligates the NYSE, as a self-regulatory organization (“SRO”), to 
comply, and enforce compliance by its members, with the Exchange Act, the rules and 
regulations thereunder, and the rules of the NYSE.  In carrying out its duty to “enforce 
compliance,” SROs must develop and maintain surveillance over its members, and “be vigilant 
in surveilling for, evaluating, and effectively addressing issues that could involve violations” of 
the securities laws.  National Ass’n of Sec. Dealers, Inc., 62 S.E.C. Docket 1346, Release No. 
34-37538, 1996 WL 447193, at *2 (Aug. 8, 1996). 
3. From 1999 through 2003, various NYSE specialists repeatedly engaged in unlawful 
“interpositioning” and “trading ahead” of customer orders resulting in more than $158 million of 
customer harm.  From 1999 through almost all of 2002, the NYSE failed to adequately monitor and 
police specialist trading activity, allowing the vast majority of this unlawful conduct to continue 
undetected.  The NYSE knew or, in view of all the facts and circumstances, should have known 
that specialists were repeatedly engaging in interpositioning and trading ahead conduct.  The 
NYSE’s regulatory response to the improper proprietary trading was materially deficient for the 
following reasons: (a) the NYSE’s surveillance system for detecting trading ahead and 
interpositioning was unreasonable in that it included parameters and procedures that captured 
only a small portion of the misconduct; (b) the NYSE failed to conduct adequate investigations 
The findings herein are made pursuant to the NYSE’s Offer and are not binding on any 
other person or entity in this or any other proceeding. 
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of the trading ahead and interpositioning violations that it did find; and (c) the NYSE failed to 
adequately discipline specialists who were found to have engaged in unlawful trading.  In so 
doing, the NYSE violated Section 19(g) of the Exchange Act by failing, without reasonable 
justification or excuse, to enforce Section 11(b) of the Exchange Act, Rule 11b-1 thereunder, and 
various NYSE Rules, including NYSE Rules 92 and 104.10 which prohibit trading ahead of 
customer orders. 
Prior Commission Action Against the NYSE 
4. The NYSE’s failure to police trading ahead and interpositioning by 
specialists follows a regulatory failure by the NYSE in the late 1990s involving independent 
floor brokers, which was addressed by the Commission in an order against the NYSE in 
June 1999 (the “1999 Order”).  In the 1999 Order, the Commission found that the NYSE 
had failed to detect and halt unlawful proprietary trading by certain independent floor 
brokers, who shared in the profits and losses of customer accounts.  See In the Matter of 
New York Stock Exchange, Inc., Admin. Proc. File 3-9925 (Securities Exchange Act Release 
No. 41574 (June 29, 1999)).  As part of those illegal schemes, the NYSE floor brokers used 
information gained from their position on the trading floor to reap illegal profits from 
improper proprietary trading, including “frontrunning” of customer orders.  In the 1999 
Order, the Commission ordered the NYSE to comply with a series of undertakings that were 
intended to improve the NYSE’s regulation of all NYSE floor members, including 
specialists.  For example, the NYSE was ordered to comply with an undertaking that within 
twelve months of the issuance of the 1999 Order, the NYSE would “enhance and improve 
its regulation” of all NYSE floor members, including specialists, by, among other things, 
“ongoing, continuous surveillance” of floor members, including specialists, and “thoroughly 
investigating indications of possible violations” by floor members, including specialists.  
5. The NYSE implemented some enhancements to its specialist surveillance 
program in response to the 1999 Order.  However, the NYSE failed to take sufficient steps 
to enhance and improve its regulation of specialists, by, among other things, failing to 
thoroughly investigate indications of possible violations by specialists. 
Overview of Specialists’ Obligations 
6. In the NYSE’s continuous two-way agency auction market, specialist firms are 
responsible for the quality of the markets in the securities in which individual specialists are 
registered.  A specialist is expected to maintain, insofar as reasonably practicable, a “fair” and 
“orderly” market.  Specialists have two primary duties in maintaining a fair and orderly market: 
performing their “negative obligation” to execute customer orders at the most advantageous price 
with minimal dealer intervention, and fulfilling their “affirmative obligation” to offset 
imbalances in supply and demand.  Specialists participate as both broker (or agent), absenting 
themselves from the market to pair executable customer orders against each other, and as dealer 
(or principal), trading for the specialists’ dealer or proprietary accounts when needed to facilitate  
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price continuity and fill customer orders when there are no available contra parties to those 
orders. 
7. Whether acting as brokers or dealers, specialists are required to hold the public’s 
interests above their own and, as such, are prohibited from trading for their dealers’ accounts 
ahead of pre-existing customer buy or sell orders that are executable against each other.  When 
matchable customer buy and sell orders arrive at specialists’ trading posts – generally either 
through the NYSE’s Super Designated Order Turnaround System (“DOT”)
2
 to an electronic 
display book (the “Display Book”),
3
 or by floor brokers gathered in front of the specialists’ 
trading posts – specialists are required to act as agent, and cross or pair off those orders and to 
abstain from participating as principal or dealer. 
8. The specialists’ obligations are embodied in the federal securities laws and NYSE 
rules, which prohibit trading ahead and interpositioning.  Section 11(b) of the Exchange Act and 
Rule 11b-1 thereunder limit a specialist’s dealer transactions to those “reasonably necessary to 
permit him to maintain a fair and orderly market.”
4
  NYSE Rule 92 provides that “no member or 
member organization shall cause the entry of an order to buy (sell) any Exchange-listed security 
for any account in which such member or member organization . . . is directly or indirectly 
interested (a ‘proprietary order’), if the person responsible for the entry of such order has 
knowledge of any particular unexecuted customer’s order to buy (sell) such security which could 
be executed at the same price.”  NYSE Rule 104.10 states in relevant part:  “No specialist shall 
effect . . . purchases or sales of any security in which such specialist is registered . . . unless such 
dealings are reasonably necessary to permit such specialist to maintain a fair and orderly 
market.” 
2 The DOT system is the NYSE’s primary order processing system, supporting equity 
trading on the trading floor and providing the NYSE with the current status of any equity order.   
Customers can transmit orders through NYSE member organizations electronically to the floor 
through the DOT system. 
3 The Display Book is an electronic workstation provided by the NYSE to the firm for use 
by its specialists at their post panels, operated by means of a customized keyboard containing 
function, letter, number and arrow keys.  The Display Book allows specialists to, among other 
things, receive and process orders, disseminate trade and quote information, report trade 
executions, research order and execution status, manage positions and view profit and loss in the 
dealer account. 
4 Where specialists effect trades for their accounts that are not “reasonably necessary to 
permit [such specialists] to maintain a fair and orderly market,” they have violated Section 11(b) 
and Rule 11b-1 of the Exchange Act. See In the Matter of Weiskopf, Silver & Co., 1980 WL 
22091, SEC Release No. 34-17361 (Dec. 10, 1980); In the Matter of Albert Fried & Co. and 
Albert Fried, Jr., 1978 WL 196046, S.E.C. Release No. 34-15293 (Nov. 3, 1978). 
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The NYSE’s Obligation to Regulate the Conduct of Specialists 
9. Section 6(b) of the Exchange Act requires the NYSE, as a national securities 
exchange, to have the capacity to be able to carry out the purposes of the Exchange Act and to 
comply, and to enforce compliance by its members, with the rules and regulations of the 
Exchange Act and the NYSE’s own rules.  Rule 11b-1 under the Exchange Act sets forth the 
specific rules that a national securities exchange must have if it registers its members to act as 
specialists.  Sections 19(g) and 19(h) of the Exchange Act further require the NYSE, as a self-
regulatory organization, to comply with, and enforce the provisions of, the Exchange Act, the rules 
and regulations thereunder and its own rules.  The NYSE has an affirmative obligation to be vigilant 
in surveilling for, evaluating, and effectively addressing activity that could involve violations of 
these provisions.   
10. The NYSE’s Regulatory Group has the responsibility to enforce compliance by its 
members with the Exchange Act, the rules and regulations thereunder, and the NYSE’s own 
rules.  During the relevant time period, the Regulatory Group was comprised of three divisions: 
(1) Market Surveillance; (2) Member Firm Regulation; and (3) the Enforcement Division.  
Market Surveillance had the principal responsibility to surveil and investigate specialists for trading 
violations.  Specialist Surveillance, a unit of Member Trading II, a department of Market 
Surveillance, was primarily responsible for conducting surveillance of specialists’ trading.  
Analysts within Specialist Surveillance reviewed “alerts” from automated surveillances and 
referred potential violations to Trading Investigations, which during the relevant time period was 
also organized within the Member Trading II department of Market Surveillance.  Trading 
Investigations was responsible for conducting in-depth investigations of potential rule violations 
referred by, among others, Specialist Surveillance.  Market Surveillance, based on the results of 
the investigation, could impose informal discipline, primarily letters of admonition or summary 
fines, but serious rule violations had to be referred to the NYSE’s Enforcement Division with a 
recommendation for formal disciplinary action. 
The NYSE’s Failure to Enforce Statutes and Rules Governing Trading by Specialists 
The Specialists’ Unlawful Trading Ahead and Interpositioning 
11. During the period January 1999 through 2003, various NYSE specialists 
repeatedly violated their duty to refrain from dealing for their own accounts while in possession 
of buy and sell customer orders executable against each other.  They did this primarily in two 
ways: (i) by “interpositioning” – i.e., effecting two improper proprietary trades close in time by 
filling both opposing orders from the proprietary account at prices that enable the specialist firm 
to profit from the spread between both prices; and (ii) by “trading ahead” – i.e. filling one 
executable order out of the firm’s own account instead of matching it with another executable 
public order – and then by filling the second executable public order through an agency trade at a 
less advantageous price. 
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12. The unlawful proprietary trading by NYSE specialists was widespread and 
pervasive, involving all seven equity specialist firms operating on the NYSE.  In March and July 
2004, the Commission and the NYSE instituted settled administrative proceedings against all 
seven firms.  The Commission and the NYSE found that, between 1999 and 2003, these 
specialist firms (i) willfully violated Section 11(b) of the Exchange Act and Rule 11b-1 
thereunder; (ii) violated various NYSE rules, including NYSE Rules 92 and 104.10; and (iii) 
failed adequately to supervise certain specialists, who themselves engaged in fraud through 
proprietary trading in violation of Section 10(b) of the Exchange Act and Rule 10b-5 
thereunder.
5
   The Commission and the NYSE further found that unlawful proprietary trading at 
the seven specialist firms caused in the aggregate more than $158 million in customer harm.  
Pursuant to the settlements between the specialist firms, the Commission and the NYSE, the 
specialist firms agreed to disgorge this amount and were penalized a total of $90 million. 
The NYSE Failed to Adequately Surveil for Trading Ahead and  
Interpositioning Violations 
13. From 1999 through almost all of 2002, the NYSE’s surveillance systems failed to 
detect the vast majority of trading ahead and interpositioning by specialists.  This failure was in 
part due to the NYSE’s reliance on an automated surveillance system whose parameters and 
procedures were unnecessarily and unreasonably broad.  The DOT Inferior Price Execution 
Surveillance (“DOT Surveillance”) had been implemented by the NYSE in the late 1980s to 
detect trading ahead by specialists.  When specialists engaged in trading that exceeded certain 
parameters of the DOT Surveillance, alerts were generated identifying potential trading ahead 
activity.  The most significant parameters of the DOT Surveillance were the time and spread 
parameters.   
14. Although every instance of trading ahead and interpositioning constitutes a 
violation, the DOT Surveillance only generated an alert if the specialist traded ahead of an 
agency DOT order that had been visible on the Display Book for a certain period of time.  From 
1999 through 2002, the time parameter was reduced from 90 seconds to 60 seconds, but was 
consistently set beyond a level that could be reasonably justified.  As a result of using 
unnecessarily long time parameters, the DOT Surveillance failed to detect the vast majority of 
trading ahead and interpositioning violations. 
See In the Matter of Bear Wagner Specialists LLC, Rel. No. 34-49498 (March 30, 2004); 
In the Matter of Fleet Specialist, Inc., Rel. No. 34-49499 (March 30, 2004); In the Matter of 
LaBranche & Co. LLC, Rel. No. 34-49500 (March 30, 2004); In the Matter of Spear, Leeds & 
Kellogg Specialists LLC, Rel. No. 34-49501 (March 30, 2004); In the Matter of Van der Moolen 
Specialists USA, LLC, Rel. No. 34-49502 (March 30, 2004); In the Matter of SIG Specialists, 
Inc., Rel. No. 34-50076 (July 26, 2004); In the Matter of Performance Specialist Group LLC, 
Rel. No. 34-50075 (July 26, 2004). 
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15. Similarly, the DOT Surveillance only generated an alert if there was a certain 
price spread in the specialist’s quote (bid and ask) at the time the specialist traded ahead of the 
customer agency order.  Historically, the spread parameter was set at the minimum price 
variation for trades in a security.  In the late 1990s, when the minimum trading increment was a 
1/16
th
 of a dollar ($.0625), the spread parameter was $.0625.  However, the $.0625 spread 
parameter remained in place until June 2002, nearly one and a half years after decimalization of 
stock quotes, which reduced the minimum price variation to one cent. In June 2002, the NYSE 
lowered the spread parameter slightly to five cents.  There is no reasonable justification for a 
spread parameter beyond the minimum price increment.  Because the DOT Surveillance did not 
capture violations involving small monetary amounts, the specialists were able to trade in small 
increments and evade detection.   
16. Over the years, the NYSE’s internal audit group, Regulatory Quality Review 
(“RQR”), and others advised Market Surveillance on several occasions that the parameters of the 
DOT Surveillance were unnecessarily broad and recommended reducing the parameters.  For 
example, in 1999 when the time parameter was 90 seconds, RQR issued a report that concluded: 
“Not to surveil specialists for 90 seconds increases the likelihood that a specialist taking 
advantage of his dealer and agency capacities for self-interest would remain undetected by 
Market Surveillance.”  Similarly, in 2001 and 2002, sample tests were performed by an 
employee in Market Surveillance’s Automation Data Group using a narrower spread parameter, 
revealing a significant increase in the number of alerts generated. Despite repeated indications 
that the parameters were too broad, the NYSE made only incremental changes to the DOT 
Surveillance.  The NYSE knew or should have known that these incremental changes were 
inadequate to gauge the full extent of the trading ahead activity.     
17. In addition, the NYSE incorporated an unreasonably narrow review period for the 
DOT Surveillance.  From at least 1996 until June 2002, Specialist Surveillance analysts 
generally reviewed alerts for each specialist firm for a single day chosen at random each month.
6 
As early as 1996, RQR recommended expanding the review period to one week in order for 
analysts to better surveil for trading ahead.  RQR proposed that the DOT Surveillance generate 
alerts for an entire week before the analyst selected which day to review.  RQR observed that 
Specialist Surveillance had, on a number of occasions, failed to conduct any review for trading 
ahead and interpositioning because no alerts were generated for the single day that was randomly 
selected for review.  Despite the fact that Market Surveillance agreed in 1996 to adopt this 
change, Market Surveillance did not implement a one-week review period until June 2002. 
Analysts were generally only required to review a maximum of three alerts for three 
different stocks.  The three stocks were selected pursuant to a specified selection process.  If any 
of these alerts for these three stocks were found to reflect potential violations, the review would 
be expanded to alerts in the same stock[s] generated for other days in the same week.  In 1999, 
the procedure was changed to require an expanded review of alerts for the same post-panel 
generated for the rest of the week. 
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18. The NYSE did not establish an automated surveillance system specifically 
designed to detect interpositioning misconduct until late 2002.  Although the DOT Surveillance 
was intended to capture trading ahead violations, the surveillance did not automatically detect 
interpositioning violations.  Rather, Market Surveillance staff used a manual process of 
reviewing trade data for interpositioning.  The NYSE knew that interpositioning was an 
egregious form of trading ahead and considered this type of conduct a serious regulatory 
concern. The 1998 and 1999 versions of the Specialist Surveillance procedures manual instructed 
Specialist Surveillance analysts to “be especially aware of situations where the specialist, after 
buying/selling the stock, turns around and sells/buys stock against the system order at a profit.”  
However, the 2000 version of the Specialist Surveillance procedures manual, drafted after the 
1999 Order, de-emphasized the detection of interpositioning by merely instructing analysts to 
“also review[] inferior price execution situations for specialist arbitrage.”  Despite knowledge of 
interpositioning violations, the NYSE did not begin to develop a surveillance system specifically 
designed to capture interpositioning until mid-2002 and did not fully implement such a system 
until late 2002.   
The NYSE Failed to Adequately Investigate Trading Ahead  

And Interpositioning Violations 

19. Even though the surveillance parameters were unnecessarily broad, they still 
generated numerous alerts that put the NYSE on notice that trading ahead and interpositioning 
was widespread.  From 1999 through 2002, the DOT Surveillance generated close to 4,000 
alerts.
7
  Nonetheless, because of inadequate sampling and selection procedures, the NYSE only 
reviewed a portion of the alerts generated, and because of inadequate referral procedures 
(requiring a pattern of likely violations), Specialist Surveillance only referred a smaller fraction 
of the alerts – approximately 200 – for further investigation.  For example, in April 1999, 
hundreds of alerts were generated for two specialist firms.  At one specialist firm, there were 
over 100 alerts, with 12 alerts in a single specialist’s post and panel and multiple alerts in 19 
different stocks.  Also in April 1999, at another specialist firm, there were almost 200 alerts, 
including over 40 alerts in a single stock and 10 or more alerts in two other stocks.  Yet, the 
surveillance analysts failed to refer any of these alerts for further investigation.  When alerts 
were referred for further investigation, pursuant to Market Surveillance procedures, Specialist 
Surveillance only reviewed and referred a small portion of the total alerts generated.  For 
example, at one specialist firm, there were at least 140 alerts in a seven month time period in 
2000; yet, Specialist Surveillance referred only 28 of these alerts, failing to refer multiple alerts 
in several stocks. 
20. Some of the failures by the NYSE’s Specialist Surveillance unit included:  (1) 
Specialist Surveillance regularly overlooked likely instances of trading ahead and 
interpositioning, even when the specialist firms under review had recently been informally 
disciplined; (2) due primarily to inadequate referral procedures, Specialist Surveillance failed to 
According to Specialist Surveillance management and analysts, approximately 75% of 
the alerts they reviewed were likely trading ahead violations.   
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refer the full extent of trading ahead and interpositioning conduct to Trading Investigations; (3) 
despite procedures that called for regular and routine surveillance of specialist firms, Specialist 
Surveillance in at least two instances suspended DOT Surveillance reviews of specialist firms for 
a period of time after disciplinary action was imposed;
8
 and (4) although Rule 92 explicitly 
prohibits trading ahead conduct, Specialist Surveillance almost always referred likely trading 
ahead and interpositioning violations to Trading Investigations under Rule 104.10.  Rule 92 
violations (which generally require proof of intent) would generally have necessitated a referral 
to Enforcement for formal disciplinary action; by contrast, Rule 104.10 violations (which do not 
require proof of intent) could be sanctioned informally by Market Surveillance. 
21. Trading Investigations failed to adequately investigate trading ahead and 
interpositioning misconduct.  Trading Investigations had the responsibility to properly 
investigate trading ahead and interpositioning violations, which included determining (1) the 
extent of such conduct; (2) whether specialists were engaging in repeated instances of 
misconduct; (3) whether the misconduct was intentional; and (4) whether the conduct should be 
referred to the Enforcement Division with a recommendation for formal disciplinary action.   
22. Trading Investigations, however, failed in these responsibilities in a number of 
ways.  Investigators did not conduct a thorough investigation of the trading ahead and 
interpositioning instances that were referred to them.  Trading Investigations merely confirmed 
the specific instances of trading ahead and interpositioning that Specialist Surveillance had 
referred and did not investigate whether the specialists or specialist firms involved had engaged 
in additional trading ahead or interpositioning.  Investigators believed it was Specialist 
Surveillance that was responsible for determining the extent of the misconduct.
9
 Furthermore, 
investigators did not examine or probe the specialists’ intent.  Other than soliciting an 
explanation from the firm, which always stated that the trading ahead was accidental, Trading 
Investigations did not undertake any effort to determine whether the trading ahead was in fact 
intentional.  For example, in an investigation of 28 instances of trading ahead at one specialist 
firm in 2001, the firm responded in writing that most of the instances were “inadvertent clerical 
error.”  As a result, the investigators concluded that “the[se] occurrences appear to be more 
operational in nature.”  The investigators did not interview the specialist or his clerk, but simply 
8 For example, in January 1999, the DOT Surveillance generated approximately 10 alerts 
in a single stock for one trade date.  Because the specialist firm for this stock had already been 
disciplined for earlier conduct, Specialist Surveillance decided not to review these 10 alerts. 
9 Investigators often lacked basic knowledge of the DOT Surveillance and the selection 
procedures that Specialist Surveillance used for its referrals.  Some investigators erroneously 
believed that Specialist Surveillance reviewed all alerts generated and referred all alerts that were 
not false positives.  Investigators also did not know how the Display Book operated.  This lack of 
knowledge significantly impaired the investigators’ ability to fully investigate instances of 
trading ahead and interpositioning. 
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relied on the firm’s written response in determining to impose only informal discipline.
10 
Finally, Trading Investigations usually did not expand its reviews of trading ahead to other time 
periods.  In the limited instances that Trading Investigations expanded its reviews, the expansion 
was cursory in nature and lacked adequate review.
11 
23. Moreover, Market Surveillance failed to pursue what it considered de minimis 
violations, i.e. violations that only caused a small amount of customer harm or only resulted in a 
small amount of specialist gain.  For example, in September 1999, Member Firm Regulation 
referred a single instance of possible interpositioning to Trading Investigations, which did not 
review the conduct further because it concluded that the customer disadvantage resulting from 
this single trade ($37) was de minimis.  In these types of situations, Market Surveillance wrongly 
assumed that specialists would not knowingly engage in unlawful conduct for a small amount of 
pecuniary gain.  In fact, various specialists repeatedly engaged in small scale unlawful 
transactions that in the aggregate added up to tens of millions of dollars. 
24. In addition to Specialist Surveillance and Trading Investigations, other units at the 
NYSE, specifically Member Firm Regulation, which conducts annual and “for cause” 
examinations of NYSE members, and the Trading Correspondence unit, which handles 
complaints from member firms and the public, also detected trading ahead conduct during the 
period 1999 through 2002.  Member Firm Regulation referred several trading ahead violations it 
detected to Market Surveillance under Rule 92 and expected that Trading Investigations would 
conduct a full investigation of the violative conduct.  Trading Investigations, however, during the 
relevant time period, failed to fully investigate the referred conduct and considered only whether 
the referred conduct violated Rule 104.10.  For example, in August 2001, an examination of one 
specialist firm by Member Firm Regulation uncovered a significant amount of trading ahead by a 
single specialist: 94 instances of trading ahead in one stock on a single day, and 44 instances of 
trading ahead in another stock in a 1½ hour period on that same day.  Member Firm Regulation 
referred the conduct to Trading Investigations in November 2001; yet, Trading Investigations 
10 Trading ahead and interpositioning require several deliberate steps executed on the 
Display Book by the specialist or his clerk that demonstrate a specialists’ intent.  The Display 
Book highlights in yellow marketable customer orders.  To fill a customer order with a 
specialist’s dealer trade, the specialist or his clerk must take the Display Book out of its “default 
mode” and input several other keyboard commands.  Pairing off two customer orders requires 
only two keystrokes, whereas trading ahead and interpositioning conduct requires several extra 
keystrokes.  The investigative files do not reflect any attempt to reconcile specialists’ repeated 
claims that multiple instances of trading ahead and interpositioning were “inadvertent” with the 
fact that such conduct required the specialists to undertake several deliberate steps. 
11 For example, in an investigation of 7 instances of trading ahead and interpositioning at 
one specialist firm in 2002, Trading Investigations noted that in reaching its decision to impose 
informal discipline, it had conducted an “expanded” review comprised of additional trade dates 
during 5 different calendar months and determined that there were no additional violations.  In 
fact, the expanded review yielded several additional trading ahead alerts in the stocks surveyed. 
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failed to take timely action to investigate this conduct.  The Trading Correspondence unit also 
received customer complaints involving trading ahead misconduct, which in some cases involved 
significant monetary disadvantage to the customer.
12 
The Trading Correspondence unit generally 
took no disciplinary action so long as the specialist firm agreed to pay back the disadvantaged 
customer.   
The NYSE Failed to Appropriately Discipline Trading Ahead  
and Interpositioning Violations 
25. Trading Investigations failed to recommend appropriate discipline of specialists 
for trading ahead and interpositioning. Throughout the relevant time period, Trading 
Investigations was the sole NYSE unit recommending discipline of specialists for trading ahead 
and interpositioning violations.  The discipline almost always took the form of informal 
discipline consisting of admonition letters and summary fines.
13
 Historically, the NYSE’s 
Regulatory Group considered informal disciplinary actions as “warnings” to the specialists firms 
that further trading misconduct could lead to formal enforcement action.  During the period 1999 
to 2002, however, the informal disciplinary actions were not used to “warn” the firms that if they 
engaged in additional violations in the future, they would face formal regulatory action.  Instead, 
repeat violations were generally addressed by additional informal action rather than a referral to 
Enforcement for formal disciplinary proceedings.  With respect to trading ahead and 
interpositioning violations, the NYSE’s Regulatory Group treated the informal disciplinary 
actions as similar in nature to “traffic tickets,” which were not followed up with more formal 
regulatory action. 
26. Trading Investigations also failed to consider whether the trading ahead and 
interpositioning instances it was investigating warranted a referral to the Enforcement Division 
for formal discipline under Rule 92.  Instead, when Trading Investigations received a trading 
ahead referral, it treated the conduct as a minor technical violation of Rule 104.10.  Even where 
the specialist firms engaged in recidivist conduct, the NYSE still failed to refer matters for 
formal disciplinary action.  For example, as early as January 1996, one specialist firm was issued 
a summary fine for 28 instances of trading ahead, including 16 instances of interpositioning.  In 
August 1998, the firm was cautioned for an additional 24 instances of trading ahead.  In July 
1999, the specialist firm received a summary fine of $1,000 for 30 additional instances of trading 
12 In one instance in 1999, a specialist traded ahead of four customer orders, which resulted 
in a total disadvantage to the customers of $4,602.50.  In another instance in 2000, a specialist 
traded ahead of a single customer order, which disadvantaged the customer by $2,062.50.  
13 There were a total of 6 admonition letters and 24 summary fines for trading ahead and 
interpositioning misconduct from 1999 through December 2002.  Summary fines typically 
ranged from $500 to $1,000 for trading ahead misconduct.  The total of the 24 summary fines 
was approximately $17,500 ($2,500 in 1999, $3,000 in 2000, $500 in 2001, and $11,500 in 
2002). 
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ahead.  Despite this recidivist conduct, Market Surveillance did not increase its surveillance of 
the specialist firm or refer any of the conduct to the Enforcement Division.  Moreover, while 
proof of intent was the critical element in referring conduct for formal enforcement action, 
investigators made little or no effort to try to determine the specialists’ intent.  NYSE 
investigators considered the conduct as violations of Rule 104.10  in large part because that was 
the rule Specialist Surveillance cited in its referrals.  As a result, from 1999 to December 2002, 
Trading Investigations did not refer any trading ahead or interpositioning violations to the 
Enforcement Division. 
27.            Market            Surveillance,            including            Specialist Surveillance and Trading 
Investigations, in all, but a few instances, failed to take disciplinary action against single 
instances of trading ahead, even when there were indications that the specialists intentionally 
traded ahead.  This failure continued even after RQR issued a report in 1996 in which it proposed 
regulatory action for single instances of trading ahead: “[g]iven our commitment to protect all 
investors, we believe Market Surveillance should consider taking regulatory action for any single 
instance where it has been confirmed that the specialist did not provide an effective execution of 
a customer order.”  In spite of this proposal, the NYSE rarely investigated or took disciplinary 
action with respect to single instances of trading ahead.  
Actions Taken by the NYSE  
28. In June 2002, after discovering significant interpositioning activity by a single 
specialist that had occurred as early as January 2000, the NYSE began developing a special study 
to assess the extent of interpositioning practices throughout the trading floor.  The study, which 
culminated in a December 2002 report on interpositioning in all NYSE stocks for a three-month 
period, revealed widespread interpositioning conduct by various specialists, and prompted the 
NYSE to open a broader investigation into the unlawful trading.  Since that time, the NYSE has 
undertaken various measures to address its regulatory failures in policing trading ahead and 
interpositioning, including changes to its surveillance system and implementation of computer 
software to better enable the NYSE to detect ongoing trading ahead and interpositioning.  The 
NYSE and the Commission further investigated such violations and instituted formal disciplinary 
proceedings, which led to settled enforcement actions against all seven equity specialist firms.   
29. The NYSE has recently made extensive changes to its governance and regulatory 
structure.  These changes include: (1) amendments to the NYSE constitution that require all 
directors to be independent from members, member organizations, listed companies and (except 
for the CEO) management, and give the independent directors sole authority over the NYSE’s 
conduct of its regulatory functions; (2) the creation of the new position of Chief Regulatory 
Officer, which reports to the Board of Directors, rather than senior NYSE management; (3) the 
creation of a standing Board of Directors committee, the Regulatory Oversight Committee, with 
direct oversight of all budgetary, compensation and staffing decisions affecting the NYSE’s 
regulatory function, including those affecting RQR; (4) the appointment of a new head of 
regulation as the Chief Regulatory Officer and new leadership in the NYSE’s Divisions of 
Market Surveillance, Member Firm Regulation and Enforcement; (5) moving Trading 
12
 

  
 
 
 
Investigations from Market Surveillance to Enforcement, in order to foster more consistent 
determinations of whether formal or informal discipline is appropriate; (6) the creation of a new 
Specialist Surveillance unit to focus exclusively on the effectiveness of existing surveillances 
and the need for new or modified surveillances; (7) the creation of the Risk Assessment Unit, 
which analyzes trends and conducts risk assessment for the NYSE’s Regulatory Group (now 
known as NYSE Regulation); (8) increases in staff and other resources available to the NYSE’s 
regulatory units, including Market Surveillance; and (9) the retention by the Regulatory 
Oversight Committee of an independent consultant, who has reviewed the NYSE’s oversight of 
specialist trading.  The NYSE is also considering changes that would provide that, any time a 
specialist comes into possession of a customer order that could trade in place of some or all of 
the specialist’s side of a proprietary trade that has not yet been reported, the specialist must 
allocate the trade to the customer order, unless a Commission-approved exception applies. 
C.        CERTAIN        UNDERTAKINGS        
30. In determining to accept the Offer, the Commission has considered the following 
voluntary undertakings by the NYSE: 
The NYSE shall continue to cooperate fully with the Commission in any and all 
investigations, litigations or other proceedings relating to the matters described in the 
Order or relating to or arising from the conduct underlying such matters.  In connection 
with such cooperation, the NYSE has undertaken: 
a. To produce, without service of a notice or subpoena, any and all 
documents and other information requested by the Commission’s staff; 
b. To use its best efforts to cause its employees to be interviewed by the 
Commission’s staff at such times as the staff reasonably may direct; 
c. To use its best efforts to cause its employees to appear and testify 
truthfully and completely without service of a notice or subpoena in such 
investigations, depositions, hearings or trials as may be requested by the 
Commission’s staff; and 
d. That in connection with any testimony of the NYSE to be conducted at 
deposition, hearing or trial pursuant to a notice or subpoena, the NYSE: 
i. Agrees that any such notice or subpoena for the NYSE’s 
appearance and testimony may be served by regular mail on its attorney, 
Dixie Johnson, Esq., Fried, Frank, Harris, Shriver & Jacobson LLP, 1001 
Pennsylvania Avenue, NW, Washington, DC 20004; and 
ii. Agrees that any such notice or subpoena for the NYSE’s 
appearance and testimony in any action pending in a United States District 
13
 

  
 
 
 
 
  
 
 
 
 
 
   
  
 
 
 
                                                
 
 
  
 
Court may be served, and may require testimony, beyond the territorial 
limits imposed by the Federal Rules of Civil Procedure. 
D.        CONCLUSION        
31. Section 19(g)(1) of the Exchange Act requires the NYSE, “absent reasonable 
justification or excuse,” to enforce compliance by its members with provisions of the Exchange 
Act, the rules and regulations thereunder, and the NYSE’s own rules.
14
  The Commission has 
stated that “the obligation to enforce imposed by Section 19(g) on an exchange necessarily 
includes an obligation to monitor and maintain surveillance over its members.” Boston Stock 
Exchange, Inc., 21 S.E.C. Docket 22, Release No. 34-17183, 1980 WL 25454 at *3 (Oct. 1, 
1980). Exchanges violate Section 19(g) when they fail “to be vigilant in surveilling for, 
evaluating, and effectively addressing issues that could involve violations” of the securities laws. 
National Ass’n of Sec. Dealers, Inc., 62 S.E.C. Docket 1346, Release No. 34-37538, 1996 WL 
447193, at *2 (Aug. 1996). 
32. From 1999 through almost all of 2002, the NYSE failed to properly detect, 
investigate, and discipline unlawful interpositioning and trading ahead by specialists. 
33. By not thoroughly investigating indications of possible violations by specialists, 
the NYSE failed to adequately enhance its regulation of specialists, as required by the 1999 
Order. 
34. The NYSE violated Section 19(g) of the Exchange Act by failing, without 
reasonable justification or excuse, to enforce Section 11(b) of the Exchange Act, Rule 11b-1 
thereunder, and NYSE Rules 92 and 104.10. 
35. Section 21(d)(3) of the Exchange Act authorizes the Commission to seek a civil 
penalty in federal district court against any person that violates the Exchange Act.  In light of the 
NYSE’s commitment to set aside a reserve fund of $20 million for the establishment, retention 
and payment of a Third Party Regulatory Auditor to conduct bi-annual regulatory audits of 
NYSE Regulation’s surveillance, examination, investigation and disciplinary programs, the 
Commission has determined not to seek a civil penalty from the NYSE.  In addition, the 
Commission has also taken into consideration the NYSE’s enhancements to its governance and 
regulatory programs, listed in Paragraph 29 of this Order. 
14 An SRO is relieved of its obligation to enforce compliance only when there is 
“reasonable justification or excuse” to fail to detect and stop violative conduct.  See Enforcement 
Obligations of Exchanges and Associations, 10 S.E.C. Docket 998, Release No. 34-12994, 1976 
WL 162853 (Nov. 18, 1976).  There is no “reasonable justification or excuse” when an SRO 
knew, or, in view of all the facts and circumstances, should have known that its systems of 
reports, examinations and inspections were materially inadequate relative to the resources 
reasonably available to that SRO for detecting the misconduct.  Id. 
14
 

  
 
  
 
 
 
 
 
 
  
 
IV. 
In view of the foregoing, the Commission deems it appropriate in the public interest and 
for the protection of investors to impose the sanctions agreed to in the NYSE’s Offer. 
Accordingly, it is hereby ORDERED, that 
A. 	The NYSE be, and hereby is, censured pursuant to Section 19(h) of the Exchange 
Act. 
B. 	The NYSE be, and hereby is, ordered pursuant to Section 21C of the Exchange 
Act to cease and desist from committing or causing any violation and any future 
violations of Section 19(g) of the Exchange Act. 
C. 	The NYSE shall comply with the following undertakings: 
1. Commencing in 2005, and every two years thereafter through 2011 (for a 
total of four two-year periods), the NYSE shall retain a Third Party Regulatory 
Auditor (“Regulatory Auditor”), not unacceptable to the Commission staff, to 
conduct a comprehensive regulatory audit of NYSE Regulation’s surveillance, 
examination, investigation and disciplinary programs applicable to specialists, 
member firm floor brokers, independent floor brokers, registered competitive 
market makers and competitive traders (collectively, “Floor Members”). 
a. The Regulatory Auditor shall assess (i) whether NYSE 
Regulation’s policies and procedures are reasonably designed and 
effective to detect and deter violations of all applicable federal securities 
laws and NYSE rules relating to trading by Floor Members; (ii) whether 
NYSE Regulation is in compliance with (1) the above-referenced policies 
and procedures; and (2) any outstanding written recommendations made 
by the Commission’s Office of Compliance Inspections and Examinations 
(“OCIE”) or the Commission’s Division of Market Regulation (“Market 
Regulation”) relating to compliance with rules, or surveillance for rule 
violations, with respect to trading by Floor Members; and (iii) whether the 
NYSE is in compliance with any outstanding undertakings contained in 
this Order and in the 1999 Order issued against the NYSE by the 
Commission.  
b. The Regulatory Auditor must develop a written regulatory audit 
plan of sufficient scope and detail to achieve the regulatory audit 
objectives and to identify regulatory areas in need of special consideration.  
In performing the regulatory audit, the Regulatory Auditor and other 
qualified persons hired by the Regulatory Auditor (“qualified persons”) 
shall have or acquire within a reasonable period of time adequate 
15
 

  
 
 
 
knowledge and understanding of the NYSE’s regulatory programs, 
policies and procedures.  The Regulatory Auditor and the qualified 
persons shall exercise due professional care and independence in 
performing the regulatory audit.  The Regulatory Auditor shall formulate 
conclusions concerning its assessment, as described in Paragraph IV.C.1.a. 
above, based on sufficient evidence that is obtained through, among other 
things, (i) inspection of documents, including written procedures, rules, 
and staff files; (ii) observation of trading processes and the NYSE’s 
regulatory systems and practices; (iii) interviews of regulatory staff, RQR 
staff, Floor Members and other relevant persons; and (iv) studies and 
testing of various regulatory functions and trading practices.  The NYSE 
shall cooperate fully with the Regulatory Auditor and qualified persons 
and provide the Regulatory Auditor and qualified persons with access to 
its files, books, records, and staff as reasonably requested for the 
regulatory audit. 
c. No later than 45 days after the regulatory audit is concluded, the 
Regulatory Auditor shall submit to the NYSE’s Board of Directors and to 
the Director of OCIE and the Director of Market Regulation (the 
“Commission Officials”) the Regulatory Auditor’s conclusions concerning 
its assessment as to (i) whether NYSE Regulation’s policies and 
procedures are reasonably designed and effective to detect and deter 
violations of all applicable federal securities laws and NYSE rules relating 
to trading by Floor Members; (ii) whether NYSE Regulation is in 
compliance with (1) the above-referenced policies and procedures; and (2) 
any outstanding written recommendations made by OCIE or Market 
Regulation relating to compliance with rules, or surveillance for rule 
violations, with respect to trading by Floor Members; and (iii) whether the 
NYSE is in compliance with any outstanding undertakings contained in 
this Order and in the 1999 Order issued against the NYSE by the 
Commission.  The Regulatory Auditor’s conclusions shall also be included 
in the NYSE’s annual report. 
d. No later than 45 days after the regulatory audit is concluded, the 
Regulatory Auditor shall also submit a regulatory audit report to the 
NYSE’s Board of Directors and to the Commission Officials (i) describing 
the purpose, scope and nature of the regulatory audit; and (ii) identifying 
any significant deficiencies or weaknesses in NYSE Regulation’s policies 
and procedures, or the NYSE’s compliance with those policies and 
procedures, any outstanding written recommendations made by OCIE or 
Market Regulation relating to compliance with rules, or surveillance for 
rule violations, with respect to trading by Floor Members, and any 
outstanding undertakings contained in this Order and in the 1999 Order 
issued against the NYSE by the Commission.  Copies of this report shall 
16
 

  
 
 
 
 
 
 
 
also be filed confidentially with the Commission Officials for use by the 
Commission pursuant to the Commission’s statutory oversight function, 
but without any limitation on the Commission’s uses.   
e. Within 90 days after submission of the Regulatory Auditor’s 
conclusions to the NYSE’s Board of Directors and the Commission 
Officials, RQR shall review with the Regulatory Auditor the conclusions 
of the Regulatory Auditor and the bases underlying any finding of a 
deficiency or weakness and shall review the proposed response of NYSE 
Regulation. 
f. The NYSE shall bear the full expense of the regulatory audits.  
Within 45 days after issuance of this Order, the NYSE shall set aside a 
reserve fund of $20 million for the establishment, retention and payment 
of the Regulatory Auditor for the four regulatory audits.  If the expenses 
for the four regulatory audits exceed the funds in the reserve fund, the 
NYSE shall provide additional funds to pay the costs of the regulatory 
audits.  Any reserve funds remaining after completion of the four 
regulatory audits shall be used to fund an additional regulatory audit, or as 
the Commission may direct.  
g. The Regulatory Auditor shall provide the Commission staff with 
any documents or other information the Commission requests regarding 
the Regulatory Auditor’s work pursuant to this undertaking for use by the 
Commission pursuant to the Commission’s statutory oversight function, 
but without any limitation on the Commission’s uses.  In connection with 
the Regulatory Auditor’s work, the NYSE shall not withhold from the 
Commission or the Commission’s staff, and shall require the Regulatory 
Auditor to agree not to withhold from the Commission or the 
Commission’s staff, any documents or information on the basis of any 
privilege or work product claims in response to any of the Commission 
staff’s requests. 
2. Within 90 days after issuance of this Order, the NYSE shall improve and 
enhance its regulation of Floor Members by developing and beginning 
implementation of policies and procedures to accomplish the following: (a) 
authorizing each and every division and unit director within NYSE Regulation to 
make immediate referrals of potential unlawful trading by Floor Members directly 
to the Enforcement Division; and (b) mandatory annual training of NYSE 
Regulation staff responsible for surveillance, investigation, examination, and 
discipline of Floor Members, including training on (i) the operations of the 
Display Book (or successor system used by specialists to execute orders); (ii) 
ways in which the Display Book has been used by Floor Members to circumvent 
or violate the federal securities laws and NYSE Rules; and (iii) the federal 
17
 

  
 
 
 
 
 
securities laws and NYSE Rules in place to prevent and deter unlawful trading by 
Floor Members. 
3. Within 60 days of full implementation of the NYSE’s proposed hybrid 
electronic and floor-based auction market system of trading, if approved by the 
Commission, or by April 1, 2006, whichever is earlier, the NYSE shall implement 
a pilot program for an on-floor video and audio surveillance system (the “Pilot 
Program”) to track floor trading activity at NYSE trading posts.  The Pilot 
Program shall be conducted over a period of eighteen months, or as directed by 
the Commission pursuant to Paragraph 3.c. below.  The Pilot Program shall be 
designed in consultation with the Commission’s Office of Information 
Technology.  At a minimum, the Pilot Program will encompass the trading 
activity of at least 20 NYSE stocks, including at least 3 of the 5 most active 
NYSE stocks and an additional 7 of the 25 most active NYSE stocks with respect 
to trading volume for the year prior to issuance of this Order.  Each specialist’s 
post and panel participating in the Pilot Program shall have sufficient audio and 
video equipment to capture, on a best efforts basis, floor trading activity occurring 
at that specialist’s post and panel.  For the Pilot Program, “floor trading activity” 
shall include all activity and interaction between each specialist and other Floor 
Members, and between Floor Members, occurring in the immediate vicinity of the 
specialist’s post and panel.  This audio and video surveillance system shall be 
designed to provide, in conjunction with information derived from the Display 
Book (or successor system used by specialists to execute orders) and the NYSE’s 
audit trail system, accurate time-sequenced records of all orders arriving at each 
specialist’s trading post (whether from the trading crowd or through the DOT 
system).  The time clocks of this video and audio surveillance system shall be 
synchronized with all other relevant time clocks operating on the floor, including 
time clocks associated with the Display Book (or successor system) and the 
NYSE’s audit trail system.  The NYSE shall maintain records of the Pilot 
Program for a period of not less than two years, the first year in an easily 
accessible place.  In connection with this undertaking, the NYSE shall file any 
necessary proposed rule changes with the Commission. 
a. The NYSE shall utilize the Pilot Program (i) to investigate 
indications of potential violations of the NYSE rules and the federal 
securities laws and (ii) to conduct certain targeted monitoring of trading 
activity, as defined below.  The indications of potential violations include, 
among other things, (i) alerts from the NYSE’s automated surveillances; 
(ii) investigative and examination findings developed by NYSE 
Regulation; (iii) inquiries and complaints from Floor Members and the 
public; and (iv) referrals of possible misconduct made by other SROs, the 
Commission, and other law enforcement agencies.  For the targeted 
monitoring, the NYSE shall review, based on certain reasonable standards 
18
 

  
 
 
 
  
 
 
 
to be determined by the NYSE, at least 3 hours of trading activity each 
month in each of the 20 stocks described above. 
b. Starting 240 days after implementation of the Pilot Program, RQR 
shall conduct a comprehensive, independent and objective review and 
evaluation of the Pilot Program (the “Review”) and the costs, benefits, 
feasibility and practicability of expanding the Pilot Program to the entire 
floor of the NYSE (including the costs, benefits, feasibility and 
practicability of maintaining the surveillance records for a reasonably 
lengthy period of time).  The RQR staff responsible for the Review (the 
“RQR Staff”) shall have access to all NYSE files, books, records, and 
personnel as reasonably requested for the Review.   
c. Within 360 days of implementation of the Pilot Program, RQR 
shall submit a report directly to the NYSE’s Board of Directors and the 
Commission Officials which sets forth RQR’s independent evaluation of 
the Pilot Program and RQR’s recommendation as to whether to expand, 
modify, or eliminate the Pilot Program.  Upon request, RQR shall also 
provide the Commission staff with sufficient underlying data to enable the 
Commission staff and Commission Officials to independently evaluate 
RQR’s recommendations.  Within 120 days of receipt of RQR’s report, 
the Commission Officials shall submit to the Commission, for the 
Commission’s approval, their own recommendation as to whether to 
modify or eliminate the Pilot Program, or expand the program to the entire 
floor of the NYSE. 
d. Neither the NYSE nor RQR shall invoke or seek to invoke the 
attorney-client privilege or any other doctrine or privilege to prevent RQR 
from transmitting any information, reports, or documents to the 
Commission Officials or the Commission, in connection with the Review 
or the independent evaluation by the Commission Staff and Commission 
Officials. 
e. In order to ensure that the Review is independent and objective, the 
NYSE shall (i) maintain the existing reporting structure in which RQR 
Staff report directly to the Regulatory Oversight Committee; (ii) prohibit 
non-RQR staff from offering unsolicited comments or observations to the 
RQR Staff, or in any way communicating, directly or indirectly, 
conclusions, evaluations and/or recommendations to the RQR Staff, or 
attempting to direct or sway the conclusions, evaluations and/or 
recommendations of the RQR Staff in connection with the Review; and 
(iii) prohibit non-RQR staff from reviewing or commenting on draft 
reports by RQR Staff of or concerning the Review. 
19
 

  
 
 
  
 
4. Within 90 days after issuance of this Order, the NYSE shall develop 
systems and procedures designed to track (a) the identity of specialists and their 
clerks; (b) the times during which each specialist acts in his or her capacity as 
specialist on the floor of the NYSE; and (c) the times during which each 
specialist’s clerk acts in the capacity of clerk to a specialist on the floor of the 
NYSE, and shall file any necessary proposed rule changes with the Commission.  
The NYSE shall maintain records of such information for a period of not less than 
five years, the first two years in an easily accessible place.  The NYSE shall 
implement this undertaking within 180 days from the date of the issuance of this 
Order. 
5. The NYSE undertakes to continue to identify and implement 
enhancements to its trading systems reasonably designed to prevent specialists 
from trading ahead and interpositioning.  Prior to the date of this Order, the NYSE 
commenced implementation of this undertaking by modifying the Display Book 
to include the Principal Inhibitor function.  The Principal Inhibitor function 
is an electronic default that blocks specialist dealer trades when the specialist is in 
the process of executing a proprietary trade while in possession of a customer 
order that could trade in place of some or all of the specialist’s side of the trade.  
The specialist may override the electronic default by inputting information 
representing that the trade meets a specified exemption approved by the NYSE.  
With respect to this undertaking, the NYSE specifically undertakes to develop 
system enhancements to the extent practicable to limit those circumstances, not 
approved by the NYSE, in which the specialist may override the electronic default 
of the Principal Inhibitor function.  The NYSE shall require that the system 
enhancements adopted in compliance with this undertaking may not be disabled 
by the specialists. 
6. Within 90 days after issuance of this Order, the NYSE shall establish and 
maintain a staff position within NYSE Regulation specifically responsible for (a) 
tracking and updating the status of all complaints, referrals, investigations and 
discipline involving all Floor Members; (b) updating and disseminating 
information about the status of such matters to the Regulatory Oversight 
Committee and NYSE Regulation staff; and (c) acting as liaison to the Regulatory 
Oversight Committee and to each Division within NYSE Regulation on the status 
of such matters. 
7. Commencing within 180 days of issuance of this Order, and at least once 
every year for a period of 5 years, the Chief Regulatory Officer of the NYSE shall 
certify to the Commission by affidavit that, to the best of his knowledge based 
upon reasonable inquiry, the NYSE has, in all material respects, fully adopted and 
complied with (a) any outstanding undertakings set forth in Paragraphs IV.C.1. 
through IV.C.6. above; and (b) any outstanding undertakings set forth in 
20
 

  
 
 
 
  
 
 
 
 
 
 
   
 
 
Paragraphs IV.1. through IV.12. of the 1999 Order.  The affidavit shall be 
delivered to the Commission Officials.   
8. Upon written request and good cause being shown, the Commission staff 
may grant the NYSE such additional time as the Commission staff deems 
necessary to implement any of the undertakings enumerated herein.    
By the Commission. 
       Jonathan G. Katz
       Secretary 
21
 

UNITED STATES OF AMERICA 

 Before the 


SECURITIES AND EXCHANGE COMMISSION 


SECURITIES EXCHANGE ACT OF 1934 
Release No. 51524 / April 12, 2005 

ADMINISTRATIVE PROCEEDING 
File No. 3-11892 

In the Matter of 


New York Stock Exchange, Inc., 


Respondent. 


ORDER INSTITUTING PUBLIC 
ADMINISTRATIVE PROCEEDINGS 
PURSUANT TO SECTIONS 19(h)(1) AND 
21C OF THE SECURITIES EXCHANGE 
ACT OF 1934, MAKING FINDINGS, 
ORDERING COMPLIANCE WITH 
UNDERTAKINGS, AND IMPOSING A 
CENSURE AND A CEASE-AND-DESIST 
ORDER 

I. 

The Securities and Exchange Commission (“Commission”) deems it necessary and 
appropriate in the public interest and for the protection of investors that public 
administrative proceedings be, and hereby are, instituted pursuant to Sections 19(h) and 21C 
of the Securities Exchange Act of 1934 (“Exchange Act”) against the New York Stock 
Exchange, Inc. (“NYSE”). 

II. 

In anticipation of the institution of these proceedings, the NYSE has submitted an 
Offer of Settlement (the “Offer”) that the Commission has determined to accept.  Solely for 
the purpose of these proceedings and any other proceedings brought by or on behalf of the 
Commission or in which the Commission is a party, and without admitting or denying the 
findings contained herein, except as to the Commission’s jurisdiction over the NYSE and 
the subject matter of these proceedings, the NYSE consents to the entry of this Order 
Instituting Public Administrative Proceedings Pursuant to Sections 19(h)(1) and 21C of the 
Securities Exchange Act of 1934, Making Findings, Ordering Compliance with 
Undertakings, and Imposing a Censure and a Cease-And-Desist Order (the “Order”), as set 
forth below. 



  

 

 

 

 
 

 
 

  

 
   

 
 

 

  
  

 
  

                                                 

 

III. 

On the basis of this Order and the Offer submitted by the NYSE, the Commission  
finds1 that: 

A. RESPONDENT 

1. The NYSE is a New York not-for-profit corporation that is, and at all times 
relevant hereto was, registered with the Commission as a national securities exchange pursuant 
to Section 6 of the Exchange Act. The NYSE first registered as a national securities exchange 
with the Commission on October 1, 1934. In 2003, the NYSE had a total of 2,750 listed 
companies trading on its market with a global market capitalization of $17.3 trillion.  The total 
share volume traded on the NYSE in 2003 was 352.4 billion shares, and the average daily share 
volume was 1.4 billion shares valued at $38.5 billion.  For the year ending December 31, 2003, 
the NYSE reported total revenues of nearly $1.1 billion and net income of $49.6 million. 

B. FACTS 

Summary 

2. This matter concerns the failure of the NYSE to properly detect, investigate, and 
discipline widespread unlawful proprietary trading by specialists on the floor of the NYSE.  Section 
19(g)(1) of the Exchange Act obligates the NYSE, as a self-regulatory organization (“SRO”), to 
comply, and enforce compliance by its members, with the Exchange Act, the rules and 
regulations thereunder, and the rules of the NYSE.  In carrying out its duty to “enforce 
compliance,” SROs must develop and maintain surveillance over its members, and “be vigilant 
in surveilling for, evaluating, and effectively addressing issues that could involve violations” of 
the securities laws.  National Ass’n of Sec. Dealers, Inc., 62 S.E.C. Docket 1346, Release No. 
34-37538, 1996 WL 447193, at *2 (Aug. 8, 1996). 

3. From 1999 through 2003, various NYSE specialists repeatedly engaged in unlawful 
“interpositioning” and “trading ahead” of customer orders resulting in more than $158 million of 
customer harm.  From 1999 through almost all of 2002, the NYSE failed to adequately monitor and 
police specialist trading activity, allowing the vast majority of this unlawful conduct to continue 
undetected. The NYSE knew or, in view of all the facts and circumstances, should have known 
that specialists were repeatedly engaging in interpositioning and trading ahead conduct.  The 
NYSE’s regulatory response to the improper proprietary trading was materially deficient for the 
following reasons: (a) the NYSE’s surveillance system for detecting trading ahead and 
interpositioning was unreasonable in that it included parameters and procedures that captured 
only a small portion of the misconduct; (b) the NYSE failed to conduct adequate investigations 

The findings herein are made pursuant to the NYSE’s Offer and are not binding on any 
other person or entity in this or any other proceeding. 

2
 

1  



  

 

  
  

 
  

 
 

 

 
 

    

 
 

 

of the trading ahead and interpositioning violations that it did find; and (c) the NYSE failed to 
adequately discipline specialists who were found to have engaged in unlawful trading.  In so 
doing, the NYSE violated Section 19(g) of the Exchange Act by failing, without reasonable 
justification or excuse, to enforce Section 11(b) of the Exchange Act, Rule 11b-1 thereunder, and 
various NYSE Rules, including NYSE Rules 92 and 104.10 which prohibit trading ahead of 
customer orders. 

Prior Commission Action Against the NYSE 

4. The NYSE’s failure to police trading ahead and interpositioning by 
specialists follows a regulatory failure by the NYSE in the late 1990s involving independent 
floor brokers, which was addressed by the Commission in an order against the NYSE in 
June 1999 (the “1999 Order”). In the 1999 Order, the Commission found that the NYSE 
had failed to detect and halt unlawful proprietary trading by certain independent floor 
brokers, who shared in the profits and losses of customer accounts.  See In the Matter of 
New York Stock Exchange, Inc., Admin. Proc. File 3-9925 (Securities Exchange Act Release 
No. 41574 (June 29, 1999)). As part of those illegal schemes, the NYSE floor brokers used 
information gained from their position on the trading floor to reap illegal profits from 
improper proprietary trading, including “frontrunning” of customer orders.  In the 1999 
Order, the Commission ordered the NYSE to comply with a series of undertakings that were 
intended to improve the NYSE’s regulation of all NYSE floor members, including 
specialists. For example, the NYSE was ordered to comply with an undertaking that within 
twelve months of the issuance of the 1999 Order, the NYSE would “enhance and improve 
its regulation” of all NYSE floor members, including specialists, by, among other things, 
“ongoing, continuous surveillance” of floor members, including specialists, and “thoroughly 
investigating indications of possible violations” by floor members, including specialists.  

5. The NYSE implemented some enhancements to its specialist surveillance 
program in response to the 1999 Order.  However, the NYSE failed to take sufficient steps 
to enhance and improve its regulation of specialists, by, among other things, failing to 
thoroughly investigate indications of possible violations by specialists. 

Overview of Specialists’ Obligations 

6. In the NYSE’s continuous two-way agency auction market, specialist firms are 
responsible for the quality of the markets in the securities in which individual specialists are 
registered.  A specialist is expected to maintain, insofar as reasonably practicable, a “fair” and 
“orderly” market. Specialists have two primary duties in maintaining a fair and orderly market: 
performing their “negative obligation” to execute customer orders at the most advantageous price 
with minimal dealer intervention, and fulfilling their “affirmative obligation” to offset 
imbalances in supply and demand.  Specialists participate as both broker (or agent), absenting 
themselves from the market to pair executable customer orders against each other, and as dealer 
(or principal), trading for the specialists’ dealer or proprietary accounts when needed to facilitate  

3
 



  

 

 
 

 
 

 

                                                 

 

 

 

 

price continuity and fill customer orders when there are no available contra parties to those 
orders. 

7. Whether acting as brokers or dealers, specialists are required to hold the public’s 
interests above their own and, as such, are prohibited from trading for their dealers’ accounts 
ahead of pre-existing customer buy or sell orders that are executable against each other.  When 
matchable customer buy and sell orders arrive at specialists’ trading posts – generally either 
through the NYSE’s Super Designated Order Turnaround System (“DOT”)2 to an electronic 
display book (the “Display Book”),3 or by floor brokers gathered in front of the specialists’ 
trading posts – specialists are required to act as agent, and cross or pair off those orders and to 
abstain from participating as principal or dealer. 

8. The specialists’ obligations are embodied in the federal securities laws and NYSE 
rules, which prohibit trading ahead and interpositioning.  Section 11(b) of the Exchange Act and 
Rule 11b-1 thereunder limit a specialist’s dealer transactions to those “reasonably necessary to 
permit him to maintain a fair and orderly market.”4  NYSE Rule 92 provides that “no member or 
member organization shall cause the entry of an order to buy (sell) any Exchange-listed security 
for any account in which such member or member organization . . . is directly or indirectly 
interested (a ‘proprietary order’), if the person responsible for the entry of such order has 
knowledge of any particular unexecuted customer’s order to buy (sell) such security which could 
be executed at the same price.”  NYSE Rule 104.10 states in relevant part:  “No specialist shall 
effect . . . purchases or sales of any security in which such specialist is registered . . . unless such 
dealings are reasonably necessary to permit such specialist to maintain a fair and orderly 
market.” 

2 The DOT system is the NYSE’s primary order processing system, supporting equity 
trading on the trading floor and providing the NYSE with the current status of any equity order.   
Customers can transmit orders through NYSE member organizations electronically to the floor 
through the DOT system. 

3 The Display Book is an electronic workstation provided by the NYSE to the firm for use 
by its specialists at their post panels, operated by means of a customized keyboard containing 
function, letter, number and arrow keys.  The Display Book allows specialists to, among other 
things, receive and process orders, disseminate trade and quote information, report trade 
executions, research order and execution status, manage positions and view profit and loss in the 
dealer account. 

4 Where specialists effect trades for their accounts that are not “reasonably necessary to 
permit [such specialists] to maintain a fair and orderly market,” they have violated Section 11(b) 
and Rule 11b-1 of the Exchange Act. See In the Matter of Weiskopf, Silver & Co., 1980 WL 
22091, SEC Release No. 34-17361 (Dec. 10, 1980); In the Matter of Albert Fried & Co. and 
Albert Fried, Jr., 1978 WL 196046, S.E.C. Release No. 34-15293 (Nov. 3, 1978). 

4
 



  

 

 
 

      
 

 

 
    

 
 

 
 
 
 

 
 

  
 

The NYSE’s Obligation to Regulate the Conduct of Specialists 

9. Section 6(b) of the Exchange Act requires the NYSE, as a national securities 
exchange, to have the capacity to be able to carry out the purposes of the Exchange Act and to 
comply, and to enforce compliance by its members, with the rules and regulations of the 
Exchange Act and the NYSE’s own rules. Rule 11b-1 under the Exchange Act sets forth the 
specific rules that a national securities exchange must have if it registers its members to act as 
specialists. Sections 19(g) and 19(h) of the Exchange Act further require the NYSE, as a self-
regulatory organization, to comply with, and enforce the provisions of, the Exchange Act, the rules 
and regulations thereunder and its own rules.  The NYSE has an affirmative obligation to be vigilant 
in surveilling for, evaluating, and effectively addressing activity that could involve violations of 
these provisions.   

10. The NYSE’s Regulatory Group has the responsibility to enforce compliance by its 
members with the Exchange Act, the rules and regulations thereunder, and the NYSE’s own 
rules. During the relevant time period, the Regulatory Group was comprised of three divisions: 
(1) Market Surveillance; (2) Member Firm Regulation; and (3) the Enforcement Division.  
Market Surveillance had the principal responsibility to surveil and investigate specialists for trading 
violations.  Specialist Surveillance, a unit of Member Trading II, a department of Market 
Surveillance, was primarily responsible for conducting surveillance of specialists’ trading.  
Analysts within Specialist Surveillance reviewed “alerts” from automated surveillances and 
referred potential violations to Trading Investigations, which during the relevant time period was 
also organized within the Member Trading II department of Market Surveillance.  Trading 
Investigations was responsible for conducting in-depth investigations of potential rule violations 
referred by, among others, Specialist Surveillance.  Market Surveillance, based on the results of 
the investigation, could impose informal discipline, primarily letters of admonition or summary 
fines, but serious rule violations had to be referred to the NYSE’s Enforcement Division with a 
recommendation for formal disciplinary action. 

The NYSE’s Failure to Enforce Statutes and Rules Governing Trading by Specialists 

The Specialists’ Unlawful Trading Ahead and Interpositioning 

11. During the period January 1999 through 2003, various NYSE specialists 
repeatedly violated their duty to refrain from dealing for their own accounts while in possession 
of buy and sell customer orders executable against each other.  They did this primarily in two 
ways: (i) by “interpositioning” – i.e., effecting two improper proprietary trades close in time by 
filling both opposing orders from the proprietary account at prices that enable the specialist firm 
to profit from the spread between both prices; and (ii) by “trading ahead” – i.e. filling one 
executable order out of the firm’s own account instead of matching it with another executable 
public order – and then by filling the second executable public order through an agency trade at a 
less advantageous price. 

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12. The unlawful proprietary trading by NYSE specialists was widespread and 
pervasive, involving all seven equity specialist firms operating on the NYSE.  In March and July 
2004, the Commission and the NYSE instituted settled administrative proceedings against all 
seven firms.  The Commission and the NYSE found that, between 1999 and 2003, these 
specialist firms (i) willfully violated Section 11(b) of the Exchange Act and Rule 11b-1 
thereunder; (ii) violated various NYSE rules, including NYSE Rules 92 and 104.10; and (iii) 
failed adequately to supervise certain specialists, who themselves engaged in fraud through 
proprietary trading in violation of Section 10(b) of the Exchange Act and Rule 10b-5 
thereunder.5   The Commission and the NYSE further found that unlawful proprietary trading at 
the seven specialist firms caused in the aggregate more than $158 million in customer harm.  
Pursuant to the settlements between the specialist firms, the Commission and the NYSE, the 
specialist firms agreed to disgorge this amount and were penalized a total of $90 million. 

The NYSE Failed to Adequately Surveil for Trading Ahead and  
Interpositioning Violations 

13. From 1999 through almost all of 2002, the NYSE’s surveillance systems failed to 
detect the vast majority of trading ahead and interpositioning by specialists.  This failure was in 
part due to the NYSE’s reliance on an automated surveillance system whose parameters and 
procedures were unnecessarily and unreasonably broad.  The DOT Inferior Price Execution 
Surveillance (“DOT Surveillance”) had been implemented by the NYSE in the late 1980s to 
detect trading ahead by specialists.  When specialists engaged in trading that exceeded certain 
parameters of the DOT Surveillance, alerts were generated identifying potential trading ahead 
activity.  The most significant parameters of the DOT Surveillance were the time and spread 
parameters.   

14. Although every instance of trading ahead and interpositioning constitutes a 
violation, the DOT Surveillance only generated an alert if the specialist traded ahead of an 
agency DOT order that had been visible on the Display Book for a certain period of time.  From 
1999 through 2002, the time parameter was reduced from 90 seconds to 60 seconds, but was 
consistently set beyond a level that could be reasonably justified.  As a result of using 
unnecessarily long time parameters, the DOT Surveillance failed to detect the vast majority of 
trading ahead and interpositioning violations. 

See In the Matter of Bear Wagner Specialists LLC, Rel. No. 34-49498 (March 30, 2004); 
In the Matter of Fleet Specialist, Inc., Rel. No. 34-49499 (March 30, 2004); In the Matter of 
LaBranche & Co. LLC, Rel. No. 34-49500 (March 30, 2004); In the Matter of Spear, Leeds & 
Kellogg Specialists LLC, Rel. No. 34-49501 (March 30, 2004); In the Matter of Van der Moolen 
Specialists USA, LLC, Rel. No. 34-49502 (March 30, 2004); In the Matter of SIG Specialists, 
Inc., Rel. No. 34-50076 (July 26, 2004); In the Matter of Performance Specialist Group LLC, 
Rel. No. 34-50075 (July 26, 2004). 

6
 

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15. Similarly, the DOT Surveillance only generated an alert if there was a certain 
price spread in the specialist’s quote (bid and ask) at the time the specialist traded ahead of the 
customer agency order.  Historically, the spread parameter was set at the minimum price 
variation for trades in a security. In the late 1990s, when the minimum trading increment was a 
1/16th of a dollar ($.0625), the spread parameter was $.0625.  However, the $.0625 spread 
parameter remained in place until June 2002, nearly one and a half years after decimalization of 
stock quotes, which reduced the minimum price variation to one cent. In June 2002, the NYSE 
lowered the spread parameter slightly to five cents.  There is no reasonable justification for a 
spread parameter beyond the minimum price increment.  Because the DOT Surveillance did not 
capture violations involving small monetary amounts, the specialists were able to trade in small 
increments and evade detection.   

16. Over the years, the NYSE’s internal audit group, Regulatory Quality Review 
(“RQR”), and others advised Market Surveillance on several occasions that the parameters of the 
DOT Surveillance were unnecessarily broad and recommended reducing the parameters.  For 
example, in 1999 when the time parameter was 90 seconds, RQR issued a report that concluded: 
“Not to surveil specialists for 90 seconds increases the likelihood that a specialist taking 
advantage of his dealer and agency capacities for self-interest would remain undetected by 
Market Surveillance.” Similarly, in 2001 and 2002, sample tests were performed by an 
employee in Market Surveillance’s Automation Data Group using a narrower spread parameter, 
revealing a significant increase in the number of alerts generated. Despite repeated indications 
that the parameters were too broad, the NYSE made only incremental changes to the DOT 
Surveillance. The NYSE knew or should have known that these incremental changes were 
inadequate to gauge the full extent of the trading ahead activity.     

17. In addition, the NYSE incorporated an unreasonably narrow review period for the 
DOT Surveillance. From at least 1996 until June 2002, Specialist Surveillance analysts 
generally reviewed alerts for each specialist firm for a single day chosen at random each month.6 

As early as 1996, RQR recommended expanding the review period to one week in order for 
analysts to better surveil for trading ahead.  RQR proposed that the DOT Surveillance generate 
alerts for an entire week before the analyst selected which day to review.  RQR observed that 
Specialist Surveillance had, on a number of occasions, failed to conduct any review for trading 
ahead and interpositioning because no alerts were generated for the single day that was randomly 
selected for review. Despite the fact that Market Surveillance agreed in 1996 to adopt this 
change, Market Surveillance did not implement a one-week review period until June 2002. 

Analysts were generally only required to review a maximum of three alerts for three 
different stocks. The three stocks were selected pursuant to a specified selection process.  If any 
of these alerts for these three stocks were found to reflect potential violations, the review would 
be expanded to alerts in the same stock[s] generated for other days in the same week.  In 1999, 
the procedure was changed to require an expanded review of alerts for the same post-panel 
generated for the rest of the week. 

7
 

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18. The NYSE did not establish an automated surveillance system specifically 
designed to detect interpositioning misconduct until late 2002.  Although the DOT Surveillance 
was intended to capture trading ahead violations, the surveillance did not automatically detect 
interpositioning violations. Rather, Market Surveillance staff used a manual process of 
reviewing trade data for interpositioning.  The NYSE knew that interpositioning was an 
egregious form of trading ahead and considered this type of conduct a serious regulatory 
concern. The 1998 and 1999 versions of the Specialist Surveillance procedures manual instructed 
Specialist Surveillance analysts to “be especially aware of situations where the specialist, after 
buying/selling the stock, turns around and sells/buys stock against the system order at a profit.”  
However, the 2000 version of the Specialist Surveillance procedures manual, drafted after the 
1999 Order, de-emphasized the detection of interpositioning by merely instructing analysts to 
“also review[] inferior price execution situations for specialist arbitrage.”  Despite knowledge of 
interpositioning violations, the NYSE did not begin to develop a surveillance system specifically 
designed to capture interpositioning until mid-2002 and did not fully implement such a system 
until late 2002.   

The NYSE Failed to Adequately Investigate Trading Ahead  

And Interpositioning Violations 


19. Even though the surveillance parameters were unnecessarily broad, they still 
generated numerous alerts that put the NYSE on notice that trading ahead and interpositioning 
was widespread. From 1999 through 2002, the DOT Surveillance generated close to 4,000 
alerts.7  Nonetheless, because of inadequate sampling and selection procedures, the NYSE only 
reviewed a portion of the alerts generated, and because of inadequate referral procedures 
(requiring a pattern of likely violations), Specialist Surveillance only referred a smaller fraction 
of the alerts – approximately 200 – for further investigation.  For example, in April 1999, 
hundreds of alerts were generated for two specialist firms.  At one specialist firm, there were 
over 100 alerts, with 12 alerts in a single specialist’s post and panel and multiple alerts in 19 
different stocks. Also in April 1999, at another specialist firm, there were almost 200 alerts, 
including over 40 alerts in a single stock and 10 or more alerts in two other stocks.  Yet, the 
surveillance analysts failed to refer any of these alerts for further investigation.  When alerts 
were referred for further investigation, pursuant to Market Surveillance procedures, Specialist 
Surveillance only reviewed and referred a small portion of the total alerts generated.  For 
example, at one specialist firm, there were at least 140 alerts in a seven month time period in 
2000; yet, Specialist Surveillance referred only 28 of these alerts, failing to refer multiple alerts 
in several stocks. 

20. Some of the failures by the NYSE’s Specialist Surveillance unit included:  (1) 
Specialist Surveillance regularly overlooked likely instances of trading ahead and 
interpositioning, even when the specialist firms under review had recently been informally 
disciplined; (2) due primarily to inadequate referral procedures, Specialist Surveillance failed to 

According to Specialist Surveillance management and analysts, approximately 75% of 
the alerts they reviewed were likely trading ahead violations.   

8
 

7  



  

 

 

 

 

                                                 

 
 

 

refer the full extent of trading ahead and interpositioning conduct to Trading Investigations; (3) 
despite procedures that called for regular and routine surveillance of specialist firms, Specialist 
Surveillance in at least two instances suspended DOT Surveillance reviews of specialist firms for 
a period of time after disciplinary action was imposed;8 and (4) although Rule 92 explicitly 
prohibits trading ahead conduct, Specialist Surveillance almost always referred likely trading 
ahead and interpositioning violations to Trading Investigations under Rule 104.10.  Rule 92 
violations (which generally require proof of intent) would generally have necessitated a referral 
to Enforcement for formal disciplinary action; by contrast, Rule 104.10 violations (which do not 
require proof of intent) could be sanctioned informally by Market Surveillance. 

21. Trading Investigations failed to adequately investigate trading ahead and 
interpositioning misconduct.  Trading Investigations had the responsibility to properly 
investigate trading ahead and interpositioning violations, which included determining (1) the 
extent of such conduct; (2) whether specialists were engaging in repeated instances of 
misconduct; (3) whether the misconduct was intentional; and (4) whether the conduct should be 
referred to the Enforcement Division with a recommendation for formal disciplinary action.   

22. Trading Investigations, however, failed in these responsibilities in a number of 
ways. Investigators did not conduct a thorough investigation of the trading ahead and 
interpositioning instances that were referred to them.  Trading Investigations merely confirmed 
the specific instances of trading ahead and interpositioning that Specialist Surveillance had 
referred and did not investigate whether the specialists or specialist firms involved had engaged 
in additional trading ahead or interpositioning.  Investigators believed it was Specialist 
Surveillance that was responsible for determining the extent of the misconduct.9  Furthermore, 
investigators did not examine or probe the specialists’ intent.  Other than soliciting an 
explanation from the firm, which always stated that the trading ahead was accidental, Trading 
Investigations did not undertake any effort to determine whether the trading ahead was in fact 
intentional.  For example, in an investigation of 28 instances of trading ahead at one specialist 
firm in 2001, the firm responded in writing that most of the instances were “inadvertent clerical 
error.”  As a result, the investigators concluded that “the[se] occurrences appear to be more 
operational in nature.” The investigators did not interview the specialist or his clerk, but simply 

8 For example, in January 1999, the DOT Surveillance generated approximately 10 alerts 
in a single stock for one trade date.  Because the specialist firm for this stock had already been 
disciplined for earlier conduct, Specialist Surveillance decided not to review these 10 alerts. 

9 Investigators often lacked basic knowledge of the DOT Surveillance and the selection 
procedures that Specialist Surveillance used for its referrals.  Some investigators erroneously 
believed that Specialist Surveillance reviewed all alerts generated and referred all alerts that were 
not false positives.  Investigators also did not know how the Display Book operated.  This lack of 
knowledge significantly impaired the investigators’ ability to fully investigate instances of 
trading ahead and interpositioning. 

9
 



  

 

  

 

 

 
 

                                                 

 
 

 

relied on the firm’s written response in determining to impose only informal discipline.10 

Finally, Trading Investigations usually did not expand its reviews of trading ahead to other time 
periods. In the limited instances that Trading Investigations expanded its reviews, the expansion 
was cursory in nature and lacked adequate review.11 

23. Moreover, Market Surveillance failed to pursue what it considered de minimis 
violations, i.e. violations that only caused a small amount of customer harm or only resulted in a 
small amount of specialist gain.  For example, in September 1999, Member Firm Regulation 
referred a single instance of possible interpositioning to Trading Investigations, which did not 
review the conduct further because it concluded that the customer disadvantage resulting from 
this single trade ($37) was de minimis. In these types of situations, Market Surveillance wrongly 
assumed that specialists would not knowingly engage in unlawful conduct for a small amount of 
pecuniary gain. In fact, various specialists repeatedly engaged in small scale unlawful 
transactions that in the aggregate added up to tens of millions of dollars. 

24. In addition to Specialist Surveillance and Trading Investigations, other units at the 
NYSE, specifically Member Firm Regulation, which conducts annual and “for cause” 
examinations of NYSE members, and the Trading Correspondence unit, which handles 
complaints from member firms and the public, also detected trading ahead conduct during the 
period 1999 through 2002. Member Firm Regulation referred several trading ahead violations it 
detected to Market Surveillance under Rule 92 and expected that Trading Investigations would 
conduct a full investigation of the violative conduct.  Trading Investigations, however, during the 
relevant time period, failed to fully investigate the referred conduct and considered only whether 
the referred conduct violated Rule 104.10. For example, in August 2001, an examination of one 
specialist firm by Member Firm Regulation uncovered a significant amount of trading ahead by a 
single specialist: 94 instances of trading ahead in one stock on a single day, and 44 instances of 
trading ahead in another stock in a 1½ hour period on that same day.  Member Firm Regulation 
referred the conduct to Trading Investigations in November 2001; yet, Trading Investigations 

10 Trading ahead and interpositioning require several deliberate steps executed on the 
Display Book by the specialist or his clerk that demonstrate a specialists’ intent.  The Display 
Book highlights in yellow marketable customer orders.  To fill a customer order with a 
specialist’s dealer trade, the specialist or his clerk must take the Display Book out of its “default 
mode” and input several other keyboard commands.  Pairing off two customer orders requires 
only two keystrokes, whereas trading ahead and interpositioning conduct requires several extra 
keystrokes. The investigative files do not reflect any attempt to reconcile specialists’ repeated 
claims that multiple instances of trading ahead and interpositioning were “inadvertent” with the 
fact that such conduct required the specialists to undertake several deliberate steps. 

11 For example, in an investigation of 7 instances of trading ahead and interpositioning at 
one specialist firm in 2002, Trading Investigations noted that in reaching its decision to impose 
informal discipline, it had conducted an “expanded” review comprised of additional trade dates 
during 5 different calendar months and determined that there were no additional violations.  In 
fact, the expanded review yielded several additional trading ahead alerts in the stocks surveyed. 

10
 



  

 

 
 
 
 
 

 
 

 

                                                 

 

 

failed to take timely action to investigate this conduct.  The Trading Correspondence unit also 
received customer complaints involving trading ahead misconduct, which in some cases involved 
significant monetary disadvantage to the customer.12 The Trading Correspondence unit generally 
took no disciplinary action so long as the specialist firm agreed to pay back the disadvantaged 
customer.   

The NYSE Failed to Appropriately Discipline Trading Ahead  
and Interpositioning Violations 

25. Trading Investigations failed to recommend appropriate discipline of specialists 
for trading ahead and interpositioning. Throughout the relevant time period, Trading 
Investigations was the sole NYSE unit recommending discipline of specialists for trading ahead 
and interpositioning violations.  The discipline almost always took the form of informal 
discipline consisting of admonition letters and summary fines.13  Historically, the NYSE’s 
Regulatory Group considered informal disciplinary actions as “warnings” to the specialists firms 
that further trading misconduct could lead to formal enforcement action.  During the period 1999 
to 2002, however, the informal disciplinary actions were not used to “warn” the firms that if they 
engaged in additional violations in the future, they would face formal regulatory action.  Instead, 
repeat violations were generally addressed by additional informal action rather than a referral to 
Enforcement for formal disciplinary proceedings.  With respect to trading ahead and 
interpositioning violations, the NYSE’s Regulatory Group treated the informal disciplinary 
actions as similar in nature to “traffic tickets,” which were not followed up with more formal 
regulatory action. 

26. Trading Investigations also failed to consider whether the trading ahead and 
interpositioning instances it was investigating warranted a referral to the Enforcement Division 
for formal discipline under Rule 92.  Instead, when Trading Investigations received a trading 
ahead referral, it treated the conduct as a minor technical violation of Rule 104.10.  Even where 
the specialist firms engaged in recidivist conduct, the NYSE still failed to refer matters for 
formal disciplinary action.  For example, as early as January 1996, one specialist firm was issued 
a summary fine for 28 instances of trading ahead, including 16 instances of interpositioning.  In 
August 1998, the firm was cautioned for an additional 24 instances of trading ahead.  In July 
1999, the specialist firm received a summary fine of $1,000 for 30 additional instances of trading 

12 In one instance in 1999, a specialist traded ahead of four customer orders, which resulted 
in a total disadvantage to the customers of $4,602.50.  In another instance in 2000, a specialist 
traded ahead of a single customer order, which disadvantaged the customer by $2,062.50.  

13 There were a total of 6 admonition letters and 24 summary fines for trading ahead and 
interpositioning misconduct from 1999 through December 2002.  Summary fines typically 
ranged from $500 to $1,000 for trading ahead misconduct.  The total of the 24 summary fines 
was approximately $17,500 ($2,500 in 1999, $3,000 in 2000, $500 in 2001, and $11,500 in 
2002). 

11
 



  

 

 

 

 

 

 

ahead. Despite this recidivist conduct, Market Surveillance did not increase its surveillance of 
the specialist firm or refer any of the conduct to the Enforcement Division.  Moreover, while 
proof of intent was the critical element in referring conduct for formal enforcement action, 
investigators made little or no effort to try to determine the specialists’ intent.  NYSE 
investigators considered the conduct as violations of Rule 104.10  in large part because that was 
the rule Specialist Surveillance cited in its referrals.  As a result, from 1999 to December 2002, 
Trading Investigations did not refer any trading ahead or interpositioning violations to the 
Enforcement Division. 

27. Market Surveillance, including Specialist Surveillance and Trading 
Investigations, in all, but a few instances, failed to take disciplinary action against single 
instances of trading ahead, even when there were indications that the specialists intentionally 
traded ahead. This failure continued even after RQR issued a report in 1996 in which it proposed 
regulatory action for single instances of trading ahead: “[g]iven our commitment to protect all 
investors, we believe Market Surveillance should consider taking regulatory action for any single 
instance where it has been confirmed that the specialist did not provide an effective execution of 
a customer order.”  In spite of this proposal, the NYSE rarely investigated or took disciplinary 
action with respect to single instances of trading ahead.  

Actions Taken by the NYSE  

28. In June 2002, after discovering significant interpositioning activity by a single 
specialist that had occurred as early as January 2000, the NYSE began developing a special study 
to assess the extent of interpositioning practices throughout the trading floor.  The study, which 
culminated in a December 2002 report on interpositioning in all NYSE stocks for a three-month 
period, revealed widespread interpositioning conduct by various specialists, and prompted the 
NYSE to open a broader investigation into the unlawful trading.  Since that time, the NYSE has 
undertaken various measures to address its regulatory failures in policing trading ahead and 
interpositioning, including changes to its surveillance system and implementation of computer 
software to better enable the NYSE to detect ongoing trading ahead and interpositioning.  The 
NYSE and the Commission further investigated such violations and instituted formal disciplinary 
proceedings, which led to settled enforcement actions against all seven equity specialist firms.   

29. The NYSE has recently made extensive changes to its governance and regulatory 
structure.  These changes include: (1) amendments to the NYSE constitution that require all 
directors to be independent from members, member organizations, listed companies and (except 
for the CEO) management, and give the independent directors sole authority over the NYSE’s 
conduct of its regulatory functions; (2) the creation of the new position of Chief Regulatory 
Officer, which reports to the Board of Directors, rather than senior NYSE management; (3) the 
creation of a standing Board of Directors committee, the Regulatory Oversight Committee, with 
direct oversight of all budgetary, compensation and staffing decisions affecting the NYSE’s 
regulatory function, including those affecting RQR; (4) the appointment of a new head of 
regulation as the Chief Regulatory Officer and new leadership in the NYSE’s Divisions of 
Market Surveillance, Member Firm Regulation and Enforcement; (5) moving Trading 

12
 



  

 

 

 

Investigations from Market Surveillance to Enforcement, in order to foster more consistent 
determinations of whether formal or informal discipline is appropriate; (6) the creation of a new 
Specialist Surveillance unit to focus exclusively on the effectiveness of existing surveillances 
and the need for new or modified surveillances; (7) the creation of the Risk Assessment Unit, 
which analyzes trends and conducts risk assessment for the NYSE’s Regulatory Group (now 
known as NYSE Regulation); (8) increases in staff and other resources available to the NYSE’s 
regulatory units, including Market Surveillance; and (9) the retention by the Regulatory 
Oversight Committee of an independent consultant, who has reviewed the NYSE’s oversight of 
specialist trading. The NYSE is also considering changes that would provide that, any time a 
specialist comes into possession of a customer order that could trade in place of some or all of 
the specialist’s side of a proprietary trade that has not yet been reported, the specialist must 
allocate the trade to the customer order, unless a Commission-approved exception applies. 

C. CERTAIN UNDERTAKINGS 

30. In determining to accept the Offer, the Commission has considered the following 
voluntary undertakings by the NYSE: 

The NYSE shall continue to cooperate fully with the Commission in any and all 
investigations, litigations or other proceedings relating to the matters described in the 
Order or relating to or arising from the conduct underlying such matters.  In connection 
with such cooperation, the NYSE has undertaken: 

a. To produce, without service of a notice or subpoena, any and all 
documents and other information requested by the Commission’s staff; 

b. To use its best efforts to cause its employees to be interviewed by the 
Commission’s staff at such times as the staff reasonably may direct; 

c. To use its best efforts to cause its employees to appear and testify 
truthfully and completely without service of a notice or subpoena in such 
investigations, depositions, hearings or trials as may be requested by the 
Commission’s staff; and 

d. That in connection with any testimony of the NYSE to be conducted at 
deposition, hearing or trial pursuant to a notice or subpoena, the NYSE: 

i. Agrees that any such notice or subpoena for the NYSE’s 
appearance and testimony may be served by regular mail on its attorney, 
Dixie Johnson, Esq., Fried, Frank, Harris, Shriver & Jacobson LLP, 1001 
Pennsylvania Avenue, NW, Washington, DC 20004; and 

ii. Agrees that any such notice or subpoena for the NYSE’s 
appearance and testimony in any action pending in a United States District 

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Court may be served, and may require testimony, beyond the territorial 
limits imposed by the Federal Rules of Civil Procedure. 

D. CONCLUSION 

31. Section 19(g)(1) of the Exchange Act requires the NYSE, “absent reasonable 
justification or excuse,” to enforce compliance by its members with provisions of the Exchange 
Act, the rules and regulations thereunder, and the NYSE’s own rules.14  The Commission has 
stated that “the obligation to enforce imposed by Section 19(g) on an exchange necessarily 
includes an obligation to monitor and maintain surveillance over its members.”  Boston Stock 
Exchange, Inc., 21 S.E.C. Docket 22, Release No. 34-17183, 1980 WL 25454 at *3 (Oct. 1, 
1980).  Exchanges violate Section 19(g) when they fail “to be vigilant in surveilling for, 
evaluating, and effectively addressing issues that could involve violations” of the securities laws. 
National Ass’n of Sec. Dealers, Inc., 62 S.E.C. Docket 1346, Release No. 34-37538, 1996 WL 
447193, at *2 (Aug. 1996). 

32. From 1999 through almost all of 2002, the NYSE failed to properly detect, 
investigate, and discipline unlawful interpositioning and trading ahead by specialists. 

33. By not thoroughly investigating indications of possible violations by specialists, 
the NYSE failed to adequately enhance its regulation of specialists, as required by the 1999 
Order. 

34. The NYSE violated Section 19(g) of the Exchange Act by failing, without 
reasonable justification or excuse, to enforce Section 11(b) of the Exchange Act, Rule 11b-1 
thereunder, and NYSE Rules 92 and 104.10. 

35. Section 21(d)(3) of the Exchange Act authorizes the Commission to seek a civil 
penalty in federal district court against any person that violates the Exchange Act.  In light of the 
NYSE’s commitment to set aside a reserve fund of $20 million for the establishment, retention 
and payment of a Third Party Regulatory Auditor to conduct bi-annual regulatory audits of 
NYSE Regulation’s surveillance, examination, investigation and disciplinary programs, the 
Commission has determined not to seek a civil penalty from the NYSE.  In addition, the 
Commission has also taken into consideration the NYSE’s enhancements to its governance and 
regulatory programs, listed in Paragraph 29 of this Order. 

14 An SRO is relieved of its obligation to enforce compliance only when there is 
“reasonable justification or excuse” to fail to detect and stop violative conduct.  See Enforcement 
Obligations of Exchanges and Associations, 10 S.E.C. Docket 998, Release No. 34-12994, 1976 
WL 162853 (Nov. 18, 1976). There is no “reasonable justification or excuse” when an SRO 
knew, or, in view of all the facts and circumstances, should have known that its systems of 
reports, examinations and inspections were materially inadequate relative to the resources 
reasonably available to that SRO for detecting the misconduct.  Id. 

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IV. 

In view of the foregoing, the Commission deems it appropriate in the public interest and 
for the protection of investors to impose the sanctions agreed to in the NYSE’s Offer. 

Accordingly, it is hereby ORDERED, that 

A. 	 The NYSE be, and hereby is, censured pursuant to Section 19(h) of the Exchange 
Act. 

B. 	 The NYSE be, and hereby is, ordered pursuant to Section 21C of the Exchange 
Act to cease and desist from committing or causing any violation and any future 
violations of Section 19(g) of the Exchange Act. 

C. 	 The NYSE shall comply with the following undertakings: 

1. Commencing in 2005, and every two years thereafter through 2011 (for a 
total of four two-year periods), the NYSE shall retain a Third Party Regulatory 
Auditor (“Regulatory Auditor”), not unacceptable to the Commission staff, to 
conduct a comprehensive regulatory audit of NYSE Regulation’s surveillance, 
examination, investigation and disciplinary programs applicable to specialists, 
member firm floor brokers, independent floor brokers, registered competitive 
market makers and competitive traders (collectively, “Floor Members”). 

a. The Regulatory Auditor shall assess (i) whether NYSE 
Regulation’s policies and procedures are reasonably designed and 
effective to detect and deter violations of all applicable federal securities 
laws and NYSE rules relating to trading by Floor Members; (ii) whether 
NYSE Regulation is in compliance with (1) the above-referenced policies 
and procedures; and (2) any outstanding written recommendations made 
by the Commission’s Office of Compliance Inspections and Examinations 
(“OCIE”) or the Commission’s Division of Market Regulation (“Market 
Regulation”) relating to compliance with rules, or surveillance for rule 
violations, with respect to trading by Floor Members; and (iii) whether the 
NYSE is in compliance with any outstanding undertakings contained in 
this Order and in the 1999 Order issued against the NYSE by the 
Commission.  

b. The Regulatory Auditor must develop a written regulatory audit 
plan of sufficient scope and detail to achieve the regulatory audit 
objectives and to identify regulatory areas in need of special consideration.  
In performing the regulatory audit, the Regulatory Auditor and other 
qualified persons hired by the Regulatory Auditor (“qualified persons”) 
shall have or acquire within a reasonable period of time adequate 

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knowledge and understanding of the NYSE’s regulatory programs, 
policies and procedures. The Regulatory Auditor and the qualified 
persons shall exercise due professional care and independence in 
performing the regulatory audit.  The Regulatory Auditor shall formulate 
conclusions concerning its assessment, as described in Paragraph IV.C.1.a. 
above, based on sufficient evidence that is obtained through, among other 
things, (i) inspection of documents, including written procedures, rules, 
and staff files; (ii) observation of trading processes and the NYSE’s 
regulatory systems and practices; (iii) interviews of regulatory staff, RQR 
staff, Floor Members and other relevant persons; and (iv) studies and 
testing of various regulatory functions and trading practices.  The NYSE 
shall cooperate fully with the Regulatory Auditor and qualified persons 
and provide the Regulatory Auditor and qualified persons with access to 
its files, books, records, and staff as reasonably requested for the 
regulatory audit. 

c. No later than 45 days after the regulatory audit is concluded, the 
Regulatory Auditor shall submit to the NYSE’s Board of Directors and to 
the Director of OCIE and the Director of Market Regulation (the 
“Commission Officials”) the Regulatory Auditor’s conclusions concerning 
its assessment as to (i) whether NYSE Regulation’s policies and 
procedures are reasonably designed and effective to detect and deter 
violations of all applicable federal securities laws and NYSE rules relating 
to trading by Floor Members; (ii) whether NYSE Regulation is in 
compliance with (1) the above-referenced policies and procedures; and (2) 
any outstanding written recommendations made by OCIE or Market 
Regulation relating to compliance with rules, or surveillance for rule 
violations, with respect to trading by Floor Members; and (iii) whether the 
NYSE is in compliance with any outstanding undertakings contained in 
this Order and in the 1999 Order issued against the NYSE by the 
Commission.  The Regulatory Auditor’s conclusions shall also be included 
in the NYSE’s annual report. 

d. No later than 45 days after the regulatory audit is concluded, the 
Regulatory Auditor shall also submit a regulatory audit report to the 
NYSE’s Board of Directors and to the Commission Officials (i) describing 
the purpose, scope and nature of the regulatory audit; and (ii) identifying 
any significant deficiencies or weaknesses in NYSE Regulation’s policies 
and procedures, or the NYSE’s compliance with those policies and 
procedures, any outstanding written recommendations made by OCIE or 
Market Regulation relating to compliance with rules, or surveillance for 
rule violations, with respect to trading by Floor Members, and any 
outstanding undertakings contained in this Order and in the 1999 Order 
issued against the NYSE by the Commission.  Copies of this report shall 

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also be filed confidentially with the Commission Officials for use by the 
Commission pursuant to the Commission’s statutory oversight function, 
but without any limitation on the Commission’s uses.   

e. Within 90 days after submission of the Regulatory Auditor’s 
conclusions to the NYSE’s Board of Directors and the Commission 
Officials, RQR shall review with the Regulatory Auditor the conclusions 
of the Regulatory Auditor and the bases underlying any finding of a 
deficiency or weakness and shall review the proposed response of NYSE 
Regulation. 

f. The NYSE shall bear the full expense of the regulatory audits.  
Within 45 days after issuance of this Order, the NYSE shall set aside a 
reserve fund of $20 million for the establishment, retention and payment 
of the Regulatory Auditor for the four regulatory audits.  If the expenses 
for the four regulatory audits exceed the funds in the reserve fund, the 
NYSE shall provide additional funds to pay the costs of the regulatory 
audits. Any reserve funds remaining after completion of the four 
regulatory audits shall be used to fund an additional regulatory audit, or as 
the Commission may direct.  

g. The Regulatory Auditor shall provide the Commission staff with 
any documents or other information the Commission requests regarding 
the Regulatory Auditor’s work pursuant to this undertaking for use by the 
Commission pursuant to the Commission’s statutory oversight function, 
but without any limitation on the Commission’s uses.  In connection with 
the Regulatory Auditor’s work, the NYSE shall not withhold from the 
Commission or the Commission’s staff, and shall require the Regulatory 
Auditor to agree not to withhold from the Commission or the 
Commission’s staff, any documents or information on the basis of any 
privilege or work product claims in response to any of the Commission 
staff’s requests. 

2. Within 90 days after issuance of this Order, the NYSE shall improve and 
enhance its regulation of Floor Members by developing and beginning 
implementation of policies and procedures to accomplish the following: (a) 
authorizing each and every division and unit director within NYSE Regulation to 
make immediate referrals of potential unlawful trading by Floor Members directly 
to the Enforcement Division; and (b) mandatory annual training of NYSE 
Regulation staff responsible for surveillance, investigation, examination, and 
discipline of Floor Members, including training on (i) the operations of the 
Display Book (or successor system used by specialists to execute orders); (ii) 
ways in which the Display Book has been used by Floor Members to circumvent 
or violate the federal securities laws and NYSE Rules; and (iii) the federal 

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securities laws and NYSE Rules in place to prevent and deter unlawful trading by 
Floor Members. 

3. Within 60 days of full implementation of the NYSE’s proposed hybrid 
electronic and floor-based auction market system of trading, if approved by the 
Commission, or by April 1, 2006, whichever is earlier, the NYSE shall implement 
a pilot program for an on-floor video and audio surveillance system (the “Pilot 
Program”) to track floor trading activity at NYSE trading posts.  The Pilot 
Program shall be conducted over a period of eighteen months, or as directed by 
the Commission pursuant to Paragraph 3.c. below.  The Pilot Program shall be 
designed in consultation with the Commission’s Office of Information 
Technology.  At a minimum, the Pilot Program will encompass the trading 
activity of at least 20 NYSE stocks, including at least 3 of the 5 most active 
NYSE stocks and an additional 7 of the 25 most active NYSE stocks with respect 
to trading volume for the year prior to issuance of this Order.  Each specialist’s 
post and panel participating in the Pilot Program shall have sufficient audio and 
video equipment to capture, on a best efforts basis, floor trading activity occurring 
at that specialist’s post and panel. For the Pilot Program, “floor trading activity” 
shall include all activity and interaction between each specialist and other Floor 
Members, and between Floor Members, occurring in the immediate vicinity of the 
specialist’s post and panel. This audio and video surveillance system shall be 
designed to provide, in conjunction with information derived from the Display 
Book (or successor system used by specialists to execute orders) and the NYSE’s 
audit trail system, accurate time-sequenced records of all orders arriving at each 
specialist’s trading post (whether from the trading crowd or through the DOT 
system).  The time clocks of this video and audio surveillance system shall be 
synchronized with all other relevant time clocks operating on the floor, including 
time clocks associated with the Display Book (or successor system) and the 
NYSE’s audit trail system.  The NYSE shall maintain records of the Pilot 
Program for a period of not less than two years, the first year in an easily 
accessible place.  In connection with this undertaking, the NYSE shall file any 
necessary proposed rule changes with the Commission. 

a. The NYSE shall utilize the Pilot Program (i) to investigate 
indications of potential violations of the NYSE rules and the federal 
securities laws and (ii) to conduct certain targeted monitoring of trading 
activity, as defined below. The indications of potential violations include, 
among other things, (i) alerts from the NYSE’s automated surveillances; 
(ii) investigative and examination findings developed by NYSE 
Regulation; (iii) inquiries and complaints from Floor Members and the 
public; and (iv) referrals of possible misconduct made by other SROs, the 
Commission, and other law enforcement agencies.  For the targeted 
monitoring, the NYSE shall review, based on certain reasonable standards 

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to be determined by the NYSE, at least 3 hours of trading activity each 
month in each of the 20 stocks described above. 

b. Starting 240 days after implementation of the Pilot Program, RQR 
shall conduct a comprehensive, independent and objective review and 
evaluation of the Pilot Program (the “Review”) and the costs, benefits, 
feasibility and practicability of expanding the Pilot Program to the entire 
floor of the NYSE (including the costs, benefits, feasibility and 
practicability of maintaining the surveillance records for a reasonably 
lengthy period of time).  The RQR staff responsible for the Review (the 
“RQR Staff”) shall have access to all NYSE files, books, records, and 
personnel as reasonably requested for the Review.   

c. Within 360 days of implementation of the Pilot Program, RQR 
shall submit a report directly to the NYSE’s Board of Directors and the 
Commission Officials which sets forth RQR’s independent evaluation of 
the Pilot Program and RQR’s recommendation as to whether to expand, 
modify, or eliminate the Pilot Program.  Upon request, RQR shall also 
provide the Commission staff with sufficient underlying data to enable the 
Commission staff and Commission Officials to independently evaluate 
RQR’s recommendations. Within 120 days of receipt of RQR’s report, 
the Commission Officials shall submit to the Commission, for the 
Commission’s approval, their own recommendation as to whether to 
modify or eliminate the Pilot Program, or expand the program to the entire 
floor of the NYSE. 

d. Neither the NYSE nor RQR shall invoke or seek to invoke the 
attorney-client privilege or any other doctrine or privilege to prevent RQR 
from transmitting any information, reports, or documents to the 
Commission Officials or the Commission, in connection with the Review 
or the independent evaluation by the Commission Staff and Commission 
Officials. 

e. In order to ensure that the Review is independent and objective, the 
NYSE shall (i) maintain the existing reporting structure in which RQR 
Staff report directly to the Regulatory Oversight Committee; (ii) prohibit 
non-RQR staff from offering unsolicited comments or observations to the 
RQR Staff, or in any way communicating, directly or indirectly, 
conclusions, evaluations and/or recommendations to the RQR Staff, or 
attempting to direct or sway the conclusions, evaluations and/or 
recommendations of the RQR Staff in connection with the Review; and 
(iii) prohibit non-RQR staff from reviewing or commenting on draft 
reports by RQR Staff of or concerning the Review. 

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4. Within 90 days after issuance of this Order, the NYSE shall develop 
systems and procedures designed to track (a) the identity of specialists and their 
clerks; (b) the times during which each specialist acts in his or her capacity as 
specialist on the floor of the NYSE; and (c) the times during which each 
specialist’s clerk acts in the capacity of clerk to a specialist on the floor of the 
NYSE, and shall file any necessary proposed rule changes with the Commission.  
The NYSE shall maintain records of such information for a period of not less than 
five years, the first two years in an easily accessible place.  The NYSE shall 
implement this undertaking within 180 days from the date of the issuance of this 
Order. 

5. The NYSE undertakes to continue to identify and implement 
enhancements to its trading systems reasonably designed to prevent specialists 
from trading ahead and interpositioning.  Prior to the date of this Order, the NYSE 
commenced implementation of this undertaking by modifying the Display Book 
to include the Principal Inhibitor function.  The Principal Inhibitor function 
is an electronic default that blocks specialist dealer trades when the specialist is in 
the process of executing a proprietary trade while in possession of a customer 
order that could trade in place of some or all of the specialist’s side of the trade.  
The specialist may override the electronic default by inputting information 
representing that the trade meets a specified exemption approved by the NYSE.  
With respect to this undertaking, the NYSE specifically undertakes to develop 
system enhancements to the extent practicable to limit those circumstances, not 
approved by the NYSE, in which the specialist may override the electronic default 
of the Principal Inhibitor function. The NYSE shall require that the system 
enhancements adopted in compliance with this undertaking may not be disabled 
by the specialists. 

6. Within 90 days after issuance of this Order, the NYSE shall establish and 
maintain a staff position within NYSE Regulation specifically responsible for (a) 
tracking and updating the status of all complaints, referrals, investigations and 
discipline involving all Floor Members; (b) updating and disseminating 
information about the status of such matters to the Regulatory Oversight 
Committee and NYSE Regulation staff; and (c) acting as liaison to the Regulatory 
Oversight Committee and to each Division within NYSE Regulation on the status 
of such matters. 

7. Commencing within 180 days of issuance of this Order, and at least once 
every year for a period of 5 years, the Chief Regulatory Officer of the NYSE shall 
certify to the Commission by affidavit that, to the best of his knowledge based 
upon reasonable inquiry, the NYSE has, in all material respects, fully adopted and 
complied with (a) any outstanding undertakings set forth in Paragraphs IV.C.1. 
through IV.C.6. above; and (b) any outstanding undertakings set forth in 

20Paragraphs IV.1. through IV.12. of the 1999 Order.  The affidavit shall be 
delivered to the Commission Officials.   

8. Upon written request and good cause being shown, the Commission staff 
may grant the NYSE such additional time as the Commission staff deems 
necessary to implement any of the undertakings enumerated herein.    

By the Commission. 

       Jonathan  G.  Katz
       Secretary  

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