EXCHANGE
An association, organization, or group of persons, incorporated or unincorporated, that constitutes, maintains, or provides a marketplace or facilities for bringing together purchasers and sellers of SECURITIES or commodities futures.
A security is a written proof of ownership of an investment, usually in the form of shares of
stock, which are fractional units of ownership in a company. Commodities are raw materials, like wheat, gasoline, or silver, that are sold either on
the spot market, where cash is paid “on the
spot,” or through futures contracts, where a
price for a contract is set in advance, not to be
changed even if the market price for the com-
modity increases or decreases by the time the
contract comes due.
Stock Exchanges
The New York Stock Exchange (NYSE) and
the American Stock Exchange are located on
Wall Street, in New York City. Wall Street
(named for a stockade built to protect the origi-
nal settlers) is the busiest hub of securities trad-
ing in the United States. There are five other,
smaller, regional exchanges: the Pacific (in Los
Angeles), Cincinnati, Chicago, Philadelphia (at
the site of the first stock exchange in the United
States), and Boston. These stock exchanges are
private associations that sell memberships
(seats) for a price, which can fluctuate based on
the price of stocks and the volume of trading.
The SECURITIES AND EXCHANGE COMMIS-
SION, which was established pursuant to the
Securities Act of 1933 (15 U.S.C.A. §§ 78a et
seq., 78d), regulates the activities of securities
exchanges (defined at 15 U.S.C.A. § 78c(a)(1)).
Private associations such as the NYSE and the
National Association of Securities Dealers
(NASD) initiate and execute a significant
amount of self-regulation and disciplinary
activities with the full support of the Securities
and Exchange Commission.
Futures Exchanges
Futures contracts for commodities are
traded on one of 11 commodities exchanges in
the United States, or on other exchanges
throughout the world. Each futures contract is
tied to the exchange that issued it. Exchanges
specialize in various commodities, including
currency and financial futures. For example, the
Chicago Mercantile Exchange deals in meat,
livestock, and currency, and the Minneapolis
Grain Exchange focuses exclusively on grain.
Other exchanges include the Chicago Board of
Trade and boards of trade and exchanges in
Philadelphia; Kansas City, Missouri; and New
Yor k Ci t y.
The COMMODITIES FUTURES TRADING COMMISSION, which was established pursuant to the
Commodity Exchange Act (7 U.S.C.A. §§ 1 et
seq., 4a(a)), regulates the activities of boards of
trade, defined as associations or exchanges
established to trade commodities futures. Pri-
vate organizations such as the Chicago Board of
Trade and the National Futures Association pro-
vide significant self-regulation to the commodi-
ties futures trading market.
The Auction Market Principle
The floor of a stock or futures exchange
operates on the “auction market” principle,
whereby brokers meet face-to-face on the floor
of the exchange to execute buy and sell orders.
Futures exchanges operate on a pure auction
system, often referred to as the open outcry sys-
tem, where all trading takes place on the floor of
the exchange, or “in the pit.” Buyers and sellers in the pit use hand signals and oral communications to place buy and sell orders simultane-
ously, acting for themselves and as agents for
others.
Securities exchanges operate on an auction-
style system, where the market prices for securi-
ties are set by buyers and sellers meeting on the
floor of the exchange. In contrast to futures
exchanges, securities exchanges also employ spe-
cialists, who stand ready to buy or sell orders at
market prices when there is, for example, a seller
and no buyer for a particular security. In this
capacity, specialists act as dealers, using their
own capital to make bids and offers for stock.
They can also act as brokers, holding limit orders
(requests to buy or sell a security when it reaches
a predetermined market price) for other brokers
and executing those orders when the market
moves up or down to the desired price. Special-
ists permit for a more orderly and continuous
securities market and prevent wild price fluctua-
tions due to imbalances in supply and demand.
Computerized and Over-the-Counter Trading
Computer technology has been introduced
in the major exchanges to automate certain
aspects of transactions, but the auction process
remains the predominant method of trading
securities in these forums. In fact, the statutory
definition of an exchange in the Securities
Exchange Act has been consistently interpreted
not to include computerized trading.
Stocks not traded on an exchange have his-
torically been termed over-the-counter (OTC)
stocks because they are sold over the counter (or
desk or telephone) of individual brokers. The
NASD once published the quotes of willing buy-
ers and sellers of OTC stocks in what were called
pink sheets. In the early 1970s, the NASD com-
puterized this service and called it the National
Association of Securities Dealers Automated
Quotations System. This decentralized method
of trading stocks has grown in efficiency and
popularity in the decades since its introduction,
but it has never been held to constitute an
exchange because it does not facilitate the phys-
ical meeting of buyers and sellers. Like special-
ists in stock exchanges, who often are called
upon to “make the market” (purchase and sell
securities with their own money) in the absence
of willing buyers and sellers, multiple “market
makers” in the OTC market use their own capi-
tal to respond to fluctuations in the market.
One of the more recent developments in the
exchange of stocks has been the use of Electronic
Communications Networks (ECNs), which
became popular in the United States and Europe
in the late 1990s. ECNs are similar to stock
exchanges in that they allow for stock transac-
tions through a third party. They match orders
to buy and sell at specified prices. They are also
faster and more efficient than the traditional
stock exchange. In 2000, the NYSE repealed a
rule that limited member firms to trade only in
stocks listed on the exchange. This has allowed
securities listed on ECNs to become more com-
petitive with stocks from larger companies.
ECNs are required to register with the Securities
