01-26864. Self-Regulatory Organizations; Boston Stock Exchange, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 Thereto and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 2 to the Proposed Rule Change ...

October 18, 2001.

I. Introduction

On May 15, 2001, the Boston Stock Exchange, Inc. (“BSE” or “Exchange”) submitted to the Securities and Exchange Commission (“SEC” or “Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”),^[1] and Rule 19b-4 thereunder,^[2] a proposed rule change regarding the trading of Nasdaq securities on the floor of the Exchange, pursuant to unlisted trading privileges (“UTP”). On June 15, 2001, the Exchange submitted Amendment No. 1 to the proposed rule change.^[3] The proposed rule change, as amended by Amendment by Amendment No. 1, was published in the Federal Register on July 3, 2001.^[4] The Commission received two comment letters on the proposed rule change.^[5] On October 4, 2001, the BSE submitted Amendment No. 2 to the proposed rule change.^[6] This order approves the proposed rule change, as amended. In addition, the Commission solicits comment on Amendment No. 2 to the proposed rule change from interested persons.

II. Description of the Proposal

The Exchange proposes to trade certain over-the-counter (“OTC”) securities. i.e., Nasdaq securities, on the floor of the Exchange, pursuant to UTP under Section 12(f) of the Act.^[7] Therefore, to accommodate these new securities on the Exchange floor, the Exchange proposes to add Chapter XXXV, Trading in Nasdaq Securities, to the Rules of Board of Governors of the Boston Stock Exchange (“BSE rules”). The rules set forth in Chapter XXXV specifically govern the trading of Nasdaq securities, with references to various sections of other BSE Rules relating to the trading of equity securities, as well as references to selected NASD rules, where appropriate. In addition, the BSE proposes a stock allocation program for Nasdaq securities, which phases out over a two year period.

III. Summary of Comments

The Commission received two comments on the proposed rule change.^[8] One commenter supported the proposal.^[9] One commenter requested that the comment period be extended and requested clarification of certain issues.^[10] BSE submitted a letter responding to Nasdaq's question.^[11]

In its letter, Nasdaq requested further clarification of BSE's proposed Section 4(c), which permits specialists to switch from automatic execution to manual execution in unusual trading situations and how this section relates to BSE's intention to participate in the Nasdaq National Market Execution System (“SuperSoes”).^[12] Moreover, Nasdaq believed that the reference to “price volatility” to be vague and did not clearly define when a BSE specialist could turn off the auto-execution functionality. Finally, Nasdaq questioned whether BSE specialists were planning on quoting away from the BBO because Nasdaq believed that such practices may result in BSE specialists' de facto withdrawal from the market.

The BSE responded that specialists will only be permitted to turn off the auto-execution functionality on their workstation in rare circumstances, such as following a regulatory halt. Further, the Exchange stated that its surveillance and front desk floor operations departments will protect against unwarranted and unfettered use of the ability to switch to manual execution. Specifically, the Exchange stated that a specialist will be required to get the approval of two floor officials to request that the auto-execution functionality be turned off and that the ability to switch to manual mode rests solely with the Exchange's surveillance and front desk floor operations departments. The Exchange, therefore, believed that the ability to switch to manual mode will not result in a de facto withdrawal from the market because it will be used only in extreme situations and will be controlled by the Exchange.

Nasdaq also requested information regarding BSE's audit trail requirements. BSE responded that as a part of the Intermarket Surveillance Group (“ISG”), all quotes and trades from the Exchange are captured by ISG's PATRINA system, which establishes an audit trail. The BSE also noted that the Exchange would be reporting its Nasdaq trades through ACT, which should further enhance the audit trail for BSE trades.

Nasdaq requested information regarding BSE's enforcement and surveillance capabilities regarding trading of Nasdaq securities. BSE noted that it had submitted its procedures to the Commission's Office of Compliance Inspections and Examinations for review.

Nasdaq also noted that BSE's examination and qualification requires are different than those applicable to Nasdaq market makers and requested information on how BSE intends to ensure that its members have a thorough understanding of the trading of Nasdaq securities. BSE responded that it had modified its floor examination to include sections relating to Nasdaq trading. Further, BSE noted that, although not required, every specialist who will be trading Nasdaq securities on the Exchange upon commencement of the process has voluntarily taken and passed the NASD Series 55 exam relating to the trading of Nasdaq securities, as well as the Series 63, NASAA Uniform State Law Examination.

Finally, Nasdaq questioned whether BSE would voluntarily comply with NASD Rule 4613 regarding locked/crossed markets before the open. BSE responded that it would not be trading before the opening.

IV. Discussion

The Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange, and in particular, with the requirements of Section 6(b)(5) of the Act.^[13] The Commission believes that BSE's proposal to trade Nasdaq securities should promote competition, consistent with Section 6 of the Act.^[14] In addition, the Commission believes that BSE has proposed rules that should ensure that trading in Nasdaq securities on its floor occurs in an orderly fashion, consistent with the requirements of the Act. The Commission, therefore, believes that the proposal should remove impediments to and perfect the mechanism of a free and open market in a manner that is consistent with the protection of investors and the public interest.^[15] The Commission also notes that BSE's responses to the comments raised in the Nasdaq letter were sufficient.^[16]

Furthermore, the proposed rule change is consistent with Section 12(f)(2) of the Act,^[17] which grants the Commission explicit authority to approve UTP in OTC securities. Section 12(f)(2) of the Act requires the Commission, prior to approving UTP, to determine that the granting of UTP is consistent with the maintenance of fair and orderly markets and the protection of investors. The Commission believes that the proposed rule change is consistent with these goals and thus, the Commission is approving the proposed rule change, subject to the BSE complying with the requirements of the OTC/UTP Plan.^[18]

Finally, the Commission finds good cause to accelerate approval of Amendment No. 2 to the proposed rule change prior to the thirtieth day after the date of publication in the Federal Register. The Commission notes that Amendment No. 2 merely clarifies the rule language and deletes inapplicable language. The amendment, therefore, does not substantively change the meaning or intent of the proposed rule change. For these reasons, the Commission believes that good cause exists, consistent with Sections 6(b)(5) ^[19] and 19(b) ^[20] of the Act, to approve Amendment No. 2 to the proposed rule change on an accelerated basis.

V. Solicitation of Comments

Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether Amendment No. 2 is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying at the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the Exchange. All submissions should refer to File No. SR-BSE-2001-01 and should be submitted by November 15, 2001.

VI. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,^[21] that the proposed rule change (SR-BSE-2001-01), as amended, is approved.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[22]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See Form 19b-4 dated June 14, 2001 (“Amendment No. 1”).

4.  Securities Exchange Act Release No. 44476 (June 26, 2001), 66 FR 35293.

5.  See letters to Jonathan G. Katz, Secretary, SEC, from Kevin J.P. O'Hara, General Counsel, Archipelago, L.L.C., dated July 13, 2001 (“Archipelago Letter”); and Eugene A. Lopez, Senior Vice President, Nasdaq Stock Market, Inc., dated August 15, 2001 (“Nasdaq Letter”).

6.  See letter from John Boese, Assistant Vice President, Legal and Regulatory, BSE, to Katherine England, Assistant Director, Division of Market Regulation, SEC, dated October 3, 2001 (“Amendment No. 2”). In Amendment No. 2, the Exchange clarified language in the rule text and deleted a sentence in proposed Section 3 that required that transactions that could not be submitted to ACT be reported to the NASD's Market Regulations Department. According to BSE, this sentence was deleted because it reflected a NASD requirement that does not apply to UTP exchanges.

7.  15 U.S.C. 781(f).

8.  See note 5 supra.

9.  See Archipelago Letter.

10.  See Nasdaq Letter.

11.  See letter to Adena Friedman, Senior Vice President, Data Products, Nasdaq, from George W. Mann, Senior Vice President and General Counsel, BSE, dated August 29, 2001.

12.  According to Nasdaq, participants in SuperSoes are required to provide automatic execution when they are at the BBO.

13.  15 U.S.C. 78f(b)(5).

14.  15 U.S.C. 78f.

15.  In approving this proposal, the Commission has considered its impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

16.  The Commission notes that proposed Section 28 of the BSE's rules, Short Sales, does not require an exemption form the Commission's short sales rule, Rule 10a-1, since Nasdaq securities currently are excluded from the Rule. See 17 CFR 240.10a-1(a)(1)(ii). However, Nasdaq has applied to become a national securities exchange. See Securities Exchange Act Release No. 44396 (June 7, 2001), 66 FR 31952 (June 13, 2001). If Nasdaq becomes a registered exchange, Nasdaq securities will be exchange listed and subparagraph (ii) of Rule 10a-1 will no longer be available. Accordingly, BSE specialists trading Nasdaq securities would be subject to Rule 10a-1 unless BSE obtains an exemption from the Rule. Nasdaq has requested an exemption from Rule 10a-1.

17.  15 U.S.C. 781(f)(2).

18.  The OTC/UTP Plan refers to the Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation, and Dissemination of Quotation and Transaction Information for Exchange-Listed Nasdaq/National Market System Securities and for Nasdaq/National Market System Securities Traded on Exchanges on an Unlisted Trading Privileges Basis. The Commission notes that on August 29, 2001, BSE became a full participant in the OTC/UTP Plan. The other participants of the OTC/UTP Plan are the American Stock Exchange LLC, the Chicago Stock Exchange, Inc, the Cincinnati Stock Exchange, Inc., the National Association of Securities Dealers, Inc., the Pacific Exchange, Inc, and the Philadelphia Stock Exchange, Inc.

19.  15 U.S.C. 78f(b)(5).

20.  15 U.S.C. 78s.

21.  15 U.S.C. 78s(b)(2).

22.  17 CFR 200.30-3(a)(12).