[Federal Register Volume 59, Number 240 (Thursday, December 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30782]
[[Page Unknown]]
[Federal Register: December 15, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35068; File No. SR-BSE-94-09]
Self-Regulatory Organizations; Boston Stock Exchange, Inc.; Order
Approving Proposed Rule Change and Amendment No. 1 to Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval to
Amendment No. 2 to Proposed Rule Change Relating to Stopping Stock
December 8, 1994.
I. Introduction
On June 20, 1994, 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 to adopt a new rule regarding
stopping stock. On June 24, 1994 and November 10, 1994, the Exchange
submitted to the Commission Amendments No. 1 and No. 2. to the proposed
rule change in order to clarify certain procedural requirements for the
handling of stopped orders and to specify the duration of the BSE's
pilot program for stopping stock in minimum variation markets.\3\
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\1\15 U.S.C. Sec. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1991).
\3\See letters from Karen A. Aluise, Assistant Vice President,
BSE, to Sandra Sciole, Special Counsel, Division of Market
Regulation, SEC, dated June 21, 1994 (``Amendment No. 1''); and
Howard Kramer, Associate Director, Division of Market Regulation,
SEC, dated November 10, 1994 (``Amendment No. 2'').
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The proposed rule change, together with Amendment No. 1, was
published for comment in Securities Exchange Act Release No. 34569
(August 22, 1994), 59 FR 44437 (August 29, 1994). No comments were
received on the BSE proposal. This order approves the proposed rule
change, including Amendment No. 2 on an accelerated basis.
II. Description of the Proposal
The Exchange proposes to amend Chapter II of its Rules to add a new
Section 38 to codify procedures for stopping stock and to establish a
pilot program permitting BSE specialists to stop stock in minimum
variation markets.\4\ Under the proposed rule change, an agreement by a
BSE specialist to ``stop'' securities at a specified price will
constitute a guarantee by the specialist of the purchase or sale of the
securities at the specified price (or better). According to the
Exchange, the practice of stopping stock enables BSE specialists to
offer primary market price protection,\5\ without negatively impacting
the national market system by disseminating executions at prices away
from the primary market (e.g., double up or down ticks, new highs or
new lows, or out-of-range prints). If, however, the stopped order is
executed at a less favorable price, the specialist will be liable for
an adjustment of the difference between the two prices.
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\4\The BSE has proposed a March 21, 1995 termination date for
its minimum variation market pilot program to conform with the pilot
program of other exchanges. See Amendment No. 1, supra, note 3.
\5\See generally, Ch. II, Sec. 33 of the BSE Rules. For
securities traded through the Intermarket Trading System (``ITS''),
the Exchange's price protection rules are designed to ensure that
customers receive an execution on the BSE that is no worse than they
would have received had their order been transmitted to the primary
market.
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The proposed rule change will impose certain procedural
requirements for the handling of stopped orders. A BSE specialist will
be permitted to stop stock upon the unsolicited request of another
member. After granting the stop, the specialist must display the order
in his or her quote. Thus, where the spread between the consolidated
best bid and offer is greater than the minimum variation, a specialist
who stops a buy (sell) order will be required to reduce the spread by
bidding (offering) at a price higher (lower) than the prevailing bid
(offer). In a minimum variation market, the specialist must change his
or her quoted bid (offer) size in order to reflect the size of the
order being stopped.\6\
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\6\As noted above, see supra note 4, BSE specialists will be
permitted to stop stock in minimum variation markets on a pilot
basis until March 21, 1995.
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Stopped orders will be placed on the specialist's limit order book
and, consistent with the BSE's price protection rules,\7\ will be
filled based on trades that occur in the primary market. The BSE
proposal also will implement certain procedures, on a pilot basis until
March 21, 1995, governing the execution of stopped stock in minimum
variation markets. Under that pilot program, a stopped buy (sell) order
will be filled (1) when a transaction takes place on the primary market
at the stop price or higher (lower); (2) when the share volume on the
Exchange at the bid (offer) is exhausted or (3) at any time at a better
price, subject to the conditions discussed below.
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\7\See supra, note 5 and accompanying text.
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In certain limited circumstances, the proposed rule change will
allow a BSE specialist to execute a stopped order before limit order
interest on the Exchange is exhausted.\8\ Before a specialist can fill
a stopped order in this manner, however, the specialist must make the
determination that such action is necessary, in his or her professional
judgment, to prevent an execution that would create a new high or new
low, double up or down tick or out-of-range print on an order that is
due.\9\
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\8\See Amendment No. 2, supra, note 3; and letter from Karen A.
Aluise, Assistant Vice President, BSE, to Howard Kramer, Associate
Director, Division of Market Regulation, SEC, dated November 16,
1994 (``November 16th letter'').
\9\See November 16th letter, supra, note 8.
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Moreover, the specialist must follow certain procedures designed to
ensure that the BSE's limit order book is adequately protected. First,
the proposed interpretation will require that the specialist split any
contra-side order flow between the stopped order and limit orders with
priority at the better price. In addition, if the specialist elects to
fill a stopped order at a price better than the stop price before it is
otherwise due an execution, he or she must allocate an equal number of
shares, up to a maximum of 500 shares, to orders at that price on the
limit order book. Finally, if any portion of a stopped order remains
unexecuted at the end of the trading day, the specialist must fill such
order in its entirety and, as described above, allocate an appropriate
number of shares to the book.
The Exchange states that the proposed rule change is consistent
with Section 6(b)(5) of the Act in that it furthers the objectives to
promote just and equitable principles of trade, to foster cooperation
and coordination with persons engaged in regulating, clearing,
settling, processing information with respect to and facilitating
transactions in securities, to remove impediments to and perfect the
mechanism of a free and open market and a national market system and,
in general, to protect investors and the public interest; and is not
designed to permit unfair discrimination between customers, issuers,
brokers or dealers.
III. Discussion
The Commission finds that the proposed rule change 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 Sections 6(b) and 11(b).\10\ In
particular, the Commission believes the proposal is consistent with the
Section 6(b)(5) requirements that the rules of an exchange be designed
to promote just and equitable principles of trade, to prevent
fraudulent and manipulative acts, and, in general, to protect investors
and the public interest. The Commission also believes that the proposed
rule change is consistent with the requirements of Section 11(b), and
Rule 11b-1 thereunder,\11\ that specialist transactions must contribute
to the maintenance of fair and orderly markets.
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\10\15 U.S.C. Sec. 78f(b) (1988).
\11\17 CFR 240.11b-1 (1991).
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The Commission historically has been concerned that the practice of
stopping stock may compromise the specialist's fiduciary duty to
unexecuted customer orders on the limit order book.\12\ The Commission,
however, has approved the practice in limited circumstances where the
potential harm is offset by the improvement in marketplace liquidity
and the possibility of price improvement for the customer.\13\
Accordingly, those exchanges with stopping stock rules\14\ require
their specialists to reduce the spread between the consolidated best
bid and offer or, in minimum variation market, to add size at the
inside quote. The Commission believes that such a requirement strikes
an appropriate balance between the interests of various market
participants. Moreover, by encouraging accurate representation of the
trading interest held by the specialist, it also facilitates greater
transparency in the securities markets. In the Commission's opinion,
such safeguards are a critical aspect of an exchange's stopping stock
rule.
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\12\See, e.g., SEC, Report of the Special Study of the
Securities Markets of the Securities and Exchange Commission, H.R.
Doc. No. 95, 88th Cong., 1st Sess. Pt 2 (1963).
When stock is stopped, book orders on the opposite side of the
market that are entitled to immediate execution lose their priority.
If the stopped order then receives a better price, limit orders at
the stop price are bypassed and, if the market turns away from that
limit, may never be executed.
\13\See, e.g., Securities Exchange Act Release No. 28999 (March
21, 1991), 56 FR 12964 (March 28, 1991) (File No. SR-NYSE-90-48)
(approving proposed rule change to permit New York Stock Exchange
(``NYSE'') specialists to stop stock in minimum variation markets
when (1) an imbalance is of sufficient size to suggest the
likelihood of price improvement) (``1991 NYSE approval order''). In
approving the NYSE proposal, the Commission found, among other
things, that a stopped order is the equivalent of a limit order for
purposes of Section 11(b) of the Act.
\14\See NYSE Rule 116.30; American Stock Exchange (``Amex'')
Rule 109; and Article XX, Rule 12 of the Chicago Stock Exchange
(``CHX'') Rules. See also Securities Exchange Act Release No. 34614
(August 30, 1994), 59 FR 46280 (September 7, 1994) (File No. SR-
Phlx-93-41) (approving a Philadelphia Stock Exchange (``Phlx'')
proposal to codify its procedures for stopping stock into Equity
Floor Procedure Advice A-2, Stopping Orders).
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After careful review, the Commission has concluded that the
proposed rule change should help ensure that BSE specialists handle
stopped orders in a manner which is consistent with their obligation to
maintain fair and orderly markets.\15\ Under the BSE proposal, a
specialist who stops an order will be required to display that order in
his or her market. In particular, the specialist must reduce the spread
between the consolidated best bid and offer or, in a minimum variation
market, add size at the inside quote. In addition, the customer will
receive an opportunity for price improvement, rather than automatic
execution at the displayed quotation. The Commission therefore is
satisfied that the proposed rule change should increase the likelihood
that a customer whose order is stopped will receive price improvement
and result in narrower and/or deeper markets. This, in turn, should
enhance the liquidity and transparency of the market for securities
traded on the BSE.
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\15\See Ch. XV, Sec. 2. of the BSE Rules. In addition, the
Commission notes that the definition of stopping stock proposed by
the BSE is substantively identical to other exchanges' definition.
See, e.g., NYSE Rule 116. Although an agreement to stop securities
at a specified price constitutes a guarantee, by the specialist, of
the purchase or sale of the securities at that price or better, the
order can interact with all market interest. For that reason, the
Commission has concluded that a specialist granting a stop does not
enter into an unconditional contract within the meaning of Rule 3b-3
under the Act. 17 CFR 240.3b-3 (1991).
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Despite these potential benefits, the Commission continues to be
particularly concerned that, in minimum variation markets, limit orders
on the specialist's book may be bypassed when stopped orders are
executed at a better price. For that reason, the Commission has
required that procedures for stopping stock in minimum variation
markets be implemented on a pilot basis. These pilot programs have been
extended until March 21, 1995, in order to allow the Commission and the
relevant exchanges to determine whether the benefits of the practice
substantially outweigh the costs thereof.\16\ In the interim, the
Commission believes that it is appropriate to place the BSE on equal
competitive footing with the other exchanges and to approve the BSE's
procedures for stopping stock in minimum variation markets as a pilot
program until March 21, 1995.
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\16\Currently, the NYSE, Amex and CHX have pilot programs that
permit specialists to stop stock in minimum variation markets. For
further discussion of these pilot programs and the Commission's
rationale for extending them until March 21, 1995, see Securities
Exchange Act Release Nos. 33792 (March 21, 1994), 59 FR 14437 (March
28, 1994) (File No. SR-NYSE-94-06); 33791 (March 21, 1994), 59 FR
14432 (March 28, 1994) (File No. SR-Amex-93-47); and 33790 (March
21, 1994), 59 FR 14434 (March 28, 1994) (File No. SR-CHX-93-30)
(``1994 CHX approval order'').
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In making this determination, the Commission recognizes the
interplay between a regional exchange's price protection rules and its
procedures for handling stopped stock. As the Commission noted in
regard to a similar CHX proposal,\17\ in a minimum variation market,
requiring regional exchange specialists to fill stopped orders at the
price of the next primary market sale may have unintended consequences.
Specifically, if the next trade occurs at a price better than the stop
price and if there are limit orders with time priority at that price,
execution of the stopped order would trigger the execution of all pre-
existing limit orders, even if they are not otherwise entitled to be
filled.
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\17\See 1994 CHX approval order, supra, note 16. Under Art. XX,
Rule 37, Interpretation .03 of the CHX Rules, in a minimum variation
market, a stopped buy (sell) order will not be filled until (1) a
transaction takes place at the offering (bid) price or higher
(lower) on the primary exchange or (2) the CHX's displayed share
volume at the bid (offer) has been exhausted (i.e., the stopped
order has time priority at the better price).
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In the Commission's opinion, the Exchange's pilot program is a
reasonable attempt to ensure that same-side limit orders on the book
are not bypassed when stock is stopped in minimum variation markets. As
proposed, the BSE specialist can fill a stopped order at the stop price
after a trade takes place in the primary market at that price or worse
(i.e., after a new range for the day is created which includes the stop
price). If the next sale takes place at a better price, the specialist
will not be required to fill the stopped order until all pre-existing
share volume on the BSE is exhausted (i.e., the stopped order has
priority at the better price). A BSE specialist, however, can elect to
fill a stopped order at a better price at any time, so long as
customers with limit orders on the book are adequately protected.
This portion of the proposed rule change will allow the specialist
to address those situations where, based on his or her professional
judgment, the specialist determines that executing a stopped order
ahead of same-side limit orders is necessary to ensure that the
customer receives the best price available in the national market
system.\18\ To the extent the specialist faces a choice between
assuming a significant position where not otherwise warranted by
Exchange rules or disseminating an execution at a price away from the
market, the Commission finds that the BSE proposal presents an
acceptable third alternative.
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\18\See November 16th letter, supra, note 8. For instance, a
specialist might rely on the proposed interpretation in a situation
where, at the time a stopped order is due, there are a substantial
number of shares ahead of that order on the book and the primary
market has not traded at the stop price that day (or has not done so
within several hours).
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In this context, the Commission notes that a specialist executing a
stopped order pursuant to the proposed interpretation will be required
to allocate an equal number of shares to the limit order book. Under
the proposed rule change, the specialist must split contra-side order
flow between the stopped order and the pre-existing limit orders; if
the specialist elects to participate, those limit orders with priority
will receive an execution of the size of the stopped stock printed (up
to a maximum of 500 shares). In light of the relatively thin limit
order books on a regional exchange such as the BSE, the Commission
believes that, as a practical matter, the proposed rule change is
unlikely materially to disadvantage customers with limit orders on the
specialist's book. The Commission, however, will monitor the Exchange's
pilot program to ensure that the benefits of stopping stock in minimum
variation markets warrant continued approval of such procedures.
The Commission therefore requests that the BSE submit a report
describing its experience with its minimum variation market pilot
program by February 7, 1995. Specifically, the Exchange should gather
and report information for a one month period on (1) the number of
orders stopped in minimum variation markets; (2) the average size of
such orders; and (3) the percentage of stopped orders that receive
price improvement. In addition, the BSE should work with the Commission
to develop an appropriate measure of the pilot program's impact on
limit orders, particularly those limit orders on the specialist's book
ahead of the stopped stock. Finally, if the Exchange determines to
request an extension of the pilot program beyond March 21, 1995 or
permanent approval thereof, the Commission requests that the BSE also
submit a proposed rule change by February 7, 1995.
The Commission finds good cause for approving Amendment No. 2 prior
to the thirtieth day after the date of publication of notice of filing
thereof. Amendment No. 2 clarifies certain procedural requirements
contained in the original filing. Finally, the Commission did not
receive any comments on the original proposal, which was published in
the Federal Register for the full comment period.
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rules
change that are filed with the Commission, and all written
communications relating to Amendment No. 2 between the Commission and
any persons, other than those that may be withheld from the public in
accordance with the provisions of 5 U.S.C. Sec. 552, will be available
for inspection and copying in the Commission's Public Reference
Section, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of such
filing will also be available at the principal office of the BSE. All
submissions should refer to File No. SR-BSE-94-09 and should be
submitted by January 5, 1995.
IV. Conclusion
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\19\ that the proposed rule change (SR-BSE-94-09), including
Amendment No. 2 on an accelerated basis, is approved.
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\19\15 U.S.C. Sec. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\20\
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\20\17 CFR 200.30-3(a)(12) (1991).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-30782 Filed 12-14-94; 8:45 am]
BILLING CODE 8010-01-M
