[Federal Register Volume 62, Number 250 (Wednesday, December 31, 1997)]
[Notices]
[Pages 68334-68338]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-33995]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39477; File No. SR-PCX-97-43]
Self-Regulatory Organizations; Order Granting Accelerated
Approval of Proposed Rule Change and Notice of Filing and Order
Granting Accelerated Approval to Amendment No. 2 to Proposed Rule
Change by the Pacific Exchange, Inc. Relating to Its Specialist
Evaluation Program
December 22, 1997.
On November 17, 1997, the Pacific Exchange, Inc. (``PCX'' 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 extend its pilot program
regarding the evaluation of its equity specialists until January 1,
1999, and to implement certain changes to the pilot program.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in Securities
Exchange Act Release No. 39358 (November 25, 1997), 62 FR 64035
(December 3, 1997). No comments were received on the proposal. The
Exchange filed Amendment No. 2 to the proposed rule filing on December
5, 1997.\3\ This order approves the proposed rule change, as amended,
on an accelerated basis.
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\3\ Amendment No. 2 states that the Equity Allocation Committee
(``EAC'') will consider mitigating circumstances on a case-by-case
basis. The restrictions will apply in all cases in which the
specialist fails to meet the standards; any failure to impose the
restrictions should not be routine and should only occur in
exceptional circumstances which demonstrate that imposing the
restrictions is not justified. For example, the EAC may consider a
systems problem to be a mitigating circumstance in a particular
case. See letter from Jeffrey S. Norris, Manager, Regulatory
Development, PCX, to Heather Seidel, Attorney, Market Regulation,
Commission, dated December 4, 1997 (``Amendment No. 2'').
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I. Description
On October 1, 1996, the Commission approved a nine-month pilot
program for the evaluation of PCX equity specialists.\4\ On June 3,
1997, the
[[Page 68335]]
Commission approved a six-month extension of that pilot program.\5\
The reason for the extension was to allow the PCX more time to evaluate
the impact of the SEC's new order handling rules on the performance
criteria and to determine an appropriate overall passing score and
individual passing scores for each criterion. The Exchange now is
proposing to extend the pilot program until January 1, 1999. The PCX
has established an overall passing score and individual passing scores
for each criterion and has determined when specialists that do not
attain the minimum passing scores should meet with the EAC. The
Exchange is also proposing to replace the ``Bettering the Quote''
criterion with Price Improvement and to lower the weighting of the
Specialist Evaluation Questionnaire from 15% to 10% so that Price
Improvement can be given a weight of 10%.
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\4\ Prior to the adoption of the pilot program, PCX Rule 5.37(a)
provided that the Exchange's EAC evaluate all registered specialists
on a quarterly basis and that each specialist receive an overall
evaluation rating based on three criteria of specialist performance:
(1) Specialist Evaluation Questionnaire Survey (``Questionnaire'')
(45% of overall score); (2) SCOREX Limit Order Acceptance
Performance (10%); and (3) National Market System Quote Performance
(45%). See PSE Rule 5.37 (July 1995).
The original pilot program modified Rule 5.37(a) by adding three
new criteria of performance and eliminating one performance
criterion. Prior to this proposed rule change, the pilot contained
the following criteria: (1) Executions (50%) (itself consisting of
four criteria: (a) Turnaround Time (15%); (b) Holding Orders Without
Action (15%); (c) Trading Between the Quote (10%); and (d)
Executions in Size Greater Than BBO (10%)); (2) Book Display Time
(15%); and (3) Post-1 p.m.Parameters (10%). The pilot also
eliminated the SCOREX Limit Order Acceptance Performance criterion.
Further, the pilot added more questions to the Questionnaire, and
reduces its weight from 45% to 15% of the overall score. Finally,
the National Market System Quote Performance criterion (renamed
Quote Performance under the pilot) was amended to include within it
an additional submeasure for bettering the quote (each of the two
submeasures under this criterion is accorded a weight of 5% of the
overall score). For a more detailed description of the performance
criteria utilized in the PCX's pilot program, see Securities
Exchange Act Release No. 37770 (October 1, 1996), 61 FR 52820
(October 8, 1996) (File NO. SR-PSE-96-28). See also generally PCX
Rule 5.37 (description of the standards and procedures applicable to
the EAC's evaluation of specialists).
\5\ See Securities Exchange Act Release No. 38712 (June 3,
1997), 62 FR 17941 (July 8, 1997).
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Price Improvement
``Price Improvement'' measures the number of trades involving
market and marketable limit orders that improve the national best bid
or offer (``NBBO'') if the NBBO quote spread at the time the original
order is received is greater than or equal to two trading
differentials, but less than or equal to eight trading differentials
for that security. The execution price for stopped market or marketable
limit orders will be compared with the guaranteed price (which is the
NBBO at the time the order was received).
Orders completely or partially executed will be considered for
price improvement. All one-sided market or marketable limit orders \6\
with an NBBO quote spread greater than \1/8\ point are eligible for
price improvement. Only agency orders entered or received by an
exchange are eligible for price improvement. Orders with time-in-force
designations such as good until canceled (GTC), good through day of
entry (DAY), immediate or cancel (IOC), and good until executed will be
eligible for price improvement. In addition, stocks, rights, warrants,
preferred stock, when issued, and when distributed equity securities
will be eligible for price improvement.
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\6\ According to the PCX, the regional exchanges have agreed to
the following definition for marketable limit orders: A marketable
limit order to buy is priced at or above the NBBO offer, a
marketable limit order to sell is priced at or below the NBBO bid.
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The following types of orders will not be considered under the
category of price improvement: all preopening market and limit orders,
limit order executions out of the limit book (i.e., booked orders),
electronically entered limit orders whose price falls in between the
NBBO, non-regular-way trades (i.e., cash, next day and seller's
option), negotiated trades or trades identified as crosses, bonds,
orders designated as possible duplicates (POSS DUPE or try to stop
(TTS), canceled orders, odd-lot market and odd-lot limit orders, orders
designated as all or none (AON), all tick sensitive executions (i.e.,
buy minus, sell plus, sell short, etc.), market quotations under 200
shares, and principal an program trade account types.\7\
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\7\ The PCX states that preopening market and limit orders were
excluded because all such orders are entered prior to there being a
market that is trading, so there is no market to improve upon. Limit
order executions out of the limit book (i.e., booked orders) were
not included because they are filled as the market moves toward
them, not when they are outside of the NBBO. Electronically entered
limit orders whose price falls in between the NBBO were excluded
because these are not executable at the time they are entered,
unless the specialist chooses to fill them. Non-regular-way trades
(i.e., cash, next day and seller's option) and negotiated trades are
not included because they are negotiated and the price does not
necessarily depend upon the NBBO. Trades identified as crosses were
excluded because specialists do not participate in crosses, by
definition. Bonds and orders designated as possible duplicates (POSS
DUPE) were not included because they are entered manually. Canceled
orders were excluded because orders cannot be improved upon if they
are not allowed to be executed. Odd-lot market and odd-lot limit
orders were not included because they are executed automatically in
the background, and the specialist never has the opportunity to
improve upon them. Orders designated as all or none (AON) and all
tick sensitive executions (i.e., buy minus, sell plus, sell short,
etc.) were excluded because they are conditional orders. Market
quotations under 200 shares were not included because they are
usually computer generated and the specialists generally have no
opportunity to improve them. Principal orders were excluded because
they cannot be sent via PCOAST. Program trades were not included
because they involve a large portfolio of stocks and derivative
index products, which are not generally routed to a regional
exchange for execution.
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Specialists will be measured on the percentage of trades that are
price improved. The following table gives the parameters and
corresponding point values:
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Percent of eligible trades improved Points
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40+............................................................ 10
36-39.99....................................................... 9
32-35.99....................................................... 8
28-31.99....................................................... 7
24-27.99....................................................... 6
20-23.99....................................................... 5
16-19.99....................................................... 4
12-15.99....................................................... 3
8-11.99...................................................... 2
4- 7.99..................................................... 1
Below 4........................................................ 0
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Overall Passing Score
The PCX has established an overall passing score of 60 as the
minimum standard that each specialist must attain each quarter. A
specialist will have to obtain better than a passing score in each
individual criterion (see minimum passing scores shown below) to obtain
a minimum passing score of 60. Any specialist who falls below the
minimum passing score will have to appear before the EAC and will be
subject to the following restrictions: no new allocations and no
trading in alternate specialist stocks for the quarter following the
quarter that the specialist was evaluated. Any specialist who does not
attain a passing score in any three out of four quarters will also be
subject to other restrictions imposed by the EAC, including
reallocation of one or more stocks. The EAC will evaluate the
effectiveness of the overall passing score and will adjust it
accordingly.
Individual Criterion Passing Scores
The PCX has established individual passing scores for each
individual criterion based upon third quarter 1997 evaluation results.
The third quarter of 1997 was the first evaluation period that the
Trading Between the Quote, Book Display Time, and Quote Performance
calculations were based upon the NBBO instead of the primary market. In
addition, the evaluation results in the third quarter were based upon
one-sixteenth trading increments instead of one-eighth increments. As a
result of the NBBO changes and the change to
[[Page 68336]]
sixteenths, individual passing scores in the affected criteria were
lower than in previous quarters. Previous quarter scores were not used
to determine individual criterion passing scores because of the
aforementioned changes. PCX states that the EAC will evaluate the
effectiveness of the individual passing scores and will adjust them
accordingly. The individual passing scores for each criterion are as
follows:
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Passing
Evaluation criterion score
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Turnaround Time.............................................. 12
Holding Orders Without Action................................ 7.5
Trading Between the Quote.................................... 5
Executions in Size Greater Than NBBO......................... 2
Specialist Evaluation Questionnaire Survey................... 5
Book Display Time............................................ 10.5
Equal or Better Quote Performance............................ 1
Post 1 P.M. Parameters....................................... 3
Price Improvement............................................ 4
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Any specialist who does not attain a minimum passing score in a
particular criterion for two or more consecutive quarters or more will
be subject to the following:
1. If a specialist does not attain a passing score in any
particular individual criterion for 2 consecutive quarters, the
specialist will have to appear before the EAC. The EAC will meet with
the specialist with the intent of helping the specialist to improve the
score.
2. If a specialist does not attain a passing score in any
particular individual criterion for 3 out of 4 consecutive quarters,
the specialist will either not be permitted to trade any alternate
specialist stocks or not be able to apply for any new stocks for one
quarter. The Equity Allocation Committee will decide which restriction
will apply.
3. If a specialist does not attain a passing score in any
particular individual criterion for 4 out of 5 consecutive quarters, 5
out of 6 quarters, etc., the specialist will be subject to both the
alternate specialist and no new stock restrictions for one quarter. The
EAC may also, at its discretion, impose other restrictions, including
reallocating one or more of the specialist stocks.
The EAC will consider mitigating circumstances on a case-by-case
basis. The restrictions will apply in all cases in which the specialist
fails to meet the standards; any failure to impose the restrictions
should not be routine and should only occur in exceptional
circumstances which demonstrates that imposing the restrictions is not
justified. For example, the EAC may consider a systems problem to be a
mitigating circumstance in a particular case.
II. Discussion
The Commission believes that specialists play a crucial role in
providing stability, liquidity, and continuity to the trading of
stocks. Among the obligations imposed upon specialists by the Exchange,
and by the Act and the rules promulgated thereunder, is the maintenance
of fair and orderly markets in their designated securities.\8\ To
ensure that specialists fulfill these obligations, it is important that
the Exchange conduct effective oversight of their performance. The
PCX's specialist evaluation program is critical to this oversight.
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\8\ Rule 11b-1, 17 CFR 240.11b-1; PSE Rule 5.29(f).
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In its order initially approving the specialist evaluation pilot
program,\9\ the Commission asked the Exchange to monitor the
effectiveness of the amended program. Specifically, the Commission
requested information about the number of specialists who fell into the
bottom 10% of all registered specialists on their respective trading
floors in the overall program, whether they subsequently appeared
before the EAC, and any restrictions placed upon, or further action
taken against, such specialists. The Commission also requested
information as to the number of specialists who appeared before the EAC
as a result of scoring in the bottom 10% in any two out of four
consecutive quarterly evaluations, whether any restrictions were
imposed on such specialists, and the results of any formal proceedings
that were initiated against them.
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\9\ For a description of the Commission's rationale for
initially approving the PCX's adoption of its specialist evaluation
pilot program, see Securities Exchange Act Release No. 37770, supra
note 4. The discussion in the aforementioned order is incorporated
by reference into this order.
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In May 1997, the PCX submitted to the Commission its monitoring
report regarding its specialist evaluation pilot program. The report
described the PCX's experience with the pilot program during the
initial two quarters of its operation (i.e., the fourth quarter of 1996
and the first quarter of 1997). In terms of the overall scope of the
program, the Commission continues to believe that the objective
measures, together with the floor broker questionnaire, should generate
sufficiently detailed information to enable the Exchange to make
accurate assessments of specialist performance. In this regard, the
increased emphasis on objective criteria under the pilot has been
useful in identifying how well specialists carry out certain aspects
(i.e., timeliness of execution, price improvement, and market making
quality) of their responsibilities as specialists.
In June 1997, the Commission approved an extension of the pilot to
January 1, 1997.\10\ Since that time, the Exchange has begun (starting
with the third quarter of 1997) to utilize the NBBO instead of the
primary market quote in Trading Between the Quote, Book Display Time,
and Quote Performance criteria, and the PCX is proposing to continue to
utilize the NBBO for these criteria during the pilot extension. The
Commission continues to believe that the NBBO is a more appropriate
standard in this context in that it will enable the Exchange to gauge
the performance of PCX specialists in comparison with their competitors
not only in the primary market, but in the national market system as a
whole.\11\ Therefore, the Commission finds that the PCX's proposal is
responsive to the Commission's request for such an amendment.
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\10\ See supra note 5.
\11\ The Exchange's use of the primary market quote in these
three measures did not allow for such comparisons to be made in
instances where the primary market quote is not equal to the NBBO.
See Id. at n.16.
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The Commission believes that the proposed overall passing score and
the individual criterion passing scores are consistent with the Act.
The Commission believes that minimum adequate performance thresholds
are an important part of any specialist performance evaluation program
because they allow the Exchange to identify specialists who are not
operating at an acceptable level of performance, both overall and in
individual objective criterion. The Commission has stated that an
effective evaluation program should subject specialists who meet
minimum performance levels on the overall program, but need help or
guidance in improving their performance in a particular area, to
review. While the PCX's current specialist evaluation program subjects
those specialists falling into the bottom 10% of all specialists on his
or her trading floor to review by the EAC, it did not set a minimum
performance level on the overall program, or for the individual
criterion. The proposed rule change rectifies this situation by
imposing overall and individual criterion passing scores.
The Commission notes that the Exchange must apply certain
restrictions on any specialist who fails the overall passing score and
the
[[Page 68337]]
individual criterion passing scores for certain specified time periods.
In addition, the Commission notes that the Exchange has represented
that the EAC will evaluate the effectiveness of the overall and
individual criterion passing scores and will adjust them as necessary.
Finally, the Commission emphasizes that the EAC will consider
mitigating circumstances only on a case-by-case basis and that the
restrictions will apply in all cases in which the specialist fails to
meet the standards, unless exceptional circumstances demonstrate that
imposing the restrictions is not justified. The Commission expects that
any failure to impose the restrictions should not be routine and should
only occur when the exceptional circumstances, such as a systems
problem in a particular case, justify not imposing the
restrictions.\12\
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\12\ See Amendment No. 2, supra note 3.
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The Commission believes that replacing the ``Bettering the Quote''
criterion with Price Improvement, and lowering the Specialist
Evaluation Questionnaire weighting to 10% and according Price
Improvement a 10% weighting, is reasonable under the Act. The
Commission notes that price improvement will measure the number of
trades involving market and marketable limit orders that improve the
NBBO; \13\ Bettering the Quote was originally measured against the
primary market and is now measured against the NBBO. The Commission
also notes that there is still a category for ``Equal or Better Quote
Performance.'' Finally, the Commission notes that Price Improvement
provides an additional objective criterion to measure specialist
performance.
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\13\ The NBBO quote spread at the time of the original order is
received must be greater than or equal to two trading differentials,
but less than or equal to eight trading differentials for that
security. The execution price for stopped market or marketable limit
orders will be compared with the guaranteed price (which is the NBBO
at the time the order was received).
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The Commission believes that it is appropriate to extend the
current pilot program for an additional year, until January 1, 1999.
This period will allow the Exchange to respond to evaluate the
effectiveness of the overall passing score and the individual criterion
passing scores, and the specialist performance program as a whole.
Moreover, the Commission expects the Exchange to conduct an ongoing
examination of the parameter ranges and corresponding points allotted
under each criterion to ensure that they continue to be set at
appropriate levels.
The Commission therefore requests that the PCX submit by October
30, 1998 a proposed rule change pursuant to Rule 19b-4 to include any
proposal by the PCX to extend the pilot beyond January 1, 1999.
In addition, the Commission requests that the PCX submit a report
to the Commission, by October 30, 1998, describing its continuing
experience with the pilot. At a minimum, this report should contain
data, for the first, second and third quarters of 1998, on (1) the
number of specialists who, as a result of failing the overall passing
score in any one quarterly evaluation, appeared before the EAC, and the
type of restrictions that were imposed on such specialists (i.e.,
restriction on new allocations or acting as an alternate specialist),
or any further action that was taken against such specialists; (2) the
number of specialists who, as a result of failing the overall passing
score in any three out of four quarters, appeared before the EAC, and
the type of restrictions that were imposed on such specialists (i.e.,
reallocation of new stocks), or any further action that was taken
against such specialists; (3) the number of specialists who, as a
result of failing any individual criterion passing score for two
consecutive quarters, or three out of four consecutive quarters, four
out of five consecutive quarters, and so on, appeared before the EAC,
and the type of restrictions that were imposed on such specialists; (4)
the number of specialists for whom formal proceedings were initiated,
the results of such proceedings, including a list of any stocks
reallocated from a particular unit; (5) the number of registered
specialists who scored in the bottom 10% of all registered specialists
on his or her trading floor in the overall program; (6) the number of
specialists who, as a result of scoring in the bottom 10% in any one
quarterly evaluation, appeared before the EAC, and the type of
restrictions that were imposed on such specialists (i.e., restrictions
on new allocations or acting as an alternate specialist), or any
further action that was taken against such specialists; (7) the number
of specialists who, as a result of scoring in the bottom 10% in any two
out of four consecutive quarterly evaluations, appeared before the EAC,
whether any restrictions were imposed on such specialists, and whether
formal proceedings were initiated against such specialists; and (8) any
situation in which the restrictions were not imposed due to mitigating
circumstances, what those circumstances where, and the reasoning as to
why the restrictions were not imposed.
The Commission notes that the Exchange's pilot program only
modifies the performance criteria of PCX Rule 5.37(a). Consequently,
the Commission expects the EAC to continue to evaluate the performance
of specialists during the pilot period in accordance with the standards
and procedures found in the PCX rules.\14\
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\14\ In this regard, all specialists falling within the bottom
10% of specialists on their respective floors in any review period
are required to meet with the EAC. See also PCX Rule 5.37 (standards
applicable to specialists falling into the bottom 10% in any two out
of four review periods, including those pertaining to the initiation
of formal reallocation proceedings). Moreover, PCX Rule 5.36(d),
Commentary .03 requires that all specialists falling into the bottom
10% in a review period must be precluded from acting as alternate
specialists until their ranking rises above the bottom 10%, unless
the EAC determines otherwise. In addition, PCX Rule 5.37(b),
Commentary .01 requires that all such specialists shall not be
eligible for new allocations until their ranking rises above the
bottom 10%. Consequently, the Commission expects that appropriate
action in accordance with PCX rules will be taken with regard to
those specialists falling into the bottom 10%. The Commission notes
that the PCX stated its intention to file a rule change to PCX Rule
5.37 to reflect all of the aforementioned changes to its Specialist
Evaluation Pilot Program.
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For the reasons discussed above, the Commission finds that the
PCX's proposal to extend its pilot program is consistent with the
requirements of Sections 6(b) and 11 of the Act \15\ and the rules and
regulations thereunder applicable to a national securities exchange.
Specifically, the Commission finds that the proposed rule change is
consistent with the Section 6(b)(5) requirement that the rules of an
exchange be designed to promote just and equitable principles of trade,
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.\16\
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\15\ 15 U.S.C. 78f(b) and 78k.
\16\ In approving this rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
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Further, the Commission finds that the proposal is consistent with
Section 11(b) of the Act \17\ and Rule 11b-1 thereunder which allow
securities exchanges to promulgate rules relating to specialists in
order to maintain fair and orderly markets and to remove impediments to
and perfect the mechanism of a national market system.
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\17\ 15 U.S.C. 78k(b).
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The Commission finds good cause for approving the proposed rule
change prior to the thirtieth day after the date of publication of
notice thereof in the Federal Register. This will permit the pilot
program to continue both on an uninterrupted basis and with the use of
overall and individual criterion passing scores, and a new measure,
Price Improvement. In addition, the rule
[[Page 68338]]
change that implemented the pilot program initially was published in
the Federal Register for the full comment period, and no comments were
received.\18\ The Commission also finds good cause for approving
Amendment No. 2 prior to the thirtieth day after the date of
publication of notice in the Federal Register. Amendment No. 2
strengthened the proposed rule change by clarifying that the EAC will
consider mitigating circumstances only an a case-by-case basis, and
will only apply them in exceptional circumstances which demonstrate
that imposing the restrictions is not justified. Accordingly, the
Commission believes good cause exists, consistent with the Act, to
accelerate approval of the proposed rule change and of Amendment No. 2.
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\18\ See Securities Exchange Act Release 37770, supra note 4.
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Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 2 to the rule proposal. 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 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. Sec. 552, will
be available for inspection and copying at the Commission's Public
Reference Room. Copies of such filing also will be available for
inspection and copying at the principal office of the Exchange. All
submissions should refer to File No. SR-PCX-97-43 and should be
submitted by January 21, 1998.
III. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) \19\ that the
proposed rule change, as amended, is hereby approved on an accelerated
basis.
\19\ 19 U.S.C. 78s(b)(2).
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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).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-33995 Filed 12-30-97; 8:45 am]
BILLING CODE 8010-01-M
