[Federal Register Volume 63, Number 236 (Wednesday, December 9, 1998)]
[Notices]
[Pages 67966-67969]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-32604]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40722; File No. SR-NYSE-97-09]
Self-Regulatory Organizations; New York Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change and Notice of Filing
and Order Granting Accelerated Approval to Amendment No. 1 Relating to
Specialists' Handling of Percentage Orders
November 30, 1998.
I. Introduction
On March 25, 1997, the New York Stock Exchange, Inc. (``NYSE'' 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 amend NYSE Rule 123A.30,
relating to specialists' handling of percentage orders.
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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 the Federal
Register on May 21, 1997.\3\ No comments were received on the proposal.
On June 15, 1998, the Exchange submitted Amendment No. 1 to the
proposed rule change.\4\ This order approves the proposed rule change
and approves Amendment No. 1 to the proposed rule change on an
accelerated basis.
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\3\ See Securities Exchange Act Release No. 38630 (May 13,
1997), 62 FR 27822.
\4\ See Letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Michael Walinskas, Deputy Associate Director,
Division of Market Regulation, Commission, dated June 12, 1998
(``Amendment No. 1''). In Amendment No. 1, the NYSE clarifies that
its proposal to add the phrase ``or converted'' to the last
paragraph of NYSE Rule 123A.30 would not change the existing rules
governing the conversion of percentage orders. Instead, the Exchange
believes that the issue of whether an executed percentage order was
``elected'' or ``converted'' to a limit order is irrelevant to its
proposal to allow such execution to trigger the election of another
percentage order on the opposite side of the market.
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II. Background and Description of the Proposal
A. Background
A percentage order is a limited price order to buy or sell 50% of
the volume of a specified stock after its entry. A percentage order is
essentially a memorandum entry left with a specialist which becomes a
``live'' order capable of execution in one of two ways: (i) all or part
of the order can be ``elected'' as a limit order on the specialist's
book based on trades in the market; or (ii) all or part of the order
can be ``converted'' into a limit order to make a bid or offer or to
participate directly in a trade.
1. The Election Process
Under the election process, as trades occur at the percentage
order's limit price or better, an equal number of shares of the
percentage order are ``elected'' and become a limit order on the
specialist's book. This limit order takes its place behind other limit
orders on the specialist's book at the same price. The percentage order
then is reduced by the number of elected shares until the entire order
has been satisfied.
Currently, there are four types of percentage orders; last sale
percentage orders, straight limit percentage orders,\5\ buy minus-sell
percentage orders,\6\ and immediate execution or cancel election
percentage orders.\7\ The Exchange has indicated that most percentage
orders are entered as last sale percentage orders, meaning that they
are elected to the book at the price of the electing sale and may be
executed at that price, or at a better price.\8\
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\5\ A straight limit percentage order carries a limit price
equal to the percentage order limit price.
\6\ A buy minus-sell plus percentage order operates in the same
fashion as a straight limit percentage order, except that it places
the additional requirement that elected portions of buy (sell)
percentage orders be elected at a price on minus or zero-minus ticks
(plus or zero plus ticks) from the previous sale.
\7\ An immediate execution or cancel election percentage order
instructs the specialist to execute the elected portion of the
percentage order immediately in whole or in part at the price of the
electing transactions. The remaining unexecuted elected portion of
the percentage order, if any, reverts back to an unelected
percentage order, subject to subsequent election or conversion. See
Securities Exchange Act Release No. 39837 (April 8, 1998) 63 FR
18244 (April 14, 1998) (order approving File No. SR-NYSE-97-38).
\8\ The various types of percentage orders differ only in terms
of execution, and not the process by which they are elected. See
notes 5-7 supra.
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2. The Conversion Process
The second way that a percentage order can be activated into a
limit order is through the conversion process. Most percentage orders
contain the additional instruction, ``CAP-D.'' ``CAP'' is an acronym
meaning ``convert and parity,'' which instructs the specialist that he
or she may convert all or a portion of the order into a limit order,
and allows the specialist to be on parity with the converted percentage
order, either to participate directly in a trade or to make a bid or
offer (``bettering the market''). The ``D'' notation instructs the
specialist that, under certain circumstances, the order may be
converted to participate in destabilizing transactions, as well as
stabilizing transactions.
The Exchange has stated that, as a practical matter, it views CAP-D
orders as a necessary adjunct to the standard election procedures
because they allow the specialist greater flexibility to match the
order with other buying and selling interest in the market. CAP-D
orders are subject to a number of restrictions intended to minimize the
specialist's discretion in handling such orders.9
Specifically, under the conversion process, the specialist may convert
a percentage order into a ``live'' limit order on a destabilizing tick
only where: (i) the transaction for which the order is being converted
is for 10,000 shares or more; and (ii) the price at which the converted
percentage order is to be
[[Page 67967]]
executed is no more than \1/4\ point away from the last sale price;
provided, however, that this price parameter may be modified, in
appropriate cases, with the prior approval of a Floor Official and the
written consent of the broker who entered the order.10
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\9\ See NYSE Rule 123A.30; Securities Exchange Act Release No.
24505 (May 22, 1987) 52 FR 20484 (June 1, 1987) (order approving
File No. SR-NYSE-85-1 to permit conversion of percentage orders on
destabilizing ticks under certain circumstances).
\10\ For a more detailed description of the procedures under
which a percentage order may be converted on a destabilizing tick,
see Securities Exchange Act Release No. 24505, supra note 9.
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B. Description of the Proposal
Currently, NYSE Rule 123A.30 provides that percentage orders shall
not be elected by any portion of volume which results from the
execution of a previously elected portion of a percentage order.
According to the Exchange, the intent of this restriction is to prevent
``chain reaction'' executions of percentage orders whereby executions
of elected portions of percentage orders trigger additional elections.
This result would be contrary to the objectives of most investors
entering percentage orders, who generally want to ``go along'' with the
overall trend of the market as reflected by other market interest,
without necessarily leading that trend.
As currently interpreted, NYSE Rule 123A.30 does not distinguish
between the election or conversion of percentage orders on the same
side of the market and the election or conversion of percentage orders
on opposite sides of the market. The Exchange believes that the
restriction should be applied only to percentage orders on the same
side of the market, as ``same side'' orders are the ones to be executed
along with the market trend.11
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\11\ For example, buy percentage orders would be elected and
executed along with other buying interest, and sell percentage
orders would be elected and executed along with other selling
interest.
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The Exchange is proposing to amend NYSE Rule 123A.30 to provide
that percentage orders held by a specialist may be elected by the
execution of a previously elected or converted 12 portion of
a percentage order that is on the opposite side of the
market.13
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\12\ See Amendment No. 1, supra note 4.
\13\ For example, assume that the market is 20 to 20\1/4\, 2,000
by 2,000, with the 2,000 share offer representing 2,000 ``elected''
or ``converted'' shares of a percentage order to sell 10,000 shares.
The specialist then receives a last sale percentage order to buy
10,000 shares at a limit price of 20\5/8\ after which he receives
through SuperDOT an order to buy 1,000 shares at the market. After
bidding 20\1/16\ on behalf of the SuperDOT order, the specialist
executes that order against the 2,000 share offer at 20\1/4\. Under
the current rule, no portion of the buy percentage order would be
elected, and no additional portion of the sell percentage order
would be elected. Under the proposed rule change, 1,000 shares of
the buy percentage order would be elected at 20\1/4\, and would then
trade the remaining 1,000 share balance of the offer at 20\1/4\. No
portion of the sell percentage order would be elected since the
execution of the remaining 1,000 share sell balance would result
from the execution of a previously elected or converted percentage
order on the same side of the market.
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The Exchange also is proposing to amend NYSE Rule 123A.30 to permit
the specialist to convert a percentage order on a destabilizing tick,
as otherwise permitted by the rule, when the transaction is 10,000
shares or more or represents a quantity of stock having a market value
of $500,000 or more (whichever is less). The Exchange notes that this
amendment will conform the size of permitted transactions to the
definition of a ``block'' in NYSE Rule 97.
III. Discussion
The Commission has considered carefully whether the NYSE's proposal
is consistent with the Act and the rules and regulations thereunder
applicable to a national securities exchange.14
Specifically, the Commission has considered whether the proposal is
consistent with the requirements set forth in Sections 6(b) and 11(b)
of the Act.15 In reviewing previous proposals involving
percentage orders, the Commission has been concerned whether such
orders provide the specialist with ``discretion'' in violation of
Section 11(b) of the Act.16 Section 11(b) was designed, in
part, to address potential conflicts of interest that may arise as a
result of a specialist's dual role as agent and principal in executing
stock transactions. In particular, Congress intended to prevent
specialists from unduly influencing market trends through their
knowledge of market interest from the specialist book and their
handling of discretionary agency orders.17 The Commission
has interpreted this section to mean that all orders other than market
or limit orders are discretionary and therefore cannot be accepted by a
specialist.18
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\14\ In approving the proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
\15\ 15 U.S.C. 78f(b) and 78k(b).
\16\ 15 U.S.C. 78k(b).
\17\ See H. Rep. No. 1383, 73d Cong., 2d Sess. 22; S. Rep. 792,
73d Cong., 2d Sess. 18 (1934).
\18\ See, e.g., SEC, Special Study of the Securities Markets,
H.R. Doc. No. 95, 88th Cong., 1st Sess., Part 2, 72 (1963)
(``Special Study'') (noting that ``Section 11(b) . . . prohibits,
without exception, a specialist's effecting any transaction except
upon a market or limit order'').
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The Commission previously has determined that it is appropriate to
treat percentage orders as equivalent to limit orders.\19\ With regard
to the conversion process in particular, while acknowledging that it
permits specialists to employ their judgment to a certain extent, the
Commission believed that the requirements imposed on the specialist
when converting a percentage order for execution or quotation purposes
provided sufficiently stringent guidelines to ensure that the
specialist only will implement the conversion provisions in a manner
consistent with his or her market making obligations and Section
11(b).\20\
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\19\ See Securities Exchange Act Release No. 24505, supra note
9.
\20\ 15 U.S.C. 78k(b).
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Furthermore, the Commission previously has determined that the
NYSE's percentage order rules are consistent with the standards set
forth under Section 6(b)(5) of the Act.\21\ This section requires that
the rules of an exchange be designed to prevent fraudulent and
manipulative acts and practices. The Commission determined that the
NYSE's percentage order rules contain various limiting and protective
provisions, to ensure that such rules will not increase the possibility
of specialist abuse of the market.
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\21\ 15 U.S.C. 78f(b)(5).
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As discussed in greater detail below, the Commission finds that the
proposed rule change, in allowing a specialist to elect a percentage
order based on the execution of a previously elected or converted
percentage order on the opposite side of the market and modifying the
restrictions pertaining to the conversion of a percentage order on a
destabilizing tick, does not adversely impact the protective scheme
that has been incorporated into the percentage order rules.
Accordingly, the Commission finds that the proposed rule change is
consistent with Sections 6(b)(5) and 11(b) of the Act \22\ in that it
neither greatly increases specialists' ability to engage in fraudulent
and manipulative practices nor allots discretion to specialists in
their handling of percentage orders.
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\22\ 15 U.S.C. 78f(b)(5) and 78k(b).
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A. Proposed Modification to the Election Process
Currently, a percentage order may not be elected based on the
execution of a previously elected or converted percentage order. For
purposes of this prohibition, the current rules do not distinguish
between percentage orders on the same side of the market and those on
opposite sides of the market. The Exchange's proposal provides that
percentage orders held by a specialist may be elected by the execution
of a previously elected or converted portion of a percentage order that
is on the opposite side of the market.
[[Page 67968]]
The Commission believes that it is consistent with the Act to allow
the election of a percentage order based on the execution of a
percentage order on the opposite side of the market. The Commission
believes that the proposed rule change is consistent with the
underlying rationale for the percentage order rule; namely, to allow
larger-sized orders to trade along with the trend of the market, rather
than lead that trend. For example, a percentage order cannot elect
itself by its execution. Instead, independent interest on the same side
of the market is needed to trigger an election. In addition, the
Commission anticipates that by allowing the execution of percentage
orders to trigger the election of percentage orders on the opposite
side of the market, the proposal should increase the likelihood that
percentage orders held by the specialist will be elected as limit
orders and ultimately, executed.
Moreover, the Commission finds that permitting the election of a
percentage order based on the execution of a previously elected or
converted percentage order on the other side of the market is
consistent with the Act in that it does not provide discretion to
specialists in the handling of percentage orders. Instead, the
Commission notes that previously executed percentage orders, regardless
of whether initially elected or converted, will trigger the election of
percentage orders on the other side of the market. The specialist is
not provided any discretion over the process of electing percentage
orders on the other side of the market, once a previously elected or
converted percentage order has been executed, in accordance with the
Exchange's rules.
Finally, the Commission notes that the Exchange's rules will
continue to prohibit the election of percentage orders based on the
execution of percentage orders on the same side of the market. The
Commission believes that this continued prohibition, which will prevent
same side percentage orders held by the specialist from being elected
by the execution of percentage orders, is appropriate.
B. Proposed Modification to the Conversion Process
The Exchange's proposal also permits the specialist to convert a
percentage order on a destabilizing tick, as otherwise permitted by the
rule, when the transaction is 10,000 shares or more or represents a
quantity of stock having a market value of $500,000 or more (whichever
is less). NYSE Rule 123A.30 currently provides that the specialist may
convert a percentage order on a destabilizing tick only where: (i) the
transaction for which the order is being converted is for 10,000 shares
or more; and (ii) the price at which the converted percentage order is
to be executed is no more than \1/4\ point away from the last sale
price; provided, however, that this price parameter may be modified, in
appropriate cases, with the prior approval of a Floor Official and the
written consent of the broker who entered the order.
The Commission notes that by allowing a specialist to convert an
order on a destabilizing tick when the transaction being converted is
for 10,000 shares or more or represents a quantity of stock having a
market value of $500,000 or more, whichever is less, the proposed
change will make the size of permitted transactions consistent with the
definition of a ``block'' transaction in NYSE Rule 97. The Commission
agrees that the proposed amendment, which will liberalize the
requirements of NYSE Rule 123A.30, should facilitate conversion of
percentage orders in stocks where the size of the trade has the
appropriate market value to qualify as a block transaction, but may not
have a share size of 10,000 or more. The Commission notes that the
conversion procedures were intended to allow percentage orders to
participate immediately with large-sized contra-side orders entering
the market.\23\ Previously, percentage orders were not eligible for
execution until an electing transaction had occurred. As a result, all
or part of a large percentage order was elected for execution in a
large-size trade's ``after-market,'' where execution of the elected
portion could disrupt price continuity.\24\ Therefore, the Commission
believes that amending the conversion rules to parallel the definition
of a block transaction in NYSE Rule 97 will align the rules more
closely with the original intent of the conversion procedures.
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\23\ See Securities Exchange Act Release No. 21704 (February 1,
1985) 50 FR 5834 (February 12, 1985) (noticing File No. SR-NYSE-85-
1).
\24\ For example, if the sale of a block of stock results in a
price decline, the subsequent execution of a large percentage buy
order elected by the execution of that block transaction could drive
the price up again. Id.
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While the proposal will afford specialists greater opportunity to
convert percentage orders on a destabilizing tick, the Commission
believes that existing requirements imposed on the specialist when
converting percentage orders for execution or quotation purposes are
sufficiently restrictive to ensure that the specialist will act in a
manner consistent with his market making obligations and Section 11(b)
of the Act.\25\ In addition, the Commission believes that the limiting
and protective provisions incorporated into the Exchange's conversion
procedures should ensure that the proposal will not increase the
likelihood of fraudulent and manipulative activities by specialists.
Therefore, the Commission believes that the proposal is consistent with
Section 6(b)(5) of the Act.\26\
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\25\ 15 U.S.C. 78k(b).
\26\ 15 U.S.C. 78f(b)(5).
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The Commission finds good cause for approving proposed Amendment
No. 1 prior to the thirtieth day after the date of publication of
notice of filing thereof in the Federal Register. In Amendment No. 1,
the NYSE attempts to clarify its proposal, with respect to the effect
of the execution of percentage orders previously converted, in response
to questions raised by Commission staff. As the NYSE's clarification
does not in any way modify its original proposal, the Commission
believes that Amendment No. 1 raises no novel issues of regulatory
concern. Accordingly, the Commission believes that it is consistent
with Section 6(b)(5) of the Act \27\ to approve Amendment No. 1 to the
proposed rule change on an accelerated basis.
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\27\ 15 U.S.C. 78f(b)(5).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 1, including whether Amendment No. 1
is consistent with the Act. 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.
552, will be available for inspection and copying in the Commission's
Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of all such filings also will be available for inspection and
copying at the principal office of the NYSE. All submissions should
refer to File No. SR-NYSE-97-09 and should be submitted by December 30,
1998.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\28\ that the proposed rule change (SR-NYSE-97-09), as amended, is
approved.
\28\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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\29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-32604 Filed 12-8-98; 8:45 am]
BILLING CODE 8010-01-M
