[Federal Register Volume 61, Number 123 (Tuesday, June 25, 1996)]
[Notices]
[Pages 32875-32876]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-16166]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37326; File No. SR-PSE-96-13]
Self-Regulatory Organizations; Pacific Stock Exchange,
Incorporated; Order Granting Approval to Proposed Rule Change Relating
to Restrictions on Equity Allocations (10% Rule)
June 19, 1996.
On April 10, 1996, the Pacific Stock Exchange, Incorporated
(``PSE'' 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 codify a policy that any
specialist whose score on a quarterly specialist performance evaluation
ranks in the bottom 10% of specialist on his or her trading floor shall
not be eligible for allocations of securities, absent mitigating
circumstances, until such ranking rises above the bottom 10%.
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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. 37142 (April 24, 1996), 61 FR 19328 (May 1,
1996). No comments were received on the proposal.
The Exchange's specialist evaluation program is governed by PSE
Rule 5.37. Subsection (a) of that Rule provides that the Equity
Allocation Committee (``EAC'') shall evaluate all registered
specialists on a quarterly basis. Those evaluations result in overall
ratings of specialists that are based upon three separate measures of
performance, as specified in the Rule.\3\ Subsection (b) provides that
any registered specialists who is in the bottom 10% of all registered
specialists on that specialist's trading floor,\4\ as determined by the
overall evaluation scores in any one quarterly evaluation, shall be
requested to meet with the EAC (or a panel appointed by the EAC) on an
informal basis.\5\ If a specialist is in the bottom 10% during any two
out of four consecutive quarterly evaluations, the specialist is
requested to appear a second time before the EAC to explain his or her
performance.\6\
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\3\ The three measures of performance currently utilized by the
PSE are: (1) National Market System Quote Performance, accounting
for 45% of the overall score, measures the percentage of times in a
given quarter that a specialist's bid and/or offer is equal to or
greater than the best bid or offer in the consolidated quote system
for each dually-traded security; (2) the Specialist Evaluation
Questionnaire Survey, also accounting for 45% of the overall score,
is composed of questions designed to evaluate a specialist's market-
making performance and is to be completed only by floor brokers who
regularly trade with a specialists; and (3) SCOREX Limit Order
Acceptance Performance, which accounts for the final 10% of the
overall score, measures the percentage of P/COAST (formerly SCOREX)
limit orders accepted by a specialist. See Securities Exchange Act
Release No. 28843 (February 1, 1991), 56 FR 5040 (February 7, 1991)
(File No. SR-PSE-87-19) for a more complete description of each of
these measures of performance.
\4\ The PSE maintains two equity trading floors, one in Los
Angeles and one in San Francisco. See PSE Rule 4.1(g).
\5\ See PSE Rules 5.37(b)-(e).
\6\ SEE Rules 5.37(g)-(i). The EAC also has the authority to
bypass the second informal proceeding and commence formal
reallocation proceedings after a specialist's second quarter of
substandard performance in a rolling twelve-month period. See PSE
Rule 5.37.
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If the EAC finds in its second informal meeting with a specialist
that there are no mitigating circumstances that would demonstrate
substantial improvement of or reasonable justification for the
specialist's most recent evaluation score, the EAC will make a
determination that the specialist's performance is below acceptable
levels, and notify the specialist of his or her right to a hearing on
such determination.\7\ The EAC may take a number of actions against a
registered specialist found to perform below acceptable levels,
including limitation, suspension or termination of the specialist's
registration as a specialist, or reallocation of his or her stocks.
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\7\ For a description of the procedures followed in such
proceedings, see PSE Rules 5.37(j)-(s).
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[[Page 32876]]
The Exchange is now proposing to adopt a rule providing that any
registered specialist who fails into the bottom 10% of all registered
specialists on his trading floor as determined by the overall
evaluation scores received by each specialist in any one quarterly
evaluation shall not be eligible for new allocations until such ranking
rises above the bottom 10%.\8\ However, the proposal also provides that
the EAC may make exceptions if there are sufficient mitigating
circumstances.\9\
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\8\ The PSE has represented that the restriction applies to both
initial allocations and allocations available as a result of
subsequent reallocations. Furthermore, it also would apply in
situations where two specialists desire to ``swap'' issues with each
other . See Letter from Michael Pierson, Senior Attorney, PSE, to
John Kroeper, Attorney, SEC, dated June 7, 1996 (``PSE Letter'').
\9\ In the PSE Letter the Exchange gave the following, non-
definitive, examples of ``mitigating circumstances'' that have been
accepted by the EAC in the past two years: i) extensive systems
problems existed that clearly were beyond the specialist's control;
ii) a specialist was able to show that, of the trades covered in a
specialist evaluation, the percentage of trades involving
interaction with a broker was very low, and undue weight therefore
was placed on the Questionnaire Survey; iii) a specialist's
financial backer withdrew mid-quarter, having a negative impact on
the specialist's performance during that quarter; and iv) the
specialist's overall score on the quarterly evaluation (as opposed
to the specialist's ranking) was above 80%. The Exchange further
represented that based on past EAC decisions, relief by mitigation
is the exception, not the rule. See PSE Letter, supra note 8.
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At the PSE's specialist evaluation results and overall rankings are
reported in the quarter following the quarter of the evaluation, e.g.,
the results of the fourth quarter of 1995 are reported in the first
quarter of 1996. Accordingly, a specialist who was in the bottom 10%
for the fourth quarter of 1995 will not be eligible for new allocations
of stocks until, at the earliest, the second quarter of 1996, when the
results from the first quarter of 1996 are reported.
The Exchange believes that the restriction on new allocations is an
effective tool in encouraging specialists to improve their performance,
and thereby to improve their evaluation scores.\10\
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\10\ Cf. Securities Exchange Act Release NO. 31539 (November 30,
1992), 57 FR 57851 (December 7, 1992) (File No. SR-PSE-92-32). This
order approved, among other things, the addition of Commentary .03
to PSE Rule 5.36(d), which precludes a specialist whose specialist
ranking falls in the bottom 10% of his or her Floor from acting as
an alternate specialist until his or her ranking raises above the
bottom 10%, unless the EAC determines otherwise.
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The Commission finds that the PSE's proposal to codify its policy
that a specialist whose quarterly evaluation score falls in the bottom
10% of registered specialists on his or her trading floor shall not be
eligible for any allocations of stock until such specialist is no
longer in the bottom 10% is consistent with the requirements of
Sections 6 and 11 of the Act 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) \11\ 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. Further, the Commission finds that the proposal is
consistent with Section 11(b) of the Act \12\ and Rule 11b-1 thereunder
\13\ which allow national 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. For the reasons set forth below, the Commission believes
that the proposal should encourage improved specialist performance,
consistent with the protection of investors and the public interest.
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\11\ 15 U.S.C. 78f(b)(5).
\12\ 15 U.S.C. 78k(b).
\13\ 17 CFR 240.11b-1.
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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.\14\ To ensure that specialists fulfill
these obligations, the Commission has encouraged the Exchange to have
an effective program for evaluating specialists' performance. In this
regard, the Commission believes that stocks should be allocated to
those specialists who are performing the best. Such stock allocation
policies encourage specialists to strive for optimal market making
performance.
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\14\ Rule 11b-1, 17 CFR 240.11b-1; PSE Rules 5.29(f).
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At present, the only incentive to improved specialist performance
found in the PSE specialist performance evaluation program that is
applicable beginning with a specialist's first quarter of ranking in
the bottom 10% is the restriction on acting as an alternate specialist
while the specialist remains ranked in the bottom 10%.\15\ The proposed
rule change will add another such incentive to the PSE rules by
codifying an existing policy of the Exchange that restricts specialists
whose ranking falls in the bottom 10% of specialists on his or her
floor from eligibility for any allocations (i.e., allocations of new
issues, reallocations of existing issues, or swapping of issues with
other specialists) until such specialist is no longer in the bottom
10%.
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\15\ See PSE Rule 5.36(d), Commentary .03. As discussed
previously, under PSE Rule 5.37 the exchange has the ability to take
more significant action against any specialist who is ranked in the
bottom 10% in any two out of four consecutive evaluations. See PSE
Rule 5.37(j).
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The Commission believes that the codification of this policy into
the PSE rules will be an effective and appropriate means by which to
encourage improved specialist performance. As a specialist's
profitability is directly related to the stocks he or she is allocated,
the possibility of a restriction on allocations will provide a strong
incentive to PSE specialists to remain out of the bottom 10%. This
should translate into improved market making performance by
specialists, thereby benefitting investors. Moreover, the imposition of
the restriction on allocations to specialists in the bottom 10% should
increase the likelihood that stocks are allocated to specialists who
will make the best markets.
Finally, the Commission notes that the EAC retains the ability to
allow specialists whose scores are in the bottom 10% in any quarterly
evaluation to continue receiving allocations if it finds that
sufficient ``mitigating circumstances'' are present. While the Exchange
has represented that relief from the restriction by mitigation is the
exception \16\ and the Commission recognizes the need for the EAC to
retain the discretion to refrain from imposing this restriction in
appropriate instances, the Commission expects that findings by the EAC
that ``mitigating circumstances'' are present will not become routine,
but will remain the exception and be made only when appropriately
warranted.
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\16\ See PSE Letter, supra note 8.
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\17\ that the proposed rule change (SR-PSE-96-13) is approved.
\17\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\18\
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\18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-16166 Filed 6-24-96; 8:45 am]
BILLING CODE 8010-01-M
