[Federal Register Volume 59, Number 113 (Tuesday, June 14, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-14337]


[[Page Unknown]]

[Federal Register: June 14, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34167; File No. SR-NYSE-93-45]

 

Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change Relating to the 
Specialist Combination Review Policy

June 6, 1994.

I. Introduction and Summary

    On December 3, 1993, 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 adopt a new set of guidelines 
for reviewing combinations among specialist units known as the 
Exchange's Specialist Combination Review Policy (the ``Policy'').
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1991).
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    The proposed rule change was published for comment in Securities 
Exchange Act Release No. 33475 (January 13, 1994), 59 FR 3145 (January 
20, 1994). No comments were received on the proposal.
    The Exchange's current Policy was first approved by the Commission 
on a six-month pilot basis in 1987.\3\ It was subsequently extended and 
then granted interim effectiveness until such time as the Commission 
makes a final determination on permanent approval.\4\
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    \3\See Securities Exchange Act Release No. 24411 (April 29, 
1987), 52 FR 17870 (May 12, 1987).
    \4\See Securities Exchange Act Release No. 25481 (March 17, 
1988), 53 FR 9554 (March 23, 1988).
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    The proposed rule change will continue to authorize the Quality of 
Markets Committee (``QOMC'') to review certain proposed combinations 
that, in the Exchange's view, may lead to undue concentration within 
the specialist community. The current combination review policy calls 
for an Exchange review of a potential combination under a two tier 
system where the combined unit exceeds any one of the four specified 
concentration measures.\5\ A tier I QOMC review occurs whenever a 
proposed combination would result in a specialist organization 
specializing in securities which exceed 5% of any one of four 
concentration measures. A tier II review occurs whenever a proposed 
combination would result in a specialist organization exceeding 10% of 
any concentration measure. The tier II review differs from the tier I 
review in that the presumption is against approval of the proposed 
combination.\6\ The proposed new Policy establishes a three tier system 
of review for combinations. The four concentration measures that 
trigger a combination review under the various tiers, however, will 
remain unchanged.
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    \5\The concentration measures include specialist share of:
     allocation (i.e. designation as registered specialist) 
for all listed common stocks
     allocation (i.e. designation as registered specialist) 
for the 250 most active listed common stocks
     total share volume of stock trading on the Exchange
     total dollar value of stock trading on the Exchange.
    \6\The burden of proof is on the proponents of the combination 
to show, by clear and convincing evidence, that the proposed 
combination would not result in undue concentration and would 
promote competition among the specialist units.
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    The proposed rule change does not affect the role of the Exchange's 
Market Performance Committee (``MPC''), acting under delegated 
authority from the QOMC, of conducting a preliminary review of all 
proposed combinations to determine the effects of the proposed 
combination on market quality. If the MPC concludes that the proposed 
combination will erode significantly market quality, it informs the 
constituent units of its concern. If the constituent units persist in 
their plans, the MPC can inform them that some or all of the affected 
stocks may be put up for reallocation.\7\
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    \7\If the proposed combination is under 5%, then the MPC is in 
effect the governing body and its decision is appealable through the 
Exchange's rules relating to hearings and appeals. If, however, the 
proposed combination would exceed one of the thresholds, then the 
MPC's determination would be taken under advisement by the QOMC in 
conducting its review pursuant to the Policy; in this case it would 
be the QOMC's decision that would be appealable. See NYSE 
Constitution, Article IV, Section 14.
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II. Description of the Proposal

    The proposed rule change modifies the NYSE's mechanism of 
monitoring the level of concentration within the Exchange specialist 
community. The proposal establishes a three tier system of review 
whereby the QOMC will be authorized to review proposed specialist 
combinations that raise concentration-related issues.
    A tier I QOMC review is triggered, both currently and under the 
proposal, whenever a proposed combination involves or would result in a 
specialist organization exceeding 5% of any concentration measure.\8\ 
In a tier I review, the QOMC reviews the proposed combination with the 
following considerations in mind: (a) Specialist performance and market 
quality in the stocks subject to the proposed combination;
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    \8\See, note 6, supra.
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    (b) The effects of the proposed combination in terms of the 
following criteria: (i) Strengthening the capital base of the resulting 
specialist organization;
    (ii) Minimizing both the potential for financial failure of the new 
unit and the negative consequences of any such failure on the 
specialist system as a whole; and
    (iii) Maintaining or increasing operational efficiencies within the 
resulting specialist organization;
    (c) The commitment to the Exchange market, focusing on whether the 
constituent specialist organizations have worked to support, strengthen 
and advance the Exchange, its agency/auction market and its 
competitiveness in relation to other markets; and
    (d) The effect of the proposed combination on overall concentration 
of specialist organizations.
    When a combination involves an entity that is not an existing 
specialist unit (e.g., if a third party's contemporaneous purchase of 
two or more units creates a combination exceeding the five percent 
threshold), the application of the ``commitment to the Exchange 
market'' criterion to the non-specialist organization will be based 
upon an assessment of whether the organization will work to support, 
strengthen and advance the Exchange, its agency/auction market and its 
competitiveness in relation to other markets.
    Moreover, the criterion relating to the ``commitment to the 
Exchange market'' under a tier I review is designed to require the QOMC 
to look to a variety of factors that extend beyond compliance with the 
Exchange's requirements for providing sufficient capital, talent and 
order handling services. Specifically, the Committee will review and 
assess each constituent unit's past conduct on the Exchange relating to 
such items as:
    (a) Participation upon request in the Exchange's FACTS program,\9\ 
in its marketing seminars, in sales calls and in other of its marketing 
initiatives seeking to attract order flow and new listings.
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    \9\The FACTS program is used to introduce member firms and other 
interested persons to the operations of the Exchange.
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    (b) Acceptance of innovations in order-routing and other trade-
support systems and willingness to make optimal use of the systems once 
they become fully operational.
    (c) Willingness to apply for allocations of stocks that are less 
lucrative from the standpoint of profitability to the specialist.
    (d) Assistance to other units by providing capital and personnel in 
unusual market situations, such as ``breakouts'' and difficult 
openings.
    (e) Efforts at customers' relations with both listed companies and 
order providers, as evidenced by personal contact, return of telephone 
calls, prompt resolution of complaints, assessment of customer needs 
and anticipation of customer problems.
    (f) Efforts to streamline the efficiency of its own operations and 
its competitive posture.
    The QOMC will continue to approve or disapprove a particular 
proposed specialist unit combination based on its assessment of the 
concentration and other considerations described above. In addition, 
the QOMC will retain the ability to condition its approval, under any 
level of review, upon compliance by the resulting specialist 
organization with any steps specified by the QOMC to address particular 
concerns in regard to the considerations above.
    Once the proposed combination potentially exceeds 10% of any 
concentration measure, the QOMC will give primary weight to the effect 
of the proposed combination on the overall concentration of specialist 
organizations. Moreover, the Policy places an affirmative obligation 
upon the proponents of the combination to make certain representations 
regarding the proposed combination in order to obtain QOMC approval. 
The breadth of the evidentiary showing required depends upon whether 
the proponents are subject to a tier II or tier III QOMC review.
    A tier II QOMC review will be triggered whenever a proposed 
combination involves or would result in a specialist organization 
exceeding 10%, up to and including 15%, of any of the four 
concentration measures. In a tier II review, the burden of proof will 
then be on the constituent specialist organizations to prove, by a 
preponderance of the evidence, that the proposed combination:
    (1) Would not create or foster concentration in the specialist 
business detrimental to the Exchange and its markets; and
    (2) Would foster competition among specialist organizations; and
    (3) Would enhance the performance of the constituent specialist 
organization and the quality of the markets in the stocks; and
    (4) Would otherwise be in the public interest.

Absent such a showing, the QOMC will disapprove the proposed 
combination.
    A tier III QOMC review will be triggered whenever a proposed 
combination involves or would result in a specialist organization 
exceeding 15% of any of the four concentration measures. In a tier III 
review, the proponents must present clear and convincing evidence 
demonstrating that, if approved, the proposed combination would satisfy 
requirements 1-4 enumerated above.
    The proposed rule change defines a ``proposed combination'' 
subjected to the Policy to include:
    (a) A merger of specialist organizations or an acquisition of one 
organization by another;
    (b) The formation of a joint account involving two or more existing 
organizations;
    (c) The ``split-up'' of an existing organization (including an 
organization operating under a joint account) and recombination with 
another organization;
    (d) An individual specialist leaving an existing organization and 
proposing to take stocks with him to join another existing 
organization; and
    (e) Any other arrangement that would result in previously separate 
organizations operating under common control.
    The NYSE also has informed the Commission of how it intends to 
address three specific situations involving the purchase of specialist 
units by an entity other than a specialist firm. First, when a non-
specialist entity purchases a single specialist unit, the acquisition 
will not be reviewable under the Policy regardless of whether or not 
the specialist unit has a concentration level of 5% or more at the time 
of purchase. The Policy only applies to combinations of specialist 
units that involve or would result in a unit exceeding 5%, 10%, or 15% 
of a concentration measure. Second, if a non-specialist entity proposes 
to purchase two or more specialist units that, combined into one unit, 
account for more than 5%, 10%, or 15% of a concentration measure, the 
acquisition will be reviewable under the Policy. Finally, a non-
specialist entity's purchase of two or more specialist units which are 
kept operationally separate, but when viewed together would cross a 5%, 
10%, or 15% concentration measure, will be reviewable under the 
Policy.\10\ In this latter example, the QMOC will seek information as 
to what the acquiror's intentions are with respect to the specialist 
units and whether or not a combination is anticipated. In sum, any time 
a threshold may be exceeded as a direct result of a potential 
combination made possible by an acquisition, it will be subject to 
review.\11\
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    \10\The NYSE states that such a review is initiated because of 
the introduction of the element of common ownership even if the 
units are to be kept separate.
    \11\For example, if a full service broker-dealer bought two 
specialist units, one with 4% of all allocations and the other with 
3%, this would constitute a combination subject to review. Likewise, 
if a full service broker-dealer that already owned one specialist 
unit with 7% of all allocations bought another unit having 2% of all 
allocations, this would be reviewable under the Policy because it is 
a combination of specialist units crossing the 5% threshold. In 
contrast, if a full service broker-dealer that had no affiliated 
specialist unit bought a unit having 11% of all allocations, this 
purchase would not be reviewable under the Policy.
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    The Exchange has previously stated, with respect to the Policy,\12\ 
that the Policy is designed to provide the Exchange with a mechanism 
for reviewing proposed mergers, acquisitions and other combinations 
between or among specialist units that may lead to a level of 
concentration within the specialist community that is detrimental to 
the Exchange and the quality of its markets. The Exchange expressed its 
belief that undue concentration may undermine its agency/auction 
process, accentuate specialist complacency, and damage the public's 
perception of the Exchange as a free market environment. Specifically, 
the Exchange's principal concern from a concentration standpoint was 
that the transformation of the specialist community into fewer and 
larger units might vitiate the competition among existing specialist 
units and present a significant barrier to new entrants to the 
specialist business, all to the detriment of the competition for the 
allocation of new listings. In implementing a policy to address these 
concerns, the Exchange sought to strike an appropriate balance between 
the perceived harm from undue concentration and the need for some 
specialist organizations to grow and attract capital through 
combinations. The instant modification strengthens this balance by 
adding a middle level of review at which the proponents of the 
combination are held to a less burdensome standard.
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    \12\See Securities Exchange Act Release No. 24411 (April 29, 
1987) 52 FR 17870 (May 12, 1987).
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III. Discussion

    The Commission recognizes the NYSE's concerns that undue 
concentration can result in various negative effects on market quality. 
The Commission also believes that in many situations consolidations 
among specialist units can be beneficial for the units themselves, 
particularly for those units with limited capital and resources, as 
well as for the quality of the market.
    The Commission has previously indicated its belief that it is 
appropriate for the NYSE to adopt a policy that authorizes it to 
monitor specialist combinations to determine their impact upon the 
competitive environment necessary to maintain an orderly market.\13\ 
Further, the Commission continues to believe the concentration factors 
identified by the NYSE are adequately designed to result in approval of 
proposed combinations which will not have an adverse impact on market 
quality or result in undue concentration, and at the same time will 
enable the NYSE to identify those combinations that can be potentially 
harmful to market quality and actually decrease competition.
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    \13\See Securities Exchange Act Release No. 24411 (April 29, 
1987), 52 FR 17870 (May 12, 1987).
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    The Commission has carefully reviewed the NYSE's Policy, placing 
particular emphasis on its differences with respect to the existing 
pilot procedure. The Commission previously expressed concern, due to 
the ability of the NYSE to disapprove proposed combinations based upon 
their potential concentration effects, as to whether the thresholds 
identified by the NYSE are appropriate measures of potentially harmful 
concentration. In particular, the Commission was concerned with the 10% 
threshold, where the constituent firms would have to overcome the 
presumption that the proposed combination would result in a level of 
business harmful to the specialist community.\14\ Although the instant 
Policy retains this presumption, the burden of proof placed upon the 
proponents under a tier II review is being decreased from a clear and 
convincing to a preponderance standard. The clear and convincing 
standard will now only apply to a tier III review. The Commission 
believes that this intermediary level of review, along with the lower 
evidentiary standard, will make it less likely that potentially 
beneficial mergers will be erroneously blocked, consistent with the Act 
and the goals of the Exchange.
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    \14\The Commission notes that to date the NYSE QOMC has only 
conducted two tier II reviews, both of which have been approved, 
despite the current high level of burden of proof.
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    Accordingly, in light of the legitimate concentration concerns the 
NYSE has identified, the Commission believes that it is consistent with 
the Act for the NYSE to have a permanent review mechanism for proposed 
specialist combinations. Further, the Commission believes that the 
threshold levels identified by the NYSE in the Policy are reasonable in 
relation to the current distribution of the four concentration measures 
among specialist units on the NYSE.
    Finally, the Commission notes that the QOMC acts on behalf of the 
Board of Directors and consists of at least three Directors that are 
representatives of the public. Currently only one member of the eight-
member committee represents a specialist unit. The Commission would be 
concerned if specialist representation of the QOMC were substantially 
increased to more than a minor representation by specialists when 
determining the outcome of a proposed specialist combination, as this 
could appear to cause a conflict of interest. In such circumstance, the 
Commission will review this Policy for continued consistency with the 
Act.

IV. Conclusion

    For the reasons discussed above, 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).\15\ In this regard, the Commission believes that 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, in that it identifies 
specific levels of review for combinations that could potentially 
impair market quality and hinder competition to the detriment of 
investors and the public interest while ensuring that combinations that 
are beneficial to the market place will not be prohibited. The 
Commission also believes that the proposal does not impose any 
unnecessary or inappropriate burden on competition under Section 
6(b)(8) of the Act in that it establishes review procedures to prevent 
undue concentration of specialist units that could potentially hinder 
market quality. Although the Commission recognizes that the Policy can 
result in prohibiting certain combinations from occurring, the 
Commission believes the considerations outlined in the Policy in 
conducting a combination review under the various tiers will help to 
ensure that combinations that are beneficial to the market will be 
permitted, while prohibiting those combinations that may have a 
negative impact on market quality. Accordingly, any potential burden on 
competition resulting from the Policy is, in the Commission's view, 
justified as necessary and appropriate under the Act.
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    \15\15 U.S.C. 78f(b) (1988).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-NYSE-93-45) is approved.

    \16\15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\17 CFR 200.30-3(a)(12) (1991).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-14337 Filed 6-13-94; 8:45 am]
BILLING CODE 8010-01-M