[Federal Register Volume 59, Number 130 (Friday, July 8, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-16566]
[[Page Unknown]]
[Federal Register: July 8, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34295; File No. SR-PSE-94-3]
Self-Regulatory Organizations; Pacific Stock Exchange, Inc.;
Order Approving Proposed Rule Change Relating to its Net Capital
Requirements for Specialists
July 1, 1994.
I. Introduction
On January 14, 1994, the Pacific Stock Exchange, Inc. (``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 amend the Exchange's net
capital requirements for Exchange specialists. On March 8, 1994, the
PSE submitted to the Commission Amendment No. 1 to the proposed rule
change.\3\ On April 1, 1994, the PSE submitted to the Commission
Amendment No. 2 to the proposed rule change.\4\
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1994).
\3\See letter from Michael D. Pierson, Senior Attorney, Market
Regulation, PSE, to Louis A. Randazzo, Attorney, Office of
Derivative and Exchange Oversight, SEC, dated March 4, 1994.
Amendment No. 1 made various clarifying amendments to the proposed
rule change.
\4\See letter from Michael D. Pierson, Senior Attorney, Market
Regulation, PSE, to Louis A. Randazzo, Attorney, Office of
Derivative and Exchange Oversight, SEC, dated March 28, 1994.
Amendment No. 2 made further clarifying amendments to the proposed
rule change.
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The proposed rule change, together with Amendment Nos. 1 and 2, was
noticed in Securities Exchange Act Release No. 34026 (May 9, 1994), 59
FR 25134 (May 13, 1994). No comments were received on the proposal.
This order approves the proposed rule change, including Amendment Nos.
1 and 2.
II. Description of the Proposal
The Exchange is amending Rules 2.8 and 2.1, and adopting Rules
2.1(b), 2.1(c) and 2.1(d) of the PSE Rules of the Board of Governors,
concerning capital requirements for specialists. The amended and
adopted rules will become effective July 1, 1994. The Exchange is
amending PSE Rule 2.8(a), which currently exempts specialists from the
Exchange's net capital rule.\5\ The Exchange is deleting
``specialists'' from this list of exempt members and adding ``lead
market makers in listed options'' to the list. The Exchange stated that
this amendment is intended to make the Exchange's rules conform to the
recent amendments to the SEC's net capital rule, which effective April
1, 1994, made the SEC's net capital rule applicable to equity
specialists.\6\
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\5\The term ``net capital'', as used in the PSE proposal, means
net capital as defined by Commission Rule 15c3-1. Rule 15c3-1
defines net capital as the net worth of a broker or dealer, adjusted
by certain adjustments prescribed in Rule 15c3-1. See 17 CFR
240.15c3-1(c)(2) (1994).
\6\See Securities Exchange Act Release No. 32737 (August 11,
1993), 58 FR 43555 (August 17, 1993).
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The PSE is amending Rule 2.1(a) to require, to the extent
applicable, every member organization to maintain a minimum net capital
in accordance with the provisions of SEC Rule 15c3-1.\7\ This amendment
also reflects the SEC's amendments to SEC Rule 15c3-1, which, as
mentioned above, made the SEC's net capital rule applicable to the
Exchange's equity specialists. Rule 2.1 is also being amended to
clarify that the PSE's net capital requirements will be in addition to
the Specialist Post Capital requirement of Rule 2.2.\8\
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\7\17 CFR 240.15c3-1 (1994).
\8\Rule 2.2 provides, in part, that members registered as
specialists shall at all times maintain for each specialist post a
minimum of $150,000 in either cash or marketable securities or an
amount equal to 25% of the sum of the market value of its securities
positions, both long and short, whichever is greater.
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The PSE is adopting Rule 2.1(b) to establish a net capital
requirement for Exchange specialist firms that are subject to the
aggregate indebtedness and alternative net capital requirements under
Rule 15c3-1.\9\ Rule 2.1(b) requires specialist firms subject to the
SEC's aggregate indebtedness requirement to maintain a minimum net
capital of not less than $200,000. Rule 2.1(b)(4) establishes a lesser
minimum net capital requirement of $150,000 for broker-dealers in
specialist posts subject to the SEC's aggregate indebtedness
requirement and backed by more than one broker-dealer.
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\9\The Aggregate Indebtedness Standard under Rule 15c3-1 states
that no broker or dealer, other than one that elects the Alternative
Standard, shall permit its aggregate indebtedness to all other
persons to exceed 1500 percent of its net capital (or 800 percent of
its net capital for 12 months after commencing business as a broker
or dealer). See 17 CFR 240.15c3-1(a)(1)(i) (1994). Rule 15c3-
1(a)(1)(ii) contains the Alternative Standard, which states in part,
that a broker or dealer shall not permit its net capital to be less
than the greater of $250,000 or 2 percent of aggregate debit items
computed in accordance with Exhibit A to Rule 15c3-3. See 17 CFR
240.15c3-1(a)(1)(ii) (1994). The Commission's net capital rule
requires the Exchange's equity specialists to maintain net capital,
under the aggregate indebtedness method, equal to a minimum of
$100,000 and, under the alternative method, equal to a minimum of
$250,000. See Securities Exchange Act Release No. 32737, supra note
6.
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Rule 2.1(c)(1) adopts a net capital requirement for equity
specialist firms subject to the SEC's alternative net capital
requirement. Pursuant to the adopted Rule, specialist firms subject to
the SEC's alternative net capital standard are required to comply with
subsection (a)(1)(ii) of Rule 15c3-1.\10\ With respect to joint
accounts, Rule 2.1(c)(2) requires each broker-dealer in a specialist
post backed by more than one broker-dealer and subject to the SEC's
alternative net capital requirement to comply with the requirements of
SEC Rule 15c3-1(a)(1)(ii).\11\
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\10\Rule 15c3-1(a)(1)(ii) contains the SEC's alternative net
capital requirement. See 17 CFR 240.15c3-1(a)(1)(ii) (1994).
\11\See supra note 10.
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The Exchange's amendments also adopt new requirements and establish
related procedures for specialist firms whose net capital falls below
certain levels.\12\ With respect to specialist firms subject to the
SEC's aggregate indebtedness requirement, adopted Rule 2.1(b)(2) states
that if at any time a specialist firm's net capital falls below
$200,000, the firm shall promptly notify the Financial Compliance
Department of the Exchange and, in addition, the firm shall not operate
as a specialist with net capital of between $150,000 and $199,999 for
more than 60 days unless such firm (a) obtains from the Vice President,
Regulation, or a senior officer of the Exchange written consent to
continue to operate as a specialist; and (b) takes corrective action
including, but not limited to, actively seeking financing to correct
its net capital deficiency. If a specialist firm's net capital falls
below $150,000, the firm shall be subject to remedial action including,
but not limited to, the loss of specialist privileges.
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\12\Pursuant to amendments to the Commission's net capital rule,
effective April 1, 1994, Exchange equity specialists became subject
to the Commission's net capital rule. See Securities Exchange Act
Release No. 32737, supra note 6. As a result, Exchange equity
specialists are required to comply generally with the provisions of
the Commission's early warning notification procedures as codified
in Section 17a-11 under the Act. See 17 CFR 240.17a-11 (1994).
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With respect to specialist posts backed by more than one broker-
dealer and subject to the SEC's aggregate indebtedness requirement,
Rule 2.1(b)(4) provides that if at any time such a broker-dealer's net
capital falls below $150,000, the broker-dealer shall promptly notify
the Financial Compliance Department of the Exchange and, in addition,
such broker-dealer shall not operate as a specialist with net capital
between $120,000 and $149,999 for more than 60 days unless such firm
(a) obtains from the Vice President, Regulation, or a senior officer of
the Exchange written consent to continue to operate as a specialist;
and (b) takes corrective action including, but not limited to, actively
seeking financing to correct its net capital deficiency. In addition,
if such broker-dealer's net capital falls below $120,000, such broker-
dealer shall be subject to remedial action including, but not limited
to, the loss of specialist privileges.
The PSE is also adopting Rule 2.1(d) to require each specialist
firm to report its net capital to the Exchange in a form and manner
prescribed by the Exchange. The Exchange will promptly notify the
Equity Floor Trading Committee of any specialist firm's net capital
deficiency and of any action taken by the Vice President, Regulation,
or senior officer of the Exchange in connection therewith.
The Exchange believes that the proposed amendments are appropriate
to assure that the customers and creditors of its equity specialists
are protected from monetary losses and delays in the event of a
specialist's failure.
The Exchange believes that the proposed rule change is consistent
with Section 6(b) of the Act, in general, and section 6(b)(5), in
particular, in that it promotes just and equitable principles of trade
and protects investors and the public interest.
III. Discussion
The Commission finds that the PSE's amendments to its net capital
requirements for specialists are 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 Section 6(b)(5) and 11(b) of the Act.\13\ The Commission believes
that the PSE's amendments are consistent with the Section 6(b)(5)
requirement that the rules of an exchange be designed to promote just
and equitable principles of trade, and, in general, to protect
investors and the public interest. The Commission also believes that
the rule change is consistent with Section 11(b) of the Act, and Rule
11b-1 thereunder,\14\ which allow securities exchanges to promulgate
rules relating to specialists in order to maintain fair and orderly
markets. The rule change is consistent with the Rule 11b-1(a)(2)(i)
requirement that the rules of a national securities exchange that
permits a member to register as a specialist and to act as a dealer
include, among other things, adequate minimum capital requirements in
view of the markets for securities on such exchange.
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\13\15 U.S.C. 78f(b)(5) and 78k(b) (1988).
\14\17 CFR 240.11b-1 (1994).
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The rules of the PSE, in addition to the rules set forth under the
act, impose certain obligations upon specialists, including, but not
limited to, the maintenance of fair and orderly markets.\15\
Specialists play a crucial role in providing stability, liquidity, and
continuity to the trading of stocks on the Exchange. Generally,
specialists are under an affirmative obligation to trade for their own
accounts to minimize order imbalances and contribute to continuity and
depth in their speciality stocks.\16\ Conversely, pursuant to their
negative obligations, specialists are precluded from trading for their
own accounts unless such dealing is necessary for the maintenance of a
fair and orderly market. To ensure that specialists fulfill these
obligations, it is important that they maintain an adequate amount of
capital.
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\15\See generally Rule 5.29(f) PSE Rules of the Board of
Governors. See also Rule 11b-1 under the Act.
\16\See supra note 15.
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The importance of specialists' net capital as it relates to the
quality of Exchange markets was highlighted during the October 1987
Market Break. In the Division of Market Regulation's (``Division'')
report on the 1987 Market Break, the Division reviewed, among other
things, specialists' ability to maintain fair and orderly markets and
minimum capital requirements imposed by the exchanges. During the 1987
Market Break, most exchange specialists were exempt from the
Commission's net capital rule, and therefore, were only required to
maintain a minimum amount of capital as determined by the rules of
their exchange. In this respect, the Division stated its concern that
the minimum capital requirements imposed by the exchanges on
specialists did not reflect the actual capital needed to ensure the
maintenance of fair and orderly markets in different types of
securities.\17\ Accordingly, as a result of the staff's concerns
regarding the availability of capital for specialists, today's more
volatile market conditions, and the state of the exchanges' specialist
surveillance and monitoring system, the staff began to examine the
ramifications of eliminating the specialist exemption from the SEC's
net capital rule and applying the net capital rule to all
specialists.\18\
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\17\See Division of Market Regulation, The October 1987 Market
Break, February 1988, at 4-66 to 4-67. See also Market Analysis of
October 13 and 16, 1989, A Report by the Division of Market
Regulation, U.S. Securities and Exchange Commission, December 1990,
at 4, 16 and 33.
\18\See 1987 Market Break, supra note 17 at 4-68.
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The Commission believes that amending Rules 2.1 and 2.8(a) to make
the PSE net capital rule applicable to all specialists except lead
market makers in listed options, and adopting minimum net capital
requirements for specialist firms and specialist posts backed by more
than one broker-dealer is consistent with recent amendments to SEC Rule
15c3-1 under the Act, as well as a positive step toward procuring
stronger capital foundations for specialists on its floor.
The Commission believes that adopting rules to require each
specialist firm and each broker-dealer in a specialist post backed by
more than one broker-dealer to maintain minimum amounts of net capital
is consistent with Section 6(b)(5) of the Act in that the required
reserves of specialist net capital should help to ensure that PSE
specialists have greater access to the capital necessary for the
maintenance of fair and orderly markets in their registered securities.
In the Commission's release amending the SEC's net capital rule to make
the rule applicable to certain specialists, the Commission stated that
it did not believe that sufficient reasons still exist to exempt
specialists other than options market makers from the net capital rule
and the overall uniform, minimum financial responsibility which results
from its application. The Commission further stated that application of
the net capital rule to specialists other than options market makers is
necessary to provide reasonable assurance that specialists are
maintaining minimum levels of liquid capital. More significantly, the
Commission believes that application of the rule will provide
significant monitoring and consistent reporting benefits.\19\ By
assuring that specialists have capital sufficient to perform their
market making responsibilities, the proposal should provide additional
protection for the Exchange, member organizations, and public
investors.
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\19\See supra note 6.
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The Commission believes that Rules 2.1(b)(2), 2.1(b)(3), 2.1(b)(4),
and 2.1(d), which establish procedures and requirements for specialist
firms whose net capital falls below certain levels should help to
ensure compliance with the PSE's net capital requirements by
encouraging specialists to actively obtain additional financing in a
reasonable amount of time. Specifically, by requiring a specialist firm
subject to the aggregate indebtedness requirement to notify the
Financial Compliance Department of the Exchange when its net capital
falls below $200,000, and requiring a specialist post backed by more
than one broker-dealer to notify the Exchange when its net capital
falls below $150,000 gives the Exchange adequate early warning of
potential financial problems. Furthermore, after receiving notice of a
potential net capital deficiency, the Exchange will be able to increase
its surveillance of a specialist experiencing difficulty and to obtain
any additional information necessary to assess and monitor the
specialist's financial condition.
Moreover, subjecting specialist firms to remedial action,
including, but not limited to, the loss of specialist privileges if a
specialist firms net capital falls below a certain amount should help
to ensure that specialists will not be allowed to make markets in
stocks indefinitely if they fall below the capital requirements.
The Commission believes that exempting lead market makers in listed
options from the PSE's net capital rule is consistent with Rule 15c3-1
under the Act. In the release amending Rule 15c3-1 to make the
Commission's net capital rule applicable to all specialists except
options market makers, the Commission stated that it does not believe
that it is necessary to apply the net capital rule to options market
makers because, on an individual basis, they are not as integral to the
proper functioning of the markets in their securities. The release
further states that specialists other than options market makers
perform several functions that options market makers do not, including
the maintenance of a specialist's book containing a listing of all
orders away from the current market price and the dissemination of
accurate quotations in their speciality securities. Moreover, the
exchanges that use options specialists look to a single specialist or
specialist unit to handle all trades whereas options market makers
compete with other market makers. Options lead market makers on the
Exchange floor compete with other market makers for orders and do not
maintain a specialist book containing a list of all orders away from
the current market price. Accordingly, the Commission agrees with the
Exchange that it is appropriate to exclude options lead market makers
from the Exchange capital regulations.\20\
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\20\See securities Exchange Act Release No. 32737, supra note 6.
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It is therefore ordered, pursuant to Section 19(b)(2) and Rule 19d-
1(c)(2) under the Act,\21\ that the proposed rule change (SR-PSE-94-3)
is approved.
\21\15 U.S.C. 78s(b)(2) (1988) and 17 CFR 240.19d-1(c)(2)
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(1994).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\22\
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\22\17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 94-16566 Filed 7-7-94; 8:45 am]
BILLING CODE 8010-01-M