[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