[Federal Register Volume 59, Number 240 (Thursday, December 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30782]


[[Page Unknown]]

[Federal Register: December 15, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35068; File No. SR-BSE-94-09]

 

Self-Regulatory Organizations; Boston Stock Exchange, Inc.; Order 
Approving Proposed Rule Change and Amendment No. 1 to Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 2 to Proposed Rule Change Relating to Stopping Stock

December 8, 1994.

I. Introduction

    On June 20, 1994, the Boston Stock Exchange, Inc. (``BSE'' 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 rule regarding 
stopping stock. On June 24, 1994 and November 10, 1994, the Exchange 
submitted to the Commission Amendments No. 1 and No. 2. to the proposed 
rule change in order to clarify certain procedural requirements for the 
handling of stopped orders and to specify the duration of the BSE's 
pilot program for stopping stock in minimum variation markets.\3\
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    \1\15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1991).
    \3\See letters from Karen A. Aluise, Assistant Vice President, 
BSE, to Sandra Sciole, Special Counsel, Division of Market 
Regulation, SEC, dated June 21, 1994 (``Amendment No. 1''); and 
Howard Kramer, Associate Director, Division of Market Regulation, 
SEC, dated November 10, 1994 (``Amendment No. 2'').
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    The proposed rule change, together with Amendment No. 1, was 
published for comment in Securities Exchange Act Release No. 34569 
(August 22, 1994), 59 FR 44437 (August 29, 1994). No comments were 
received on the BSE proposal. This order approves the proposed rule 
change, including Amendment No. 2 on an accelerated basis.

II. Description of the Proposal

    The Exchange proposes to amend Chapter II of its Rules to add a new 
Section 38 to codify procedures for stopping stock and to establish a 
pilot program permitting BSE specialists to stop stock in minimum 
variation markets.\4\ Under the proposed rule change, an agreement by a 
BSE specialist to ``stop'' securities at a specified price will 
constitute a guarantee by the specialist of the purchase or sale of the 
securities at the specified price (or better). According to the 
Exchange, the practice of stopping stock enables BSE specialists to 
offer primary market price protection,\5\ without negatively impacting 
the national market system by disseminating executions at prices away 
from the primary market (e.g., double up or down ticks, new highs or 
new lows, or out-of-range prints). If, however, the stopped order is 
executed at a less favorable price, the specialist will be liable for 
an adjustment of the difference between the two prices.
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    \4\The BSE has proposed a March 21, 1995 termination date for 
its minimum variation market pilot program to conform with the pilot 
program of other exchanges. See Amendment No. 1, supra, note 3.
    \5\See generally, Ch. II, Sec. 33 of the BSE Rules. For 
securities traded through the Intermarket Trading System (``ITS''), 
the Exchange's price protection rules are designed to ensure that 
customers receive an execution on the BSE that is no worse than they 
would have received had their order been transmitted to the primary 
market.
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    The proposed rule change will impose certain procedural 
requirements for the handling of stopped orders. A BSE specialist will 
be permitted to stop stock upon the unsolicited request of another 
member. After granting the stop, the specialist must display the order 
in his or her quote. Thus, where the spread between the consolidated 
best bid and offer is greater than the minimum variation, a specialist 
who stops a buy (sell) order will be required to reduce the spread by 
bidding (offering) at a price higher (lower) than the prevailing bid 
(offer). In a minimum variation market, the specialist must change his 
or her quoted bid (offer) size in order to reflect the size of the 
order being stopped.\6\
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    \6\As noted above, see supra note 4, BSE specialists will be 
permitted to stop stock in minimum variation markets on a pilot 
basis until March 21, 1995.
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    Stopped orders will be placed on the specialist's limit order book 
and, consistent with the BSE's price protection rules,\7\ will be 
filled based on trades that occur in the primary market. The BSE 
proposal also will implement certain procedures, on a pilot basis until 
March 21, 1995, governing the execution of stopped stock in minimum 
variation markets. Under that pilot program, a stopped buy (sell) order 
will be filled (1) when a transaction takes place on the primary market 
at the stop price or higher (lower); (2) when the share volume on the 
Exchange at the bid (offer) is exhausted or (3) at any time at a better 
price, subject to the conditions discussed below.
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    \7\See supra, note 5 and accompanying text.
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    In certain limited circumstances, the proposed rule change will 
allow a BSE specialist to execute a stopped order before limit order 
interest on the Exchange is exhausted.\8\ Before a specialist can fill 
a stopped order in this manner, however, the specialist must make the 
determination that such action is necessary, in his or her professional 
judgment, to prevent an execution that would create a new high or new 
low, double up or down tick or out-of-range print on an order that is 
due.\9\
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    \8\See Amendment No. 2, supra, note 3; and letter from Karen A. 
Aluise, Assistant Vice President, BSE, to Howard Kramer, Associate 
Director, Division of Market Regulation, SEC, dated November 16, 
1994 (``November 16th letter'').
    \9\See November 16th letter, supra, note 8.
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    Moreover, the specialist must follow certain procedures designed to 
ensure that the BSE's limit order book is adequately protected. First, 
the proposed interpretation will require that the specialist split any 
contra-side order flow between the stopped order and limit orders with 
priority at the better price. In addition, if the specialist elects to 
fill a stopped order at a price better than the stop price before it is 
otherwise due an execution, he or she must allocate an equal number of 
shares, up to a maximum of 500 shares, to orders at that price on the 
limit order book. Finally, if any portion of a stopped order remains 
unexecuted at the end of the trading day, the specialist must fill such 
order in its entirety and, as described above, allocate an appropriate 
number of shares to the book.
    The Exchange states that the proposed rule change is consistent 
with Section 6(b)(5) of the Act in that it furthers the objectives to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to and facilitating 
transactions in securities, 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; and is not 
designed to permit unfair discrimination between customers, issuers, 
brokers or dealers.

III. Discussion

    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) and 11(b).\10\ In 
particular, the Commission believes 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 interest. The Commission also believes that the proposed 
rule change is consistent with the requirements of Section 11(b), and 
Rule 11b-1 thereunder,\11\ that specialist transactions must contribute 
to the maintenance of fair and orderly markets.
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    \10\15 U.S.C. Sec. 78f(b) (1988).
    \11\17 CFR 240.11b-1 (1991).
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    The Commission historically has been concerned that the practice of 
stopping stock may compromise the specialist's fiduciary duty to 
unexecuted customer orders on the limit order book.\12\ The Commission, 
however, has approved the practice in limited circumstances where the 
potential harm is offset by the improvement in marketplace liquidity 
and the possibility of price improvement for the customer.\13\ 
Accordingly, those exchanges with stopping stock rules\14\ require 
their specialists to reduce the spread between the consolidated best 
bid and offer or, in minimum variation market, to add size at the 
inside quote. The Commission believes that such a requirement strikes 
an appropriate balance between the interests of various market 
participants. Moreover, by encouraging accurate representation of the 
trading interest held by the specialist, it also facilitates greater 
transparency in the securities markets. In the Commission's opinion, 
such safeguards are a critical aspect of an exchange's stopping stock 
rule.
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    \12\See, e.g., SEC, Report of the Special Study of the 
Securities Markets of the Securities and Exchange Commission, H.R. 
Doc. No. 95, 88th Cong., 1st Sess. Pt 2 (1963).
    When stock is stopped, book orders on the opposite side of the 
market that are entitled to immediate execution lose their priority. 
If the stopped order then receives a better price, limit orders at 
the stop price are bypassed and, if the market turns away from that 
limit, may never be executed.
    \13\See, e.g., Securities Exchange Act Release No. 28999 (March 
21, 1991), 56 FR 12964 (March 28, 1991) (File No. SR-NYSE-90-48) 
(approving proposed rule change to permit New York Stock Exchange 
(``NYSE'') specialists to stop stock in minimum variation markets 
when (1) an imbalance is of sufficient size to suggest the 
likelihood of price improvement) (``1991 NYSE approval order''). In 
approving the NYSE proposal, the Commission found, among other 
things, that a stopped order is the equivalent of a limit order for 
purposes of Section 11(b) of the Act.
    \14\See NYSE Rule 116.30; American Stock Exchange (``Amex'') 
Rule 109; and Article XX, Rule 12 of the Chicago Stock Exchange 
(``CHX'') Rules. See also Securities Exchange Act Release No. 34614 
(August 30, 1994), 59 FR 46280 (September 7, 1994) (File No. SR-
Phlx-93-41) (approving a Philadelphia Stock Exchange (``Phlx'') 
proposal to codify its procedures for stopping stock into Equity 
Floor Procedure Advice A-2, Stopping Orders).
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    After careful review, the Commission has concluded that the 
proposed rule change should help ensure that BSE specialists handle 
stopped orders in a manner which is consistent with their obligation to 
maintain fair and orderly markets.\15\ Under the BSE proposal, a 
specialist who stops an order will be required to display that order in 
his or her market. In particular, the specialist must reduce the spread 
between the consolidated best bid and offer or, in a minimum variation 
market, add size at the inside quote. In addition, the customer will 
receive an opportunity for price improvement, rather than automatic 
execution at the displayed quotation. The Commission therefore is 
satisfied that the proposed rule change should increase the likelihood 
that a customer whose order is stopped will receive price improvement 
and result in narrower and/or deeper markets. This, in turn, should 
enhance the liquidity and transparency of the market for securities 
traded on the BSE.
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    \15\See Ch. XV, Sec. 2. of the BSE Rules. In addition, the 
Commission notes that the definition of stopping stock proposed by 
the BSE is substantively identical to other exchanges' definition. 
See, e.g., NYSE Rule 116. Although an agreement to stop securities 
at a specified price constitutes a guarantee, by the specialist, of 
the purchase or sale of the securities at that price or better, the 
order can interact with all market interest. For that reason, the 
Commission has concluded that a specialist granting a stop does not 
enter into an unconditional contract within the meaning of Rule 3b-3 
under the Act. 17 CFR 240.3b-3 (1991).
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    Despite these potential benefits, the Commission continues to be 
particularly concerned that, in minimum variation markets, limit orders 
on the specialist's book may be bypassed when stopped orders are 
executed at a better price. For that reason, the Commission has 
required that procedures for stopping stock in minimum variation 
markets be implemented on a pilot basis. These pilot programs have been 
extended until March 21, 1995, in order to allow the Commission and the 
relevant exchanges to determine whether the benefits of the practice 
substantially outweigh the costs thereof.\16\ In the interim, the 
Commission believes that it is appropriate to place the BSE on equal 
competitive footing with the other exchanges and to approve the BSE's 
procedures for stopping stock in minimum variation markets as a pilot 
program until March 21, 1995.
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    \16\Currently, the NYSE, Amex and CHX have pilot programs that 
permit specialists to stop stock in minimum variation markets. For 
further discussion of these pilot programs and the Commission's 
rationale for extending them until March 21, 1995, see Securities 
Exchange Act Release Nos. 33792 (March 21, 1994), 59 FR 14437 (March 
28, 1994) (File No. SR-NYSE-94-06); 33791 (March 21, 1994), 59 FR 
14432 (March 28, 1994) (File No. SR-Amex-93-47); and 33790 (March 
21, 1994), 59 FR 14434 (March 28, 1994) (File No. SR-CHX-93-30) 
(``1994 CHX approval order'').
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    In making this determination, the Commission recognizes the 
interplay between a regional exchange's price protection rules and its 
procedures for handling stopped stock. As the Commission noted in 
regard to a similar CHX proposal,\17\ in a minimum variation market, 
requiring regional exchange specialists to fill stopped orders at the 
price of the next primary market sale may have unintended consequences. 
Specifically, if the next trade occurs at a price better than the stop 
price and if there are limit orders with time priority at that price, 
execution of the stopped order would trigger the execution of all pre-
existing limit orders, even if they are not otherwise entitled to be 
filled.
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    \17\See 1994 CHX approval order, supra, note 16. Under Art. XX, 
Rule 37, Interpretation .03 of the CHX Rules, in a minimum variation 
market, a stopped buy (sell) order will not be filled until (1) a 
transaction takes place at the offering (bid) price or higher 
(lower) on the primary exchange or (2) the CHX's displayed share 
volume at the bid (offer) has been exhausted (i.e., the stopped 
order has time priority at the better price).
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    In the Commission's opinion, the Exchange's pilot program is a 
reasonable attempt to ensure that same-side limit orders on the book 
are not bypassed when stock is stopped in minimum variation markets. As 
proposed, the BSE specialist can fill a stopped order at the stop price 
after a trade takes place in the primary market at that price or worse 
(i.e., after a new range for the day is created which includes the stop 
price). If the next sale takes place at a better price, the specialist 
will not be required to fill the stopped order until all pre-existing 
share volume on the BSE is exhausted (i.e., the stopped order has 
priority at the better price). A BSE specialist, however, can elect to 
fill a stopped order at a better price at any time, so long as 
customers with limit orders on the book are adequately protected.
    This portion of the proposed rule change will allow the specialist 
to address those situations where, based on his or her professional 
judgment, the specialist determines that executing a stopped order 
ahead of same-side limit orders is necessary to ensure that the 
customer receives the best price available in the national market 
system.\18\ To the extent the specialist faces a choice between 
assuming a significant position where not otherwise warranted by 
Exchange rules or disseminating an execution at a price away from the 
market, the Commission finds that the BSE proposal presents an 
acceptable third alternative.
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    \18\See November 16th letter, supra, note 8. For instance, a 
specialist might rely on the proposed interpretation in a situation 
where, at the time a stopped order is due, there are a substantial 
number of shares ahead of that order on the book and the primary 
market has not traded at the stop price that day (or has not done so 
within several hours).
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    In this context, the Commission notes that a specialist executing a 
stopped order pursuant to the proposed interpretation will be required 
to allocate an equal number of shares to the limit order book. Under 
the proposed rule change, the specialist must split contra-side order 
flow between the stopped order and the pre-existing limit orders; if 
the specialist elects to participate, those limit orders with priority 
will receive an execution of the size of the stopped stock printed (up 
to a maximum of 500 shares). In light of the relatively thin limit 
order books on a regional exchange such as the BSE, the Commission 
believes that, as a practical matter, the proposed rule change is 
unlikely materially to disadvantage customers with limit orders on the 
specialist's book. The Commission, however, will monitor the Exchange's 
pilot program to ensure that the benefits of stopping stock in minimum 
variation markets warrant continued approval of such procedures.
    The Commission therefore requests that the BSE submit a report 
describing its experience with its minimum variation market pilot 
program by February 7, 1995. Specifically, the Exchange should gather 
and report information for a one month period on (1) the number of 
orders stopped in minimum variation markets; (2) the average size of 
such orders; and (3) the percentage of stopped orders that receive 
price improvement. In addition, the BSE should work with the Commission 
to develop an appropriate measure of the pilot program's impact on 
limit orders, particularly those limit orders on the specialist's book 
ahead of the stopped stock. Finally, if the Exchange determines to 
request an extension of the pilot program beyond March 21, 1995 or 
permanent approval thereof, the Commission requests that the BSE also 
submit a proposed rule change by February 7, 1995.
    The Commission finds good cause for approving Amendment No. 2 prior 
to the thirtieth day after the date of publication of notice of filing 
thereof. Amendment No. 2 clarifies certain procedural requirements 
contained in the original filing. Finally, the Commission did not 
receive any comments on the original proposal, which was published in 
the Federal Register for the full comment period.
    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 2 to the proposed rule change. 
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 rules 
change that are filed with the Commission, and all written 
communications relating to Amendment No. 2 between the Commission and 
any persons, other than those that may be withheld from the public in 
accordance with the provisions of 5 U.S.C. Sec. 552, will be available 
for inspection and copying in the Commission's Public Reference 
Section, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of such 
filing will also be available at the principal office of the BSE. All 
submissions should refer to File No. SR-BSE-94-09 and should be 
submitted by January 5, 1995.

IV. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\19\ that the proposed rule change (SR-BSE-94-09), including 
Amendment No. 2 on an accelerated basis, is approved.

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    \19\15 U.S.C. Sec. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\17 CFR 200.30-3(a)(12) (1991).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-30782 Filed 12-14-94; 8:45 am]
BILLING CODE 8010-01-M