[Federal Register Volume 60, Number 194 (Friday, October 6, 1995)]
[Notices]
[Pages 52440-52443]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-24910]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36323; File No. SR-BSE-95-14]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the Boston 
Stock Exchange, Inc., Relating to its Competing Specialist Pilot 
Program

September 29, 1995.

I. Introduction

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 25, 1995, the Boston Stock Exchange, Inc. (``BSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change, and on September 27, 1995, 
Amendment No. 1 thereto,\3\ as described in Items II and III below, 
which Items have been prepared by the self-regulatory organization. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ See letter from Karen Aluise, Assistant Vice President, BSE, 
to Glen Barrentine, Senior Counsel, SEC, dated September 27, 1995. 
Amendment No. 1 amended the request for an extension through June 
28, 1996, to an extension through March 29, 1996.
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II. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The BSE seeks to extend the current pilot program for competing 
specialists on its floor until March 29, 1996, and to adopt clarifying 
language for limit order execution under the pilot. The Exchange also 
proposes to expand the program to four competing specialists that may 
trade up to 100 stocks each.

III. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The purpose of the proposed rule change is to extend the current 
pilot program for competing specialists until March 29, 1996 and to 
clarify the priority rule regarding the execution of limit orders on 
the central limit book.\4\

    \4\ The language of the proposed rule change is as follows, with 
additions to the current rule in italics and deletions in brackets:
    Because there is only one Exchange market in a security subject 
to competition, all limit [Limit] orders sent to the Exchange will 
be maintained by the BEACON System's central limit book and will be 
[entrusted to each competing specialist are to be represented and] 
executed strictly according to time priority as to receipt of the 
order in the BEACON System, irrespective of firm order routing 
procedures.
    This rule change previously was published for public comment in 
Securities Exchange Act Release No. 36100 (August 14, 1995), 60 FR 
43628 (August 22, 1995), as an amendment to a BSE request for 
permanent approval of the competing specialist program. See File No. 
SR-BSE-95-02.

[[Page 52441]]

    This competing specialist program has been operating on a pilot 
basis since May 18, 1994.\5\ In addition to extending the pilot until 
March 29, 1996, the Exchange proposes to expand the pilot. The program 
currently provides for up to two competing specialists in a stock on 
the floor of the Exchange in addition to the regular specialists. The 
Exchange is seeking to increase the number of competitors from two to 
four. The Exchange also proposes to increase the number of stocks per 
competing specialist firm from 20 to 100 for the duration of the pilot 
program.

    \5\ See Securities Exchange Act Release No. 34078 (May 18, 
1994), 59 FR 27082 (May 25, 1994).
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    The Exchange believes that these increases are reasonable and will 
enable the Exchange to further evaluate the effectiveness of the 
program on a wider scale to determine if any changes are necessary to 
improve the program and the Exchange's market-making function 
generally. The Exchange believes the program has proven to provide 
adequate protection of customer orders sent to the Exchange and has 
maintained a true agency auction market for customer orders.
2. Statutory Basis
    The Exchange believes 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.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange has neither solicited nor received comments on the 
proposed rule change.\6\

    \6\ The Commission received two comment letters regarding the 
BSE's request for permanent approval of the competing specialist 
program. See letter from Paula Gavin, Chair, NYSE Individual 
Investors Advisory Council, to Chairman Arthur Levitt, SEC, dated 
July 17, 1995 (``Gavin Letter'') (asserting that preferencing 
programs deny orders the benefits and protections of auction market 
trading); and letter from Robert Jennings, Faculty Fellow and 
Professor of Finance, Indiana University School of Business, to 
Jonathan Katz, Secretary, SEC, dated June 30, 1995 (containing a 
preliminary draft of an academic paper from Indiana University that 
studied the short term effects of preferencing on market quality and 
found any such effects to be minimal). These letters are available 
at the Commission in File No. SR-BSE-95-02.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street NW., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying at the 
Commission's Public Reference Section, 450 Fifth Street NW., 
Washington, D.C. 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the BSE. All 
submissions should refer to File No. SR-BSE-95-14 and should be 
submitted by October 27, 1995.

V. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

A. Description

    The BSE normally assigns one specialist to each stock traded on the 
Exchange floor (the ``regular'' specialist). The competing specialist 
program allows the Exchange to approve additional specialists for a 
particular stock (``Competing Specialists''), who compete with each 
other and the regular specialist on the trading floor of the 
Exchange.\7\ The competing specialist pilot currently limits the number 
of specialists that can compete in a stock to three--one regular 
specialist and up to two Competing Specialists. The pilot also limits 
each Competing Specialist to a maximum of 10 stocks unless the Market 
Performance Committee approves an increase of up to 20 stocks per 
applicant firm. The BSE proposes to expand these limitations to allow 
up to four Competing Specialists that may compete in up to 100 stocks 
each.

    \7\ The Commission notes that the Competing Specialists must 
conduct their activity on the floor of the Exchange. There are no 
existing Exchange rules that allow specialists to operate off the 
floor of the Exchange. Such a change in operations would require 
Commission approval.
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    Under the pilot program, Competing Specialists have the same 
affirmative and negative market making obligations as regular 
specialists.\8\ The regular specialist, however, remains responsible 
for (1) updating all quotations,\9\ (2) coordinating all openings and 
reopenings to ensure that they are unitary, (3) inputing quotations on 
the Intermarket Trading System (``ITS'') to reflect the best BSE quote 
among all the specialists,\10\ and (4) coordinating trading halts.

    \8\ Among the obligations imposed upon specialists by the 
Exchange, and by the Act and rules thereunder, is the maintenance of 
fair and orderly markets. See, e.g., 17 CFR 240.11b-1; BSE Rules, 
Ch. XV, Section 2.
    \9\ The BSE needs to implement system upgrades that will allow 
the Competing Specialists to enter their own quotes into BEACON. The 
system will coordinate the aggregation and dissemination of 
quotations, but the regular specialist will continue to coordinate 
openings, reopenings, and trading halts. See infra text accompanying 
note 28.
    \10\ See id. Regardless of the number of specialists competing 
in a stock, the BSE displays only one consolidated quotation (the 
best quote among all the specialists) to other markets in the 
National Market System at all times.
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    Under the competing specialist program, the Exchange's rules 
governing the auction market principles of priority, parity, and 
precedence remain unchanged for quotes at the ITS/BBO.\11\ Specialists 
quoting at the ITS/BBO have priority over specialists not quoting at 
the ITS/BBO. Under the rules, if two or more specialists are quoting at 
the ITS/BBO, the earliest bid/offer at that price has time priority and 
will be filled first up to its specified size. If the specialists are 
on both price and time parity at the ITS/BBO, all bids/offers equal to 
or greater than the size of the contra-side order are on parity and 
entitled to precedence over smaller orders.

    \11\ See BSE Rules, Ch. II. Section 6.
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    When none of the specialists are quoting at the ITS/BBO, the 
competing specialist program permits orders to be directed to a 
particular specialist for execution (i.e., there is no priority between 
quotes outside of the ITS/BBO).\12\ If a particular specialist is not 

[[Page 52442]]
specified, the order is directed to the regular specialist unless the 
routing firm is affiliated with a Competing Specialist.\13\ In that 
case, the order is routed automatically to that member firm's 
affiliated specialist, thereby preventing member firms affiliated with 
a specialist from routing non-profitable orders through the BSE's 
automated order routing system (``BEACON'') to another specialist when 
market conditions are unfavorable.

    \12\ For example, assume that the ITS/BBO is 20 bid to 20\1/8\ 
offered, and specialist A is bidding 19\3/4\ while specialist B is 
bidding 19\1/2\. A market order to sell may be directed to 
specialist B for execution even through specialist A has a better 
bid because neither specialist is bidding at the ITS/BBO. Under the 
competing specialist program, specialist B would execute the order 
at 20 (the ITS best bid) or better. If specialist A had been bidding 
20 (the ITS best bid), specialist A would have had priority to 
execute the order even though it was directed to specialist B.
    \13\ As noted above, however, if the Competing Specialist is 
quoting the ITS/BBO and clearly has established priority on the BSE 
floor, then the Competing Specialist will fill the order despite the 
default routing to the regular specialist.
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    All limit orders in BEACON are represented and executed strictly 
according to time priority, irrespective of firm routing 
procedures.\14\ BEACON (which handles approximately 95% of all order 
flow on the BSE) automatically executes incoming orders against any 
contra-side orders on the limit order book. Prior to automatic 
execution, however, all market and marketable limit orders are exposed 
to the designated specialist for 15 seconds for possible price 
improvement.\15\ Only where there is no contra-side order on the limit 
order book (and no other specialist has a priority quote at the ITS/
BBO) is the incoming order routed to the designated specialist for 
execution.

    \14\ The BSE is proposing to codify this policy in Chapter XV, 
Section 18, of the BSE Rules.
    \15\ See BSE Rules, Ch. II, Sec. 6.
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    The BSE represents that it is in the process of developing 
additional enhancements to BEACON to assist the efficiency of the 
competing specialist program. First, at the outset of the pilot only 
the regular specialist was sent quote alerts \16\ and trade alerts \17\ 
in a given security. The BSE represents that BEACON has been modified 
so that such alerts are currently sent to the Competing Specialist.\18\ 
Additionally, BEACON recently was enhanced to alert the regular 
specialist to trade-throughs of the BSE market.\19\ The Exchange 
anticipates providing this alert to Competing Specialists as well.\20\ 
In addition, the regular specialist currently must coordinate pre-
openings with Competing Specialist verbally. The BSE expects to 
implement shortly improvements to BEACON that enable each specialist to 
directly enter pre-opening trading interest into BEACON.\21\

    \16\ Quote alerts are messages sent by BEACON to a BSE 
specialist when a quote from among the ITS participants occurs at or 
through the price at which there is a limit order on the BSE book.
    \17\ Trade alerts are messages sent by BEACON to the BSE 
specialist when a trade occurs among the ITS participants at the 
price of an outstanding limit order on the specialist's book.
    \18\ Conversation between George Mann, General Counsel and 
Senior Vice President, BSE, and N. Amy Bilbija, Attorney, 
Commission, on June 23, 1995.
    \19\ A ``trade-through'' of the BSE market occurs whenever 
another ITS Participant initiates the purchase of a security at a 
price that is higher than the price at which the security is being 
offered (or initiates the sale at a price lower than the price at 
which the security is being bid) at the time of purchase (or sale) 
on the BSE.
    \20\ See BSE January Report, infra note 25.
    \21\ See id.
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    In addition, Competing Specialists currently do not have the 
capability to enter their own quotes into BEACON, but rather must 
communicate them orally to the regular specialist who then enters the 
quote into BEACON on the Competing Specialist's behalf. In order to 
encourage competitive quoting by all specialists making markets in a 
security, the BSE has been working to modify BEACON so that the system 
will accept quotes from Competing Specialists. Because there currently 
is only one quote entered into the system by the regular specialist, 
BEACON presently routes orders as directed without systematically 
determining whether another specialist may have a priority quote at the 
ITS/BBO. Once the system is enhanced so that BEACON accepts quotes from 
each specialist directly, the BSE will also reprogram BEACON to route 
incoming orders to the specialist with priority on the Exchange at the 
ITS/BBO, or, if no such priority has been established, to the 
designated specialist.\22\

    \22\ See infra note 38.
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B. Discussion

    The Commission finds that the BSE's proposal to extend its 
competing specialist pilot program, as amended, to March 29, 1996, is 
consistent with the requirements 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 Section 6(b)(5) of the Act,\23\ which requires that the 
rules of an exchange be designed to promote just and equitable 
principles of trade, prevent fraudulent and manipulative acts, 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.

    \23\ 15 U.S.C. 78f(b)(5) (1988).
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    In its original pilot approval order, the Commission expressed 
concerns regarding what impact the competing specialist program might 
have on the BSE market. To this end, the Commission requested that the 
BSE submit quarterly data reports and a report analyzing such data.\24\ 
The BSE has filed these interim reports with the Commission.\25\

    \24\ See Securities Exchange Act Release No. 34078, supra note 
5.
    \25\ See Competing Specialist Initiative January 1995 Report, 
submitted to the Commission on February 13, 1995 (``BSE January 
Report''); and letter from Karen Aluise, Assistant Vice President, 
BSE, to N. Amy Bilbija, Attorney, SEC, dated April 28, 1995 (``BSE 
April Report''). These reports are available in the public file for 
SR-BSE-95-02.
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    The data submitted by the BSE indicates that the volume of orders 
directed to the BSE in the stocks with multiple specialists increased 
steadily during the pilot. In addition, the depth of the limit order 
book for the stocks increased, indicating that firms are sending both 
market and limit orders to their affiliated specialists.
    Finally, while the BSE has provided evidence that the competing 
specialist program has increased order flow to the Exchange, the data 
regarding quote competition between specialists in a particular 
security is mixed. The data shows an increase in the volume of the 
BSE's incoming ITS commitments for the securities traded pursuant to 
the competing specialist program. The data also indicates, however, 
that there is a lack of interaction by the regular specialist with 
incoming orders directed to a competing specialist. Specifically, 
directed orders are almost always executed by the designated 
specialist. Under the program's rules, if the specialists were quoting 
at the ITS/BBO, they would at times have priority over the designated 
specialist and intercept some of the directed order flow. While this 
data is inconclusive, the Commission believes that certain system 
enhancements may facilitate quote competition on the BSE.\26\

    \26\ See infra note 28.
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    In addition, an extension of the pilot will enable the BSE to 
provide additional data for a more thorough analysis of the effects of 
multiple specialists on the BSE market and the national market system. 
Accordingly, during the extension of the pilot, the Commission requests 
that the BSE continue to submit the quarterly reports described in the 
pilot approval order.\27\ The Commission also requests that the BSE 
include in future reports data identifying the percentage of BSE quotes 
that either match or better the ITS/BBO. This data should isolate 
stocks in which there are multiple specialists and be compared to 
statistics for stocks with only one specialist.\28\

    \27\ See Securities Exchange Act Release No. 34078, supra note 
5.
    \28\ As discussed above, see supra text accompanying note 9, the 
BSE needs to adopt enhancements to BEACON to permit Competing 
Specialists to enter their own quotes into the system and to enable 
orders to be automatically routed to the specialist with priority 
under the rules. During the pilot extension, the Commission expects 
the BSE to continue developing these system enhancements, and 
expects progress to be made toward implementation of direct quote 
entry capability and systematic routing of orders.

[[Page 52443]]

    More importantly, the Commission is interested in exploring whether 
broader market structure initiatives can address the commenters' 
concerns regarding order interaction and the effects of referencing on 
the NMS in general, and on order execution quality in particular. In 
this regard, the Commission recently proposed rules that attempt to 
address, among other things, the order interaction and best execution 
issues presented by referencing of order flow.\29\ Extension of the BSE 
pilot will allow the Commission an opportunity to study the 
implications of these proposals for the BSE's competing specialist 
pilot.

    \29\ See Securities Exchange Act Release No. 36310 (September 
29, 1995).
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    The Commission finds good cause for approving the proposed rule 
change, as amended, prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. The 
Commission believes that accelerated approval of the proposal to extend 
the pilot is appropriate in order to avoid an unnecessary interruption 
to the pilot while the Commission conducts its market structure 
rulemaking and continues to collect data. Moreover, the Commission 
received only minimal comment on the BSE proposal to adopt the pilot on 
a permanent basis, making it unlikely that additional comment would be 
submitted regarding the extension. The Commission also believes that 
accelerated approval of the clarifying language to the limit or order 
execution rule is appropriate. The rule, which merely clarifies the 
existing practice, was previously published for public comment for the 
full statutory period \30\ and no comments were receive on the 
proposal.

    \30\ See supra note 4.
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    Finally, the Commission believes that accelerated approval of the 
proposed expansion of the program to four Competing Specialists that 
may compete in up to 100 securities is appropriate. Expansion of the 
program will provide the Commission with additional data upon which to 
decide whether the program should be permanently approved. In addition, 
the Commission published the BSE's request for permanent approval, 
which contained no destructions on the number of specialist or the 
number of stocks in which they could compete, for the full statutory 
period.\31\ Only one comment letter that criticized the proposal was 
received.\32\ The Commission will consider that comment when deciding 
either to approve the BSE's request to make the competing specialist 
program. permanent.

    \31\ See Securities Exchange Act Release No. 35404 (February 22, 
1995), 60 FR 10882 (February 28, 1995).
    \32\ See Gavin Letter, supra note 6.
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VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2),\33\ that the 
proposed rule change to extend the BSE's competing specialist program 
as amended, through March 29, 1996, is hereby approved on an 
accelerated basis.

    \33\ 15 U.S.C. 78s(b)(2) (1988)
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    By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 95-24910 Filed 10-5-95; 8:45 am]
BILLING CODE 8010-01-M