[Federal Register Volume 60, Number 207 (Thursday, October 26, 1995)]
[Notices]
[Pages 54886-54889]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-26573]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36400; File No. SR-Amex-95-14]
Self-Regulatory Organizations; American Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change Relating to Permanent
Approval of Its Pilot Program That Permits Specialists to Grant Stops
in a Minimum Fractional Change Market
October 20, 1995.
I. Introduction
On March 23, 1995, the American Stock Exchange, Inc. (``Amex'' 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 approve permanently amendments
to Exchange Rule 109 that would permit specialists to stop stock in a
minimum fractional change market.
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in Securities
[[Page 54887]]
Exchange Act Release No. 35909 (June 28, 1995), 60 FR 34562 (July 3,
1995). No comments were received on the proposal.\3\ For the reasons
discussed below, the Commission has decided to approve the Amex's
proposal.
\3\ The Commission has received three comment letters opposing
the New York Stock Exchange's proposal for permanent approval of the
NYSE's procedures for stopping stock in minimum variation markets,
two of which were from the same commenter (Junius Peake). See letter
from Junius W. Peake, Monfort Professor of Finance, University of
Northern Colorado, to Secretary, SEC, dated March 1, 1995; letter
from Junius W. Peake, Monfort Professor of Finance, University of
Northern Colorado, to Secretary, SEC, dated July 21, 1995; letter
from Morris Mendelson, Professor Emeritus of Finance, The Wharton
School of the University of Pennsylvania, to Jonathan Katz,
Secretary, SEC, dated August 2, 1995. Because the NYSE's procedures
are identical to those of the Amex, issues raised in the comment
letters apply equally to both rule proposals. The comment letters
and the NYSE's response to Junius Peake's first comment letter are
summarized in the Commission's order. In addition, the Commission's
discussion in the NYSE order is applicable to this order. See
Securities Exchange Act Release No. 36399 (Oct. 20, 1995)
(permanently approving NYSE's pilot program for stopping stock in
minimum variation markets); see also letter from James Buck, Senior
Vice President and Secretary, NYSE, to Jonathan Katz, Secretary,
SEC, dated July 17, 1995.
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II. Description of Proposal
The practice of stopping stock by specialists refers to a guarantee
by a specialist that an order the specialist receives will be executed
at no worse a price than the contra side price in the market when the
order was received, with the understanding that the order may obtain a
better price. Prior to the proposed rule change, Exchange Rule 109(c)
permitted a specialist to stop stock only when the quotation spread was
at least twice the permitted minimum fractional change in the stock
(i.e., for most stocks \1/4\ point), with the specialist then being
required to narrow the quotation spread by making a bid or offer, as
appropriate, on behalf of the order that is stopped.
In April 1992, the Commission approved on a pilot basis \4\
amendments to Exchange Rule 109 that permitted a specialist to stop
stock in a minimum fractional change market.\5\ The Commission has
subsequently extended the Exchange's pilot program several times
without any modifications.\6\ The most recent extension of the pilot
program is scheduled to expire on October 21, 1995.
\4\ See Securities Exchange Act Release No. 30603 (Apr. 17,
1992), 57 FR 15340 (Apr. 27, 1992) (File No. SR-Amex-91-05) (``1992
Approval Order'').
\5\ Amex Rule 127 sets forth the minimum fractional changes for
securities traded on the Exchange. This Rule provides that the
minimum fractional change for dealings in securities shall be as
follows: securities selling under $5.00 and above \1/4\ of $1.00,
\1/16\ of $1.00 per share; under \1/4\ of $1.00, \1/32\ of $1.00 per
share; and at $5.00 and over, \1/8\ of $1.00 per share. This Rule
also provides that the Exchange may fix different minimum fractional
changes for dealings in securities.
\6\ See Securities Exchange Act Release Nos. 32185 (Apr. 21,
1993), 58 FR 25681 (Apr. 27, 1993) (File No. SR-Amex-93-10) (``April
1993 Approval Order''); 32664 (July 21, 1993) 58 FR 40171 (July 27,
1993) (File No. SR-Amex-93-22) (``July 1993 Approval Order''); 33791
(Mar. 21, 1994), 59 FR 14432 (Mar. 28, 1994) (File No. SR-Amex-93-
47) (``1994 Approval Order''); 35310 (Jan. 31, 1995), 60 FR 7236
(Feb. 7, 1995) (File No. SR-Amex-95-01) (``January 1995 Approval
Order''); 36010 (July 21, 1995), 60 FR 38869 (July 28, 1995) (``July
1995 Approval Order).
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The pilot program amends Rule 109 to permit a specialist, upon
request, to stop individual orders of 2,000 shares or less, up to an
aggregate total of 5,000 shares for all stopped orders (i.e., multiple
orders) in minimum fractional change markets. A specialist may stop an
order of a specified larger order size threshold, or a larger aggregate
number of shares after obtaining Floor Official approval. For a
specialist to stop an order in a minimum fractional change market,
there must be a significant disparity between the bid and ask size (on
the opposite side of the market from the order being stopped) that
suggests the likelihood of price improvement.\7\ In the 1992 Approval
Order, first approving the pilot, the Commission noted that a large
imbalance on the opposite side of the market would help ensure that
stops in a minimum fractional change market occur only when the
likelihood of the benefits to the customer's order being stopped far
exceeds the possibility of harm to customers' orders on the limit order
book.\8\
\7\ See letter from Claire P. McGrath, Senior Counsel, Legal &
Regulatory Policy Division, Amex, to Mary Revell, Branch Chief,
Division of Market Regulation, SEC, dated January 6, 1992; 1992
Approval Order, supra note 4; Amex Information Circular Nos. 92-74
(Apr. 24, 1992) and 93-333 (Apr. 7, 1993).
\8\ The 1992 Approval Order also noted Amex's representation and
the Commission's understanding that specialists would not routinely
use such procedures.
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Under these limited circumstances, the pilot permitted a specialist
to stop a buy (sell) order at the market upon request and guarantee
that the order will receive no worse than the best then-prevailing
offer (bid) price. The specialist would then increase the bid (offer)
size to reflect the stopped order.\9\ If the pre-existing volume at the
bid (offer) is exhausted and a seller (buyer) hits the bid (offer) made
on behalf of the stopped order, the buyer's (seller's) stopped order
would obtain price improvement. If, however, before that event occurs
another buyer's (seller's) order is executed at the offer (bid), then
the specialist will execute the stopped order at the stopped price.
\9\ The stopped order would be placed behind the existing limit
orders at the bid (offer) for priority purposes.
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In the orders approving the pilot procedures, the Commission
requested that the Exchange study the effects of stopping stock in
minimum fractional change markets and collect certain data to allow the
Commission to evaluate fairly and comprehensively the pilot
program.\10\ The Exchange has submitted to the Commission several
monitoring reports regarding the amendments to Rule 109, with the
latest report submitted on January 1995. The Commission then approved
an extension of the pilot until October 21, 1995, so that the
Commission would have additional time to evaluate the information
provided in the monitoring reports, especially in the latest report,
and to ensure that Rule 109, as amended, provides a benefit to
investors through the possibility of price improvement to customers
whose orders are granted stops in minimum fractional change markets
while not unduly harming public customer limit orders on the specialist
book.
\10\ See supra notes 4 and 6.
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III. Discussion
After careful consideration, the Commission has determined to
approve permanently the proposed rule change. For the reasons discussed
below, 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 Section 6(b)(5) \11\ and Section 11(b) \12\ of the
Act.
\11\ 15 U.S.C. 78f.
\12\ 15 U.S.C. 78k.
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Historically, the Commission has had mixed reactions about the
practice of stopping stock. The 1963 Report of the Special Study of the
Securities Markets found that unexecuted customer limit orders on the
specialist's book might be by passed by the stopped orders.\13\ The
Commission, nevertheless, has allowed the practice of stopping stock in
markets where the spread is at least twice the permitted minimum
fractional change in the stock because the possible harm to orders on
the book is offset by the
[[Page 54888]]
reduced spread that results and the possibility of price improvement.
\13\ See SEC, Report of the Special Study of Securities Markets
of the Securities and Exchange Commission, H.R. Doc. No. 95, 88th
Cong., 1st Sess., Pt. 2 (1963) (``Special Study'').
When stock is stopped, limit book orders on the opposite side of
the market do not receive an immediate execution. Consequently, if
the stopped order then receives an improved price, limit orders at
the stop price are bypassed and, if the market turns away from that
limit, may never be executed.
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Although the procedures for stopping stock in minimum fractional
change markets do not reduce the spread between the quotes, the
Commission has allowed, on a pilot basis, the practice in limited
circumstances where there is a substantial imbalance on the opposite
side of the market from the order being stopped. This limitation is
intended to assure that specialists would stop stock in minimum
fractional change markets only in situations where the likelihood of
price improvement outweighs the possibility that contra-side limit
orders would be bypassed.\14\ Moreover, the order size restrictions
would act to ensure that most stops are granted to public customers
with small orders, whose orders could most benefit from the
professional handling by specialists. In addition, limiting the total
stops to 5,000 shares is intended to ensure that the amount of stopped
stock does not become so large that there would, in effect, cease, to
be an imbalance on the opposite side of the market from the order being
stopped. (i.e, less likelihood of price improvement for the stopped
orders). Finally, although the spread cannot be reduced by stopping
stock in minimum fractional change markets, specialists must change the
quoted bid or offer size to reflect the size of the order being
stopped. This should ensure that the stopped stock will be shown in the
quote.
\14\ As for limit book orders on the same side of the market as
the stopped stock, the Commission believes that Rule 109's
requirements make it unlikely that these limit orders would not be
executed. Under the Amex pilot program, an order can be stopped only
if a substantial imbalance exists on the opposite side of the
market. In those circumstances, the stock would probably trade away
from the large imbalance, resulting in execution of orders on the
limit order book.
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To examine whether specialist have been using the pilot program as
intended, the Commission had asked the Exchange to provide data on the
stopping stock program in a minimum fractional change market.\15\ The
Exchange has submitted to the Commission several monitoring reports
regarding the amendments to Rule 109. The Commission believes that the
monitoring reports, especially the latest monitoring report, provide
useful information regarding the effectiveness of the program during
the pilot period.
\15\ See supra notes 4 and 6.
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Specifically, according to the Amex's latest report, approximately
half of eligible orders (i.e., orders for 2,000 shares or less) stopped
in minimum fractional change markets received price improvement.
Moreover, according to the Amex report, stops in minimum fractional
change markets generally have been granted when there was a significant
disparity (in both absolute and relative terms) between the number of
shares bid for and the number offered. In particular, the report notes
that the ratio between the quotes (i.e., disparity between the bid and
ask size on the opposite side of the market from the order being
stopped) when orders were stopped was approximately 3 to 1. The
Exchange also reports between 37% and 65% of the limit orders on the
opposite side of the market from all market orders stopped in a minimum
fractional change market were executed by the end of the day.\16\
Moreover, based on the one-day review of the ten stocks receiving the
greatest number of stops, the Amex found that 92% of the shares on the
opposite side of the market at the time the stop was granted was
executed by the close of the day's trading. Finally, with respect to
Floor Official approval of waivers to the numerical limitations, the
Exchange reports that a very high percentage of orders requiring Floor
Official approval received such an approval.
\16\ The percentages depended upon whether the stocks have been
phased into the Exchange's electronic display book. For stocks in
which the electronic display book had been implemented, the Exchange
was able to monitor the limit orders on the opposite side of the
market from the market orders stopped in minimum fractional change
market. For other stocks, the Amex determined how often an
equivalent volume (i.e., the same number of shares as the stopped
order) was executed on the opposite side's limit price by the close
of the day's trading.
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The Commission, therefore, believes that the data on stopping stock
in minimum fractional change markets show that the pilot has operated
as intended and should be approved permanently.\17\
\17\ Cf. Securities Exchange Act Release No. 36399 n.24 (Oct.
20, 1995) (permanently approving NYSE's pilot procedures for
stopping stock in minimum variation markets).
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In addition to a determination that the Amex proposal is consistent
with Section 6 of the Act, the Commission also believes that the
proposal is consistent with the prohibition in Section 11(b) against
providing discretion to a specialist in the handling of an order.\18\
Section 11(b) was designed, in part, to address potential conflicts of
interest that may arise as a result of the specialist's dual role as
agent and principal in executing stock transactions. In particular,
Congress intended to prevent specialists from unduly influencing market
trends through their knowledge of market interest from the specialist's
book and their handling of discretionary agency orders.\19\ The
Commission has stated that, pursuant to Section 11(b), all orders other
than market or limit orders are discretionary and therefore cannot be
accepted by specialists.\20\
\18\ Section 11(b) permits a specialist to accept only market or
limit orders.
\19\ See H. Rep. No. 1383, 73d Cong. 2d Sess. 22, S. Rep. 792,
73d Cong. 2d Sess. 18 (1934).
\20\ See Special Study, supra note 13.
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As previously noted in the 1992 Approval Order, the Commission
believes that it is appropriate to treat stopped orders, even those
under the pilot procedures, as equivalent to limit orders. The Amex's
rules define a limit order as an order to buy or sell a stated amount
of a security at a specified price, or at a better price if
obtainable.\21\ The Commission believes that stopped orders are
equivalent to limit orders, in this instance, because the orders would
be automatically elected at the best bid or offer, or better if
obtainable. Although the proposed amendments permit the specialist to
employ his judgment to some extent, the Commission believes that the
requirements imposed on the specialist for granting stops in minimum
fractional change markets provide sufficient stringent guidelines to
ensure that the specialist will only implement these provisions in a
manner consistent with his market making duties and Section 11(b).\22\
\21\ See Amex Rule 131(b).
\22\ Moreover, stopped orders as ``limit orders'' would not
bypass pre-existing limit orders on the same side of the market.
Under the Amex's procedures, specialists may not execute a stopped
order before the limit order interest on the Exchange (at the same
price as the stopped order) is exhausted.
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In permanently approving the stopping stock procedures for minimum
fractional change markets, the Commission is relying on three aspects
of the program and expects the Amex to reiterate these requirements in
an Information Circular to members. First the Commission continues to
believe that the requirement of a sufficient market imbalance is
important to the proper application of the program. This requirement
should help the Amex ensure that stops are only granted in a minimum
fractional change market when the benefit (i.e., price improvement) to
orders being stopped far exceeds the potential for harm to orders on
the specialist's book. Second, the Commission expects the Amex to take
appropriate action in response to any instance of specialist non-
compliance with the stopping stock procedures in minimum fractional
change markets. Third, the Commission emphasized that Floor Official
approval of an increase in the size of the stopped order or stopping
more than 5000 shares must not be routine. The Commission
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expects the Amex to monitor compliance with these aspects of the
stopping stock program through its special surveillance procedures.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\23\ that the proposed rule change (SR-Amex-95-14) is approved.
\23\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\24\
\24\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-26573 Filed 10-25-95; 8:45 am]
BILLING CODE 8010-01-M