[Federal Register Volume 61, Number 67 (Friday, April 5, 1996)]
[Notices]
[Pages 15318-15322]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-8398]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37045; File No. SR-BSE-95-02]


Self-Regulatory Organizations; Boston Stock Exchange, Inc.; Order 
Granting Approval of Proposed Rule Change Permitting Competing 
Specialists on the Floor of the Exchange

March 29, 1996.

I. Introduction

    On February 6, 1995, 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 permanently rules 
permitting competing specialists on the floor of the Exchange and 
guidelines governing their registration and activity. The proposed rule 
change was published for comment in Securities Exchange Act Release No. 
35404 (February 22, 1995), 60 FR 10882 (February 28, 1995).\3\ Four 
comment letters were received on the proposed rule change.

    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On August 10, 1995, the BSE submitted Amendment No. 1 to the 
proposed rule change. Amendment No. 1 clarified that, under the BSE 
rules, limit orders will be executed in the order in which they are 
received by the BEACON System, i.e., according to strict time 
priority, irrespective of firm order routing procedures. The rule 
change contained in Amendment No. 1 has been approved as part of the 
most recent extension of the competing specialist pilot. See 
Securities Exchange Act Release No. 36323 (September 29, 1995), 60 
FR 52440 (October 6, 1995) (order extending pilot through March 29, 
1996).
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II. Background

    On May 18, 1994, the Commission approved a one-year pilot program, 
referred to as the Competing Specialist Initiative (``CSI''), that 
permits competing specialists on the floor of the BSE.\4\ The pilot has 
been extended twice and will expire after March 29, 1996.\5\

    \4\ See Securities Exchange Act Release No. 34078 (May 18, 
1994), 59 FR 27082 (May 25, 1994) (``Pilot Approval Order''). 
Competition between multiple specialists on the Exchange did not 
begin, however, until July 1994, when two firms began acting as 
Competing Specialists in a total of seven issues.
    \5\ See Securities Exchange Act Release No. 35716 (May 15, 
1995), 60 FR 26908 (May 19, 1995) (order extending pilot through 
October 2, 1995); and Securities Exchange Act Release No. 36323, 
supra note 3 (order extending pilot through March 29, 1996).
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    Initially, the CSI pilot limited the number of specialists that 
could compete in a stock to three--one regular specialist and up to two 
Competing Specialists. Each Competing Specialist was limited to 10 
stocks, unless the Exchange's Market Performance Committee approved an 
increase of up to 20 stocks per applicant firm. Competing Specialists 
were also prohibited from making cash payments for order flow. In its 
most recent extension of the program, the Commission approved an 
expansion of the program to allow a total of four specialists per 
stock. In addition, Competing Specialists were permitted to trade up to 
100 stocks each. Presently, there are four member firms participating 
in the pilot program, cumulatively making markets in 44 stocks (``CSI 
stocks''). The Exchange proposes that the CSI be permanently approved 
without the above restrictions.

III. Description of the Program

    As explained further below, the principal feature of the CSI is 
that it permits members to route order flow to a designated specialist 
for execution. Such order flow would only be executed by the designated 
specialist if there are then no limit orders on the BSE book at the 
execution price and one of the other specialists are quoting at the 
ITS/BBO with time priority.

A. Mechanics of the Competing Specialist Program

    Under the BSE's competing specialist pilot, the Exchange's rules 
governing the auction market principles of priority, parity, and 
precedence remain unchanged for quotes at the Intermarket Trading 
System (``ITS'') best bid or offer (``BBO'').\6\ Quotes representing 
customer orders have priority over specialists' quote at the same 
price,\7\ and specialist quoting at the ITZ/BBO have priority over 
specialists not quoting at the ITS/BBO. 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.\8\ If the 
specialists are on both price

[[Page 15319]]
and time parity at the ITZ/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.

    \6\ See BSE Rules, Chapter II, Sec. 6.
    \7\ When acting as an agent, specialists are required to hold 
the interests of orders entrusted to them above their own interests. 
See BSE Rules Chapter XV, Sec. 2(b). Specialists may not trade for 
their own accounts at the same or better price as unexecuted limit 
orders that are being held for customers. See BSE Rules, Chapter II, 
Sec. 11. The Exchange recently clarified in its rules that because 
there is only one Exchange market in a security, specialists may not 
trade ahead of any limit order on the Exchange, irrespective of firm 
order routing designations. See Securities Exchange Act Release No. 
36323, supra note 3.
    \8\ Regardless of the number of specialists competing in a 
stock, the BSE displays only one consolidated quotation (best quote 
among all the specialists) to other markets in the national market 
system at all times.
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    All limit orders sent to the BSE must be entered into the BSE's 
automated order routing system (``BEACON''), which maintains one 
consolidated limit order book for the Exchange and ensures that limit 
orders at the same price are kept in strict time priority, irrespective 
of routing designations. Each specialist in a security has the ability 
to execute limit orders on the Exchange's consolidated limit order book 
through its BEACON terminal. Market orders and marketable limit orders 
routed through BEACON (approximately 95% of all orders on the BSE) \9\ 
are automatically executed by the system against any contra-side orders 
on the consolidated limit order book. Before any market and marketable 
limit orders are automatically executed by the BEACON system, however, 
they are exposed to the designated specialist for 15 seconds to give 
that specialist an opportunity to improve the price.\10\

    \9\ Orders communicated to a specialist (rather than routed to 
the specialist through BEACON) are entered into BEACON by the 
specialist for execution.
    \10\ See BSE Rules, Chapter XXXIII, Sec. 3(c).
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    Under CSI rules, when there are no customer limit orders at the 
ITS/BBO and none of the other specialists in the stock are quoting at 
the ITS/BBO with time priority, orders may be executed at the ITS/BBO 
or better by the designated specialist.\11\ Orders not directed to a 
particular specialist are automatically routed to the regular 
specialist for execution,\12\ except that the orders of a routing firm 
that is affiliated with a Competing Specialist are deemed to be 
designated to that member firm's affiliated specialist. This prevents 
member firms affiliated with a specialist from routing non-profitable 
orders to a non-affiliated specialist when market conditions are 
unfavorable.\13\

    \11\ 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 though 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.
    \12\ See infra notes 14 and 15, and accompanying text.
    \13\ See infra notes 14 and 15, and accompanying text.
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    Currently, a Competing Specialist is not able to enter quotes 
directly into BEACON but must manually communicate its quotes to the 
regular specialist who then enters the quotes into BEACON on its 
behalf. Because all quotes are entered into the system by the regular 
specialist, BEACON presently routes orders that are not executed 
against the consolidated limit order book to the designated specialist 
without systematically determining whether another specialist may have 
a priority quote at the ITS/BBO.\14\ In order to encourage competitive 
quoting by all specialists making markets in a security, the BSE has 
committed to modify BEACON so that the system will accept quotes 
directly from Competing Specialists.\15\ Once the system is enhanced so 
that BEACON accepts quotes from each specialist directly, the BSE will 
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.\16\

    \14\ The Commission notes that, although the BSE's system 
currently is not able to automatically route orders to the 
specialist with priority, the BSE's rules on competing specialists 
do not permit a specialist to trade through another BSE specialist's 
quote that has priority at the ITS/BBO. If this were to occur, it 
would be a violation of BSE rules. The Commission expects the BSE to 
take appropriate regulatory action in the event of such a violation 
of the CSI rules.
    \15\ See letter from John I. Fitzgerald, Executive Vice 
President, BSE, to Howard Kramer, Associate Director, SEC, dated 
February 29, 1996 (agreeing to complete system enhancements within 
one year from permanent approval of the CSI).
    \16\ Id.
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B. Procedures for Competing Specialists

    Under the CSI pilot, Competing Specialists have the same 
affirmative and negative market making obligations as regular 
specialists \17\ and must conform to all other specialist performance 
requirements and standards set forth in the Rules of the Exchange,\18\ 
including minimum capital and equity requirements.\19\

    \17\ See, e.g., U.S.C. 78k; and BSE Rules, Chapter XV.
    \18\ See generally BSE Rules, Ch. XV (rules governing the 
responsibilities of specialists). The Commission notes that all BSE 
specialists, including Competing Specialists, affiliated with an 
approved person must have proper information barriers in place in 
conformance with BSE Rules, Ch. II, Sec. 36. See Securities Exchange 
Act Release No. 34076, (May 18, 1994) 59 FR 26822 (May 24, 1994).
    \19\ See BSE Rules, Ch. VIII and Ch. XII.
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    To register as a Competing Specialist, an applicant must submit a 
written application to the BSE's Market Performance Committee 
(``MPC''), listing in order of preference the stock(s) in which the 
applicant wishes to compete. Applicants for participation in the CSI 
must be registered with the Exchange as specialists. The MPC reviews 
applications \20\ with consideration for the following factors:

    \20\ The decision of the MPC may be appealed to the Executive 
Committee.
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     Overall performance evaluation results of the applicant;
     Financial capability;
     Adequacy of manpower on the floor; and
     Objection by the regular specialist in a stock, with or 
without cause.\21\

    \21\ Any objection by the regular specialist to permit 
competition in one or more of such specialist's stock must be in 
writing and filed with the Exchange within 48 hours (unless the 
specialist is unavailable, in which case within 48 hours of becoming 
available) of notice of filing of the competing specialist 
application. The MPC may not deny applications based solely on such 
an objection. Rather, it is only to be used in circumstances wherein 
the stock at issue requires special treatment such that an entering 
competitor could jeopardize the fair and orderly market maintained 
by the regular specialist.
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    A Competing Specialist seeking to terminate such status must notify 
the MPC at least three business days prior to the desired effective 
date of such withdrawal from competition. Withdrawal from registration 
by a Competing Specialist bars that Competing Specialist from applying 
to compete in that same stock for 90 days following the effective date 
of withdrawal. When the regular specialist requests to be relieved of a 
stock, the stock is posted for reallocation by the Stock Allocation 
Committee. In the interim, if the MPC is satisfied that the Competing 
Specialist can continue to maintain a fair and orderly market in such 
stock, the Competing Specialist will serve as the regular specialist 
until the stock has been reallocated.\22\ Where there is more than one 
Competing Specialist in the stock, Enchange staff will place the stock 
with a caretaker\23\ until reallocation.

    \22\ Once competition begins in a security, any subsequent 
reallocation will bar objection rights from that day forward.
    \23\ A ``caretaker'' is a specialist from another specialist 
unit who is chosen by the Exchange to temporarily act as the regular 
specialist.
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    The registration of a Competing Specialist, as is the case with 
regular specialists, may be suspended or terminated by the MPC upon a 
determination of any substantial or continued failure by such Competing 
Specialist to engage in dealings in accordance with the Constitution 
and Rules of the Exchange.

IV. Summary of Comments

    The Commission received four comment letters on the proposed rule 
change. Paula Gavin, Chairwoman of the NYSE Individual Investors 
Advisory Council, submitted two letters asserting that ``preferencing'' 
programs (i.e.,

[[Page 15320]]
allowing orders to be directed to a particular specialist for execution 
against itself) deny such orders the benefits and protections of 
auction market trading\24\. As a result, Ms. Gavin believes such orders 
do not get the benefit of potential price improvement, nor do they add 
to the pricing mechanism of the national market system. Ms. Gavin 
therefore believes that preferencing programs should not be permitted 
to continue.

    \24\ See letters from Paula Gavin, Chair, NYSE Individual 
Investors Advisory Council, to Chairman Levitt, SEC, dated July 17, 
1995, and October 2, 1995.
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    The Commission received two letters that included preliminary 
drafts of an academic paper from Indiana University that studies the 
short term effects of preferencing on market quality (``IU 
Study'').\25\ The IU Study looked for potential shifts in market share, 
bid/ask spreads, and liquidity premiums for 34 NYSE-listed securities 
that were traded pursuant to the CSI pilot between July 1994 and March 
1995. The IU Study's preliminary results indicate that the introduction 
of competing specialists on the BSE appears to have substantially 
increased the BSE's trade volume in the 34 stocks and that, in 
particular, the share of small trades executed on the BSE doubled in 
short period of time. The IU Study found, however, that over the short 
term studied the effects of competing specialists on market quality 
appear to be minimal. Although the IU Study found that spreads and 
liquidity premiums decreased, \26\ it concludes that this decrease is 
not statistically significant because of the limited number of stocks 
studied. The IU study further notes that, to the extent that retail 
brokers internalizing trades reduce (or even eliminate) commissions, 
investor welfare is improved.

    \25\ See letter from Robert Jennings, Faculty Fellow and 
Professor of Finance, Indiana University School of Business, to 
Jonathan Katz, Secretary, SEC, dated June 30, 1995; and letter from 
Robert Battalio, Assistant Professor University of Notre Dame, to 
Jonathan G. Katz, Secretary, SEC, dated March 6, 1996 (``IU 
Study'').
    \26\ The liquidity premium measures the closeness of transaction 
prices to the mid-point of the quotation spread. Thus, a decrease in 
the liquidity premium indicates that transaction prices have moved 
closer to the mid-point of the spread.
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V. Data Summary

    In its approval of the CSI pilot, the Commission requested that the 
BSE provide, through specified periodic reporting requirements, data 
regarding the CSI's effect on competition on the BSE and within the 
national market system. Since the commencement of the CSI pilot, the 
Exchange has submitted to the Commission several reports that contained 
trade and share data for stocks traded on the BSE.\27\

    \27\ The reports are available in the public file. See Competing 
Specialist Initiative Report, submitted to the Commission on 
February 13, 1995 (``BSE Report No. 1''); letter from Karen Aluise, 
Assistant Vice President, BSE, to N. Amy Bilbija, Attorney, SEC, 
dated April 28, 1995 (``BSE Report No. 2''); and letter from Karen 
Aluise, Assistant Vice President, BSE, to Glen Barrentine, Senior 
Counsel, SEC, dated February 14, 1996 (``BSE Report No. 3'').
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    The data provided by the Exchange indicated that trade and share 
volume for the BSE overall increased during the CSI pilot.\28\ The data 
also indicated that Competing Specialists have received a substantial 
amount of order flow in CSI stocks. Specifically, the most recent BSE 
report states that in December 1995, orders directed to a Competing 
Specialist accounted for 58% of total trades and 43% of total shares 
executed in CSI issues.\29\ In addition, the data showed that the depth 
of the limit order book generally increased in CSI stocks during the 
pilot, and that approximately 25% of the orders directed to the 
Competing Specialist were limit orders.\30\ Furthermore, over the last 
year, between 12% and 21% of the orders directed to a Competing 
Specialist were executed against limit orders on the Exchange's 
consolidated book.\31\

    \28\ The BSE reports, for example, that for the month of 
December 1994, there were 171,075 trades and 106,753,284 shares 
executed on the Exchange. For the month of December 1995, 195,272 
trades and 120,665,485 shares where executed on the Exchange. The 
number of reports for all BSE trades to the Consolidated Tape 
Association (``CTA'') also increased slightly. The BSE reports that 
in the first quarter of 1994, before the competing specialist 
program was initiated, CTA trades for the Exchange reached 461,264. 
See BSE Report No. 1, supra note 27. In 1995, CTA trades had 
increased to 475,425 for the first quarter, 564,750 for the second 
quarter, 550,337 for the third quarter, and 463,616 for the fourth 
quarter. See BSE Report No. 3, supra note 27.
    \29\ The percentage of the total trades and number of shares in 
CSI issues has increased steadily over the pilot period. See BSE 
Reports Nos. 1, 2, and 3, supra note 27.
    \30\ See BSE Reports Nos. 2 and 3, supra note 27. The BSE 
reported that during the month of January 1995, the Exchange had 
3457 open limit orders (1,313,576 shares), compared to 6928 open 
limit orders (11,808,335) during the month of December 1995.
    \31\ See BSE Reports Nos. 2 and 3, supra note 27.
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    The data was mixed in regard to whether the CSI has increased 
competition on the BSE. Specifically, the BSE reported that regular 
specialists executed less than 1% of the orders directed to Competing 
Specialists.\32\ Under CSI rules, regular specialists would have 
executed a higher percentage of the orders directed to Competing 
Specialists had they been aggressively quoting at the ITS/BBO.\33\ BSE 
data also indicated, however, that the CSI may contribute to the BSE's 
competitiveness within the national market system. The Exchange 
reported that during November 1995, BSE quotes matched at least one 
side of the ITS/BBO more often in CSI stocks than in a comparable 
sample of BSE-traded issues in which there was only one specialist.\34\

    \32\ Id.
    \33\ As discussed later in this order, the Commission believes 
that quote competition between the regular specialist and Competing 
Specialists could be stimulated by system enhancements that allow 
all specialists to enter their own quotes into BEACON.
    \34\ Letter from Karen Aluise, Assistant Vice President, BSE, to 
Glen Barrentine, Senior Counsel, SEC, dated March 5, 1996. The BSE 
reported that during the month of November, approximately 20% of BSE 
quotes in 43 CSI stocks matched at least one side of the ITS/BBO. In 
a sample of 44 non-CSI stocks, only approximately 17% of the BSE's 
quotes matched at least one side of the ITS/BBO. The BSE also 
indicated that for both groups of stocks, the BSE produced 
approximately 1% of all quotes that established a new ITS/BBO.
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VI. Discussion

    After careful review of the competing specialist program, and for 
the reasons discussed below, the Commission believes that approval of 
the CSI is consistent with the requirements of the Act and the rules 
and regulations thereunder applicable to a national securities 
exchange. In particular, the Commission believes the proposal is 
consistent with Section 6(b)(5) of the Act,\35\ which requires, among 
other things, that the rules of an exchange be designed to promote just 
and equitable principles of trade and to perfect the mechanism of a 
free and open market and a national market system and to protect 
investors and the public interest. The competing specialist program 
also is consistent with Section 11A of the Act,\36\ which generally 
promotes, among other things, the development of a national market 
system for securities to assure economically efficient execution of 
securities transactions and fair competition among brokers and dealers, 
among exchange markets and markets other than exchange markets.

    \35\ 15 U.S.C. 78f(b).
    \36\ 15 U.S.C. 78k-1.
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    The Commission supports efforts by exchanges to provide increased 
liquidity and competition on their trading floors or trading systems. 
Such efforts can enhance market quality and enable exchanges to compete 
more effectively for order flow. The BSE's competing specialist program 
was designed to improve BSE market making and, although the data is 
mixed, it appears as though the CSI has provided some increased 
competition and order interaction on the BSE floor. At the same time, 
the Commission is sensitive to concerns presented by internalized order 
flow and its potential effect on the

[[Page 15321]]
handling of customer orders and the ability of broker-dealers to fulfil 
their duty to seek best execution of customers' orders. Accordingly, 
the Commission has considered, among other things, the CSI's effect on 
achievement of economically efficient execution of securities 
transactions, fair competition among brokers and dealers and among 
exchange markets, as well as the practicability of brokers executing 
investors' orders in the best market.
    The Commission believes that the BSE's competing specialist 
program, while it may increase internalization, is not necessarily 
inconsistent with a broker-dealer's duty to seek best execution of 
customer orders. All limit orders are represented and executed 
according to the order of their receipt in the BSE's consolidated limit 
order book (i.e., time priority), irrespective of whether the orders 
are designated for a particular specialist. Before an incoming market 
or marketable limit order is routed to a designated specialist, the 
BEACON system scans the consolidated limit order book for a contra-side 
order. If there is such an order on the book, BEACON automatically 
exposes the order to the designated specialist for possible price 
improvement before matching the order with the contra-side order on the 
book. This system of matching incoming orders with orders on the BSE's 
consolidated book ensures that customer market and limit orders are 
given an opportunity to interact before a specialist can execute the 
orders against itself, while also providing an opportunity for price 
improvement for market and marketable limit orders before they are 
automatically executed. Indeed, the CSI has enhanced order interaction 
on the BSE by increasing the volume of limit orders sent to the 
exchange.
    While the Commission concludes, for the reasons discussed above, 
that the CSI is not necessarily inconsistent with a broker-dealer's 
duty to seek best execution, the Commission recognizes that execution 
quality is, in large part, dependent on the diligence of BSE members in 
handling customer orders. While this is true of all markets, it is of 
particular significance in markets where dealers execute customer 
orders as principal. It is therefore incumbent on the BASE,\37\ as well 
as the Commission in its oversight capacity, to ensure that BSE members 
provide best execution of customer orders.

    \37\ At a minimum, the Commission would expect the BSE, as with 
any self-regulatory organization, to conduct regular, comprehensive 
surveillance of the execution quality provided by its members.
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    In this regard, the Commission's recent order routing disclosure 
requirements \38\ and its proposed order handling rules \39\ signal a 
renewed emphasis on the importance of price improvement opportunities 
in connection with the duty to seek best execution. As the Commission 
has noted, while an automated order routing environment is not 
necessarily inconsistent with the achievement of best execution, 
broker-dealers choosing where to automatically route orders must assess 
periodically the quality of competing markets to assure that order flow 
is directed to markets providing the most advantageous terms for their 
customers' orders.\40\ Thus, a broker-dealer may not simply employ 
default order routing to an affiliated BSE specialist without 
undertaking such an evaluation on an ongoing basis. A broker-dealer 
sending orders to the BSE must satisfy itself that its routing decision 
is consistent with its best execution obligations, irrespective of the 
firm's desire to internalize order flow through an affiliated BSE 
specialist. To reach this conclusion, the broker-dealer must rigorously 
and regularly examine the executions likely to be obtained for customer 
orders in the different markets trading the security, in addition to 
any other relevant considerations in routing customer orders.

    \38\ See Securities Exchange Act Release No. 34902 (October 27, 
1994), 59 FR 55006 (November 2, 1994).
    \39\ See Securities Exchange Act Release No. 36310 (September 
29, 1995), 60 FR 52792 (October 10, 1995).
    \40\ Id. The Commission also noted that the availability of 
sophisticated order handling systems has made it possible for some 
broker-dealers and market centers to provide an opportunity for 
price improvement for their customer orders. The use of these 
efficient routing and execution facilities by firms and exchanges 
suggest that price improvement procedures and other best execution 
safeguards in an automated environment are increasingly practicable 
and are setting new standards for the industry. See also Division of 
Market Regulation, SEC, Market 2000 An Examination of Current Equity 
Market Developments, (January 1994), at Study V.
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    The Commission also believes that the competing specialist program 
is reasonably designed to facilitate competition among BSE specialists. 
A specialist may not execute directed order flow against itself if a 
competing specialist has priority at the ITS/BBO.\41\ By maintaining 
time priority for quotes at the ITS/BBO, the Commission believes that 
the BSE's competing specialist program provides an incentive for 
specialists desiring to attract order flow to enter competitive quotes. 
Although data collected during the pilot indicates a lack of quote 
competition presently, the Commission anticipates greater quote 
competition at the ITS/BBO once Competing Specialists are able to enter 
their own quotes directly into BEACON. In this regard, the BSE has 
committed to completing the systems enhancements required to allow the 
direct entry of quotes by the Competing Specialists within one year of 
this approval.\42\ In addition, as noted above, the program has 
increased the volume of limit orders. This adds to the depth and 
liquidity of the BSE market and increases order interaction.

    \41\ System enhancements, to be completed within one year, will 
allow BEACON to automatically route incoming orders that are not 
executed against the consolidated limit order book directly to the 
specialist that has time priority at the ITS/BBO. See supra notes 14 
and 15.
    \42\ See supra note 15. Failure to complete the systems 
modifications as agreed would raise serious concerns for the 
Commission regarding whether the conclusions of this order remain 
valid.
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    The Commission further believes that the procedures for Competing 
Specialists are adequate and consistent with the Act. Specifically, 
Competing Specialists have all of the same rights and obligations of 
``regular'' specialists under the BSE rules and the federal securities 
laws. In addition, before approving the application for registration as 
a Competing Specialist, the Exchange will consider the applicant's 
overall performance evaluation results, financial capability, and 
adequacy of manpower on the floor. The Commission believes that these 
criteria are reasonably designed to ensure investor protection.\43\

    \43\ The fourth criteria specified by the Exchange, objection by 
the regular specialist, will only be used in stocks presenting 
special handling considerations and cannot be used by regular 
specialists as a veto to competition. See supra note 21.
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    Finally, the Commission believes it is consistent with the Act for 
the BSE to remove the restrictions placed on the competing specialist 
program during the pilot. Specifically, specialists have been 
prohibited from making cash payments for order flow in those stocks in 
which they are registered as Competing Specialists. The Commission 
believed that a limitation on the inducements for preferencing order 
flow was necessary until the Commission had an opportunity to assess 
the effects of the CSI pilot. As discussed above, the Commission has 
assessed the CSI pilot and determined that it is not inconsistent with 
the Act, nor necessarily, a broker-dealer's obligation to seek best 
execution. Moreover, lifting the payment for order flow restriction on 
BSE competing specialists will place them in the same position as the 
BSE's other members. Accordingly, the

[[Page 15322]]
Commission believes it is appropriate at this time to remove this 
restriction.
    The Commission also is approving the CSI without the restrictions 
on the number of Competing Specialists permitted in each stock and the 
number of stocks in which a single Competing Specialist is permitted to 
compete. These restrictions only were necessary to limit the scope of 
the pilot program so that the BSE and Commission could evaluate the 
effects of introducing Competing Specialists on the floor of the 
Exchange. The Commission has completed such an evaluation and finds no 
reason to continue the restrictions.

VII. Conclusion

    The Commission believes it is consistent with the Act to allow the 
BSE to implement its competing specialist program on a permanent basis. 
In making this determination, the Commission carefully evaluated the 
data provided by the BSE and other sources, and concluded that the CSI 
is competitively beneficial to the BSE, while not inconsistent with the 
attainment of best execution of customer orders, the maintenance of 
fair and orderly markets, or the protection of investors and the public 
interest.
    Nevertheless, Commission approval of the BSE's competing specialist 
program is not a determination by the Commission that mere default 
routing by a firm to its affiliated competing specialist is consistent 
with a firm's best execution obligations. A broker-dealer associated 
with a competing specialist must still ensure that its order routing 
decisions are consistent with its best execution obligations and assess 
periodically the quality of competing markets to assure that order flow 
is directed to markets providing the most advantageous terms for its 
customers' orders.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\44\ that the proposed rule change (SR-BSE-95-02) is approved.

    \44\ 15 U.S.C. 78s(b)(2).
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    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-8398 Filed 4-4-96; 8:45 am]
BILLING CODE 8010-01-M