[Federal Register Volume 61, Number 123 (Tuesday, June 25, 1996)]
[Notices]
[Pages 32875-32876]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-16166]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37326; File No. SR-PSE-96-13]


Self-Regulatory Organizations; Pacific Stock Exchange, 
Incorporated; Order Granting Approval to Proposed Rule Change Relating 
to Restrictions on Equity Allocations (10% Rule)

June 19, 1996.
    On April 10, 1996, the Pacific Stock Exchange, Incorporated 
(``PSE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to codify a policy that any 
specialist whose score on a quarterly specialist performance evaluation 
ranks in the bottom 10% of specialist on his or her trading floor shall 
not be eligible for allocations of securities, absent mitigating 
circumstances, until such ranking rises above the bottom 10%.
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    \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 
Exchange Act Release No. 37142 (April 24, 1996), 61 FR 19328 (May 1, 
1996). No comments were received on the proposal.
    The Exchange's specialist evaluation program is governed by PSE 
Rule 5.37. Subsection (a) of that Rule provides that the Equity 
Allocation Committee (``EAC'') shall evaluate all registered 
specialists on a quarterly basis. Those evaluations result in overall 
ratings of specialists that are based upon three separate measures of 
performance, as specified in the Rule.\3\ Subsection (b) provides that 
any registered specialists who is in the bottom 10% of all registered 
specialists on that specialist's trading floor,\4\ as determined by the 
overall evaluation scores in any one quarterly evaluation, shall be 
requested to meet with the EAC (or a panel appointed by the EAC) on an 
informal basis.\5\ If a specialist is in the bottom 10% during any two 
out of four consecutive quarterly evaluations, the specialist is 
requested to appear a second time before the EAC to explain his or her 
performance.\6\
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    \3\ The three measures of performance currently utilized by the 
PSE are: (1) National Market System Quote Performance, accounting 
for 45% of the overall score, measures the percentage of times in a 
given quarter that a specialist's bid and/or offer is equal to or 
greater than the best bid or offer in the consolidated quote system 
for each dually-traded security; (2) the Specialist Evaluation 
Questionnaire Survey, also accounting for 45% of the overall score, 
is composed of questions designed to evaluate a specialist's market-
making performance and is to be completed only by floor brokers who 
regularly trade with a specialists; and (3) SCOREX Limit Order 
Acceptance Performance, which accounts for the final 10% of the 
overall score, measures the percentage of P/COAST (formerly SCOREX) 
limit orders accepted by a specialist. See Securities Exchange Act 
Release No. 28843 (February 1, 1991), 56 FR 5040 (February 7, 1991) 
(File No. SR-PSE-87-19) for a more complete description of each of 
these measures of performance.
    \4\ The PSE maintains two equity trading floors, one in Los 
Angeles and one in San Francisco. See PSE Rule 4.1(g).
    \5\ See PSE Rules 5.37(b)-(e).
    \6\ SEE Rules 5.37(g)-(i). The EAC also has the authority to 
bypass the second informal proceeding and commence formal 
reallocation proceedings after a specialist's second quarter of 
substandard performance in a rolling twelve-month period. See PSE 
Rule 5.37.
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    If the EAC finds in its second informal meeting with a specialist 
that there are no mitigating circumstances that would demonstrate 
substantial improvement of or reasonable justification for the 
specialist's most recent evaluation score, the EAC will make a 
determination that the specialist's performance is below acceptable 
levels, and notify the specialist of his or her right to a hearing on 
such determination.\7\ The EAC may take a number of actions against a 
registered specialist found to perform below acceptable levels, 
including limitation, suspension or termination of the specialist's 
registration as a specialist, or reallocation of his or her stocks.
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    \7\ For a description of the procedures followed in such 
proceedings, see PSE Rules 5.37(j)-(s).

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[[Page 32876]]

    The Exchange is now proposing to adopt a rule providing that any 
registered specialist who fails into the bottom 10% of all registered 
specialists on his trading floor as determined by the overall 
evaluation scores received by each specialist in any one quarterly 
evaluation shall not be eligible for new allocations until such ranking 
rises above the bottom 10%.\8\ However, the proposal also provides that 
the EAC may make exceptions if there are sufficient mitigating 
circumstances.\9\
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    \8\ The PSE has represented that the restriction applies to both 
initial allocations and allocations available as a result of 
subsequent reallocations. Furthermore, it also would apply in 
situations where two specialists desire to ``swap'' issues with each 
other . See Letter from Michael Pierson, Senior Attorney, PSE, to 
John Kroeper, Attorney, SEC, dated June 7, 1996 (``PSE Letter'').
    \9\ In the PSE Letter the Exchange gave the following, non-
definitive, examples of ``mitigating circumstances'' that have been 
accepted by the EAC in the past two years: i) extensive systems 
problems existed that clearly were beyond the specialist's control; 
ii) a specialist was able to show that, of the trades covered in a 
specialist evaluation, the percentage of trades involving 
interaction with a broker was very low, and undue weight therefore 
was placed on the Questionnaire Survey; iii) a specialist's 
financial backer withdrew mid-quarter, having a negative impact on 
the specialist's performance during that quarter; and iv) the 
specialist's overall score on the quarterly evaluation (as opposed 
to the specialist's ranking) was above 80%. The Exchange further 
represented that based on past EAC decisions, relief by mitigation 
is the exception, not the rule. See PSE Letter, supra note 8.
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    At the PSE's specialist evaluation results and overall rankings are 
reported in the quarter following the quarter of the evaluation, e.g., 
the results of the fourth quarter of 1995 are reported in the first 
quarter of 1996. Accordingly, a specialist who was in the bottom 10% 
for the fourth quarter of 1995 will not be eligible for new allocations 
of stocks until, at the earliest, the second quarter of 1996, when the 
results from the first quarter of 1996 are reported.
    The Exchange believes that the restriction on new allocations is an 
effective tool in encouraging specialists to improve their performance, 
and thereby to improve their evaluation scores.\10\
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    \10\ Cf. Securities Exchange Act Release NO. 31539 (November 30, 
1992), 57 FR 57851 (December 7, 1992) (File No. SR-PSE-92-32). This 
order approved, among other things, the addition of Commentary .03 
to PSE Rule 5.36(d), which precludes a specialist whose specialist 
ranking falls in the bottom 10% of his or her Floor from acting as 
an alternate specialist until his or her ranking raises above the 
bottom 10%, unless the EAC determines otherwise.
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    The Commission finds that the PSE's proposal to codify its policy 
that a specialist whose quarterly evaluation score falls in the bottom 
10% of registered specialists on his or her trading floor shall not be 
eligible for any allocations of stock until such specialist is no 
longer in the bottom 10% is consistent with the requirements of 
Sections 6 and 11 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 the 
Section 6(b)(5) \11\ requirement that the rules of an exchange be 
designed to promote just and equitable principles of trade, 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. Further, the Commission finds that the proposal is 
consistent with Section 11(b) of the Act \12\ and Rule 11b-1 thereunder 
\13\ which allow national securities exchanges to promulgate rules 
relating to specialists in order to maintain fair and orderly markets 
and to remove impediments to and perfect the mechanism of a national 
market system. For the reasons set forth below, the Commission believes 
that the proposal should encourage improved specialist performance, 
consistent with the protection of investors and the public interest.
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    \11\ 15 U.S.C. 78f(b)(5).
    \12\ 15 U.S.C. 78k(b).
    \13\ 17 CFR 240.11b-1.
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    Specialists play a crucial role in providing stability, liquidity, 
and continuity to the trading of stocks. Among the obligations imposed 
upon specialists by the Exchange, and by the Act and the rules 
promulgated thereunder, is the maintenance of fair and orderly markets 
in their designated securities.\14\ To ensure that specialists fulfill 
these obligations, the Commission has encouraged the Exchange to have 
an effective program for evaluating specialists' performance. In this 
regard, the Commission believes that stocks should be allocated to 
those specialists who are performing the best. Such stock allocation 
policies encourage specialists to strive for optimal market making 
performance.
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    \14\ Rule 11b-1, 17 CFR 240.11b-1; PSE Rules 5.29(f).
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    At present, the only incentive to improved specialist performance 
found in the PSE specialist performance evaluation program that is 
applicable beginning with a specialist's first quarter of ranking in 
the bottom 10% is the restriction on acting as an alternate specialist 
while the specialist remains ranked in the bottom 10%.\15\ The proposed 
rule change will add another such incentive to the PSE rules by 
codifying an existing policy of the Exchange that restricts specialists 
whose ranking falls in the bottom 10% of specialists on his or her 
floor from eligibility for any allocations (i.e., allocations of new 
issues, reallocations of existing issues, or swapping of issues with 
other specialists) until such specialist is no longer in the bottom 
10%.
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    \15\ See PSE Rule 5.36(d), Commentary .03. As discussed 
previously, under PSE Rule 5.37 the exchange has the ability to take 
more significant action against any specialist who is ranked in the 
bottom 10% in any two out of four consecutive evaluations. See PSE 
Rule 5.37(j).
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    The Commission believes that the codification of this policy into 
the PSE rules will be an effective and appropriate means by which to 
encourage improved specialist performance. As a specialist's 
profitability is directly related to the stocks he or she is allocated, 
the possibility of a restriction on allocations will provide a strong 
incentive to PSE specialists to remain out of the bottom 10%. This 
should translate into improved market making performance by 
specialists, thereby benefitting investors. Moreover, the imposition of 
the restriction on allocations to specialists in the bottom 10% should 
increase the likelihood that stocks are allocated to specialists who 
will make the best markets.
    Finally, the Commission notes that the EAC retains the ability to 
allow specialists whose scores are in the bottom 10% in any quarterly 
evaluation to continue receiving allocations if it finds that 
sufficient ``mitigating circumstances'' are present. While the Exchange 
has represented that relief from the restriction by mitigation is the 
exception \16\ and the Commission recognizes the need for the EAC to 
retain the discretion to refrain from imposing this restriction in 
appropriate instances, the Commission expects that findings by the EAC 
that ``mitigating circumstances'' are present will not become routine, 
but will remain the exception and be made only when appropriately 
warranted.
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    \16\ See PSE Letter, supra note 8.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-PSE-96-13) is approved.

    \17\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-16166 Filed 6-24-96; 8:45 am]
BILLING CODE 8010-01-M