[Federal Register Volume 61, Number 166 (Monday, August 26, 1996)]
[Notices]
[Pages 43797-43800]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-21606]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37581; File No. SR-BSE-96-05]


Self-Regulatory Organizations; Boston Stock Exchange, Inc.; Order 
Granting Approval to Proposed Rule Change Relating to Its Specialist 
Performance Evaluation Program

August 19, 1996.

I. Introduction

    On June 11, 1996, to 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 amend its Specialist 
Performance Evaluation Program (``SPEP'').\3\ On June

[[Page 43798]]

11, 1996, the Exchange submitted to the Commission Amendment No. 1 to 
the proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The SEC initially approved the BSE's SPEP pilot program in 
Securities Exchange Act Release No. 22993 (March 10, 1986), 51 FR 
8298 (March 14, 1986) (File No. SR-BSE-84-04). The SEC subsequently 
extended the pilot program in Securities Exchange Act Release Nos. 
26162 (October 6, 1988), 53 FR 40301 (October 14, 1988) (File No. 
SR-BSE-87-06); 27656 (January 30, 1990), 55 FR 4296 (February 7, 
1990) (File No. SR-BSE-90-01); 28919 (February 26, 1991), 56 FR 9990 
(March 8, 1991) (File No. SR-BSE-91-01); and 30401 (February 24, 
1992), 57 FR 7413 (March 2, 1992) (File No. SR-BSE-92-01). The BSE 
was permitted to incorporate objective measures of specialist 
performance into its pilot program in Securities Exchange Act 
Release No. 31890 (February 19, 1993), 58 FR 11647 (February 26, 
1993) (File No. SR-BSE-92-04); at which point the initial pilot 
program ceased to exist as a separate program. The current pilot 
program was subsequently extended in Securities Exchange Act Release 
Nos. 33341 (December 15, 1993), 58 FR 67875 (December 22, 1993) 
(File No. SR-BSE-93-16); 35187 (December 30, 1994), 60 FR 2406 
(January 9, 1995) (File No. SR-BSE-94-12); and 36668 (January 2, 
1996), 61 FR 672 (January 9, 1996) (File No. SR-BSE-95-16) 
(``January 1996 Approval Order''). SEC approval of the current pilot 
program expires on Decembesr 31, 1996.
    \4\ See Letter from Karen Aluise, Assistant Vice President, BSE, 
to Sharon Lawson, Senior Special Counsel, SEC, dated June 11, 1996 
(``Amendment No. 1''). Amendment No. 1 corrected typographical 
errors in the original filing and added a proposal to raise the 
overall score at which a specialist will be deemed to have 
adequately performed from 5.80 to 6.70 in order to account for the 
proposed changes to the threshold levels and weights.
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    The proposed rule change, and Amendment No. 1 thereto, was 
published for comment in Securities Exchange Act Release No. 37308 
(June 12, 1996), 61 FR 31573 (June 20, 1996). No comments were received 
on the proposal. This order approves the proposed rule change, 
including Amendment No. 1.

II. Description

A. Background

    The BSE's SPEP utilizes the BEACON system \5\ to assess how well a 
specialist handles market and marketable limit orders routed to him or 
her for execution. For each specialist, a record of all action on these 
orders is accumulated in a separate file from which four calculations 
are run.
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    \5\ BEACON is the BSE's automated order-routing and execution 
system. BEACON provides a guarantee of execution for market and 
marketable limit orders up to and including 1,299 shares. In 
addition, BEACON can be used to transmit orders not subject to 
automatic execution. See BSE Rules, Ch. XXXIII, Paras. 2654-55.
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    First, Turnaround Time measures the average number of seconds from 
the receipt of a guaranteed market or marketable limit order (i.e., for 
1299 shares or less) in BEACON until it is executed (in whole or in 
part), stopped or cancelled. An order that is moved from the auto-ex 
screen to the manual screen will accumulate time until executed, 
partially executed, stopped or cancelled.\6\
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    \6\ This calculation will not be in effect until the stock has 
opened on the primary market. Certain situations, such as trading 
halts and periods where the BEACON system is off auto-ex floorwide, 
will result in blocks of time being excluded from the calculation.
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    Second, Holding Orders Without Action measures the number of market 
and marketable limit orders (all sizes included) \7\ that are held 
without action for greater than 25 seconds. As in the Turnaround Time 
calculation, a stop, cancellation, execution or partial execution stops 
the clock. The same exclusions which apply in the Turnaround Time 
calculation also apply here.
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    \7\ Unlike Turnaround Time, Holding Orders Without Action is not 
limited to those orders guaranteed automatic execution through 
BEACON.
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    Third, Trading Between the Quote measures the number of market and 
marketable limit orders that are executed between the best consolidated 
bid and offer where the spread is greater than one-eighth.
    Fourth, Executions in Size Greater Than BBO measures the number of 
market and marketable limit orders which exceed, and are executed in a 
size larger than, best consolidated bid or offer size.
    For each of these four objective measures, and the Specialist 
Performance Evaluation Questionnaire, a 10 point scale is applied to a 
range of scores. Based on the raw score for each measure, the 
respective specialist receives an associated score between one and 10 
points, which is weighted for each measure as follows: Turnaround Time 
(15%); Holding Orders Without Action (15%); Trading Between the Quote 
(25%); Executions in Size Greater Than BBO (25%); and Questionnaire 
(20%).
    Any specialist who is deficient \8\ in any one of the objective 
measures for two out of three consecutive review periods will be 
required to appear before the Performance Improvement Action Committee 
(``PIAC'') to discuss ways of improving performance. If performance 
does not improve in the subsequent period, the specialist will appear 
before the Market Performance Committee (``MPC'') for appropriate 
action, as described below.\9\
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    \8\ A specialist is deficient in any measure if he or she scores 
below the minimum adequate performance thresholds set forth below. 
See infra text accompanying note 11.
    \9\ In the event a specialist's performance does not improve, 
the Supplemental Material to the SPEP authorizes the MPC to take the 
following actions: suspending the specialist's trading account 
privilege, suspending his or her alternate specialist account 
privilege, or reallocating his or her specialty stocks. See BSE 
Rules, Ch. XV, para. 2156.10-2156.60.
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    Any specialist who falls below the threshold level for the overall 
evaluation program for two of three consecutive review periods will be 
required to appear before the MPC, which will take action to address 
the deficient performance as provided for in the Supplemental Material 
to the SPEP.\10\ A specialist who is ranked in the bottom 10% of the 
overall evaluation program but who is above the threshold level for the 
overall program will be subject to staff review to determine if there 
is sufficient reason to warrant informing the PIAC of potential 
performance problems.
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    \10\ See supra note 9.
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    Due to the subjectiveness of the questionnaire, a specialist who is 
deficient on the questionnaire alone will be subject to review by 
Exchange staff to determine if there is sufficient reason to warrant 
informing the PIAC of potential performance problems. However, a 
deficient score on the questionnaire may result in a performance 
improvement action when it lowers the overall program score below 5.80.
    The Exchange has set thresholds at which a specialist will have 
been deemed to have adequately performed overall, and with regard to 
each measure, on the SPEP: Overall Evaluation Score--at or above 
weighted score of 5.80; Turnaround Time--below 21 seconds (8 points); 
Holding Orders Without Action--below 21% (7 points); Trading Between 
the Quote--at or above 26.0% (5 points); Executions in Size Greater 
Than BBO--at or above 76% (6 points); and Questionnaire--at or above 
weighted score of 50.0 (4 points).\11\
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    \11\ A specialist who receives a score that is below a minimum 
adequate performance threshold will be deemed to be deficient in 
that measure. See supra note 8.
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B. Proposed Rule Change

    The purpose of the proposed rule change is to modify the threshold 
levels and weights of the current SPEP measures, as well as the review 
standards applicable under the SPEP. The Exchange has determined that 
the following modifications should be made as a result of its 
continuous monitoring of the current SPEP standards:
    (1) The Trading Between the Quote threshold level, currently at 
26.0, should be raised to 31.0;
    (2) Executions in Size Greater Than BBO threshold level, currently 
at 76.0, should be raised to 81.0;
    (3) The Turnaround Time program weight, currently at 15%, should be 
increased to 20%;
    (4) The Holding Orders Without Action program weight, currently at 
15%, should be decreased to 5%;
    (5) The Trading Between the Quote program weight, currently at 25%, 
should be increased to 35%;
    (6) The Executions in Size Greater Than BBO program weight, 
currently at 25%, should be increased to 35%;
    (7) The Questionnaire program weight, currently at 20%, should be 
decreased to 5%;
    (8) The standard for PIAC review for substandard performance in any 
one objective measure, currently set at two out of three consecutive 
review periods,

[[Page 43799]]

will be changed to the first instance of substandard performance;
    (9) The standard for MPC review for substandard performance in any 
one objective measure, currently set at three out of four consecutive 
review periods, will be changed to two out of three consecutive review 
periods;
    (10) The standard for MPC review for substandard performance on the 
overall program, currently set at two out of three consecutive review 
periods, will be changed to the first instance of substandard 
performance; and
    (11) The Overall Program score, currently at 5.80, should be 
increased to 6.70 to account for the proposed changes to the threshold 
levels and weights.
    Under the proposal, the current threshold levels for Turnaround 
Time, Holding Orders Without Action and the Questionnaire, as well as 
the staff review standards, will remain unchanged. The Exchange 
believes that these modifications will enhance the SPEP by providing 
more appropriate threshold levels when overall performance has improved 
beyond the current limits, more effective measure weightings which 
reflect the industry's current market quality focus, and a more 
realistic approach to committee review in view of the timeframe 
required to address substandard performance.\12\
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    \12\ In its proposed rule change, the Exchange stated that it is 
currently reviewing additional market quality statistics in an 
effort to develop other measures of performance for inclusion in the 
SPEP, and hopes to file for additional modifications to the program 
in the near future.
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III. Discussion

    The Commission believes that 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.\13\ To 
ensure that specialists fulfill these obligations, it is important that 
the Exchange conduct effective oversight of their performance. The 
BSE's SPEP is critical to this oversight. In addition, the Commission 
notes that the SPEP weighs heavily in the BSE's stock allocation 
decisions, and believes that performance based stock allocations help 
to ensure that stocks are allocated to specialists who will make the 
best markets.
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    \13\ Rule 11b-1, 17 CFR 240.11b-1; BSE Rules Ch. XV, para. 
2155.01.
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    In its January 1996 Approval Order extending the SPEP pilot for an 
additional one-year period, until December 31, 1996,\14\ the Commission 
set forth its concerns with the current program. First, the Commission 
stated that it expected the BSE to evaluate the incorporation of 
additional objective criteria into the SPEP, so that the Exchange can 
conduct a thorough analysis of specialist performance.\15\ The 
Commission also requested that the Exchange assess whether each measure 
is assigned an appropriate weight, and conduct an ongoing examination 
of its minimum adequate performance levels to insure that performance 
thresholds are set at appropriate levels. In addition, the Commission 
advised the Exchange to closely monitor the conditions for committee 
review and take steps to ensure that all specialists whose performance 
is deficient or diverges widely from the best units will be subject to 
meaningful review.\16\ The Commission finds that the proposed rule 
change is a positive step forward with regard to a number of these 
concerns. Specifically, the proposal modifies the appropriate weights 
and thresholds to be assigned to each measure and the conditions for 
committee review for substandard specialist performance.
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    \14\ The Commission notes that while the proposed rule change 
modifies certain aspects of the current SPEP, the Exchange remains 
obligated to submit by September 16, 1996 a report describing its 
experience with the pilot, in addition to any requests to further 
modify it, to extend its effectiveness or to seek permanent approval 
for the SPEP. See January 1996 Approval Order, supra note 3.
    \15\ For example, the Commission has stated that the BSE could 
develop additional measures of market depth, such as how often the 
specialist's quote exceeds 500 shares or how often the BSE quote, in 
size, is larger than the best consolidated bid or offer (excluding 
quotes for 100 shares). Another possible objective criteria could 
measure quote performance (i.e., how often the BSE specialist's 
quote, in price, is alone at or tied with the BBO).
    \16\ In this regard, the Commission stated that in its opinion, 
a meaningful review process would ensure that adequate corrective 
actions are taken with regard to each deficient specialist.
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    In connection with the respective weights assigned to each measure, 
the Commission has recommended that because of the substantial overlap 
between Turnaround Time and Holding Orders Without Action, the BSE 
should consider having only one measure in this category (i.e., 
timeliness of executions), or reduce the weights of the existing 
measures, which together account for 30% of the current SPEP. The 
Commission believes that the proposal is a positive step in this 
direction, as it decreases the weight assigned to these two categories 
from 30% to 25% of the overall program. Moreover, the decrease in the 
combined weight of these two categories, as well as the weight of the 
Questionnaire, has enabled the Exchange to increase the weight of each 
of the other objective criteria, Trading Between the Quote and 
Executions in Size Greater Than BBO, from 25% to 35% of the SPEP. The 
Commission believes that the increase in the weights of these measures 
is appropriate in the context of the current program, in that these 
measures have been useful in identifying how well specialists carry out 
certain aspects (i.e., price improvement and market depth) of their 
responsibilities as specialists.\17\
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    \17\ The Commission continues to believe that objective measures 
together with a floor broker questionnaire, should generate 
sufficiently detailed information to enable the Exchange to make 
accurate assessments of specialist performance.
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    In reviewing the BSE's experience with its minimum adequate 
performance thresholds, the Commission has noted that although it 
appears that these standards have been helpful in identifying some 
specialists with potential performance problems, as well as providing 
an incentive for improved market making performance, the acceptable 
levels of performance have not been revised since the inception of the 
pilot. The proposal makes such revisions, in that it increases the 
threshold level for adequate performance both with regard to the 
overall program and particular measures. Specifically, the overall 
threshold program score is being increased from 5.80 to 6.70, while the 
threshold level of Trading Between the Quote is being increased from 
26.0 to 31.0 and Executions in Size Greater Than BBO from 76.0 to 81.0. 
The Commission believes that these changes are appropriate given that 
they will provide a higher benchmark for acceptable specialist 
performance on the Exchange. This, in turn, should benefit the 
execution of public orders on the BSE and further the protection of 
investors.
    The Commission has also requested that the BSE closely monitor the 
conditions for review and take steps to ensure that all specialists 
whose performance is deficient and/or diverges widely from the best 
units will be subject to meaningful review. The Commission believes 
that the proposed rule change makes significant progress in this 
regard, as it tightens the standards for committee review for 
substandard specialist performance both in the overall program and in 
individual measures.\18\ Under the proposal, the

[[Page 43800]]

criteria for PIAC review for substandard performance in any one 
objective measure, currently set at two out of three consecutive review 
periods, is being reduced to any one review period of substandard 
performance. The criteria for MPC review of substandard performance in 
any one objective measure, currently set at three out of four review 
periods, is being changed to two out of three consecutive review 
periods of substandard performance, while MPC review for substandard 
overall performance, currently set at two out of three review periods, 
is being changed to any one review period of substandard performance. 
The Commission believes that as the proposal increases the possibility 
of the institution of a performance improvement action as a result of 
substandard performance, it should help motivate and provide an 
incentive for specialists to maintain high levels of market making 
performance. In addition, the changes should help the Exchange to 
identify earlier those specialists needing help or guidance in 
improving their performance either overall or in a particular area.
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    \18\ The Commission continues to believe that relative 
performance rankings that subject the bottom 10% of all specialist 
units to mandatory review by an Exchange committee are an important 
part of an effective evaluation program.
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    In conclusion, although the Commission believes that the proposed 
modifications will increase the effectiveness of the BSE's SPEP, the 
Exchange should continue to evaluate means to strengthen its 
performance oversight program, with an emphasis on incorporating 
additional objective measures and including competing specialist 
activity into the SPEP.\19\
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    \19\ In this regard, the Commission notes the Exchange's 
proposed rule change states that it is currently engaged in an 
effort to develop other measures of performance for inclusion in the 
SPEP, and hopes to file for additional modifications to the program 
in the near future. Moreover, in connection with the permanent 
approval of the BSE's Competing Specialist Initiative, the Exchange 
represented that it was in the process of revising its SPEP 
standards to include competing specialist activity as well as other 
market quality initiatives and planned on submitting rule amendments 
during the current extension of the SPEP pilot. See Letter from John 
I. Fitzgerald, Executive Vice President, BSE, to Howard Kramer, 
Associate Director, SEC, dated February 29, 1996.
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    For the reasons discussed above, the Commission finds that the 
BSE's proposal to modify its SPEP pilot program 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) \20\ 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.
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    \20\ 15 U.S.C. 78f(b)(5).
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    Further, the Commission finds that the proposal is consistent with 
Section 11(b) of the Act \21\ and Rule 11b-1 thereunder which allow 
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.
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    \21\ 15 U.S.C. 78k(b).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\22\ that the proposed rule change (SR-BSE-96-05) is approved.

    \22\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-21606 Filed 8-23-96; 8:45 am]
BILLING CODE 8010-01-M