[Federal Register Volume 62, Number 131 (Wednesday, July 9, 1997)]
[Notices]
[Pages 36860-36862]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-17941]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38806; File No. SR-PCX-97-19]


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

July 1, 1997.

I. Introduction

    On May 29, 1997, the Pacific Exchange, Inc. (``PCX'' 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 extend its specialist 
evaluation pilot program for an additional six months, until January 1, 
1998, and make certain amendments to the pilot.
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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. 38712 (June 3, 1997), 62 FR 31857 (June 11, 
1997). No comments were received on the proposal. This order approves 
the proposed rule change on an accelerated basis.

II. Description

    On October 1, 1996, the Commission approved a nine-month pilot 
program for the evaluation of PCX equity specialists.\3\ The exchange 
is now proposing to extend the pilot program for an additional six 
month period, until January 1, 1998. The Exchange represented that the 
reason for the extension is to allow it more time to evaluate the 
impact of the SEC's new order handling rules on the performance 
criteria.\4\ During the extension of the pilot, the Exchange has 
represented that it will determine an appropriate overall passing score 
and individual passing scores for each criterion used in the pilot 
program.
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    \3\ Prior to the adoption of the pilot program, PCX Rule 5.37(a) 
provided that the Exchange's Equity Allocation Committee (``EAC'') 
evaluate all registered specialists on a quarterly basis and that 
each specialist receive an overall evaluation rating based on three 
criteria of specialist performance: (1) Specialist Evaluation 
Questionnaire Survey (``Questionnaire'') (45% of overall score); (2) 
SCOREX Limit Order Acceptance Performance (10%); and (3) National 
Market System Quote Performance (45%). See PSE Rule 5.37 (July 
1995).
    The pilot program modifies Rule 5.37(a) by adding three new 
criteria of performance and eliminating one performance criterion. 
The new criteria are: (1) Executions (50%) (itself consisting of 
four criteria: (a) Turnaround Time (15%); (b) Holding Orders Without 
Action (15%); (c) Trading Between the Quote (10%); and (d) 
Executions in Size Greater Than BBO (10%)); (2) Book Display Time 
(15%); and (3) Post-1 p.m. Parameters (10%). The pilot eliminates 
the SCOREX Limit Order Acceptance Performance criterion. Further, 
the pilot adds more questions to the Questionnaire, and reduces its 
weight from 45% to 15% of the overall score. Finally, the National 
Market System Quote Performance criterion (renamed Quote Performance 
under the pilot) has been amended to include within it a submeasure 
for bettering the quote (each of the two submeasures is accorded a 
weight of 5% of the overall score). For a more detailed description 
of the performance criteria utilized in the PCX's pilot program, see 
Securities Exchange Act Release No. 37770 (October 1, 1996), 61 FR 
52820 (October 8, 1996) (File No. SR-PSE-96-28). See also generally 
PCX Rule 5.37 (description of the standards and procedures 
applicable to the EAC's evaluation of specialists).
    \4\ See Securities Exchange Act Release No. 37619A (September 6, 
1996), 61 FR 48290 (September 12, 1996) (File No. S7-30-95).
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    In addition, the Exchange proposes to implement for use in the 
evaluation program, beginning with the third quarter review period of 
1997 (i.e., the quarter beginning July 1, 1997), certain programming 
changes requested by the Commission in its October 1, 1996 order 
approving the pilot program. Specifically, the Commission requested 
that the Exchange reprogram its systems so that the following criteria 
are calculated using the NBBO instead of the primary market quote: 
Trading Between the Quote, Book Display Time, and Quote Performance 
(Equal or Better Quote Performance and Better Quote Performance). The 
description of these performance criteria will be modified as follows:

Trading Between the Quote \5\

    ``Trading Between the Quote'' currently measures the number of 
market and marketable limit orders that are executed between the best 
primary market bid and offer. For this criterion to count toward the 
overall evaluation score, ten orders or more must have been executed 
during the quarter in which the specialist is being evaluated. If less 
than ten orders are executed, this criterion will not be counted and 
the rest of the evaluation criteria will be given more weight.
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    \5\ ``Trading Between the Quote'' is one of the four criteria 
which together constitute the ``Executions'' criterion. See supra 
note 3.
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    When a market or marketable limit order is executed, the execution 
price is compared to the primary market bid and

[[Page 36861]]

offer. The specialist will be awarded points based on the percentage of 
orders the specialist receives that are executed between the primary 
market bid and offer. If the execution price falls between the primary 
market bid and offer, the trade is counted as one that traded between 
the quote at the time of execution. Each time a trade is executed, the 
primary market quote will be noted. If the spread of that quote is two 
or more trading fractions apart, that trade will count as one eligible 
for the comparison of the execution price to the quote.
    The Exchange is now proposing to continue using this criterion, but 
to replace references to the ``primary market bid and offer'' with 
references to the ``NBBO.''

Book Display Time

    This criterion calculates the percentage of book shares at the best 
price in the book that is displayed in the specialist's quote, by 
symbol, and the duration of time that each percentage is in effect. 
This criterion rates the P/COAST book displayed 100% of the time. The 
sizes of all open buy limit orders at the best price for the symbol in 
the specialist's book are totaled and compared to the bid size quote. 
The sizes of all open sell limit orders at the best price for the 
symbol in the book are totaled and compared to the offer size quote. 
This will be done for each symbol traded by the specialist, but only 
for those orders within the primary market quote. Limit orders in the 
book that were priced beyond the primary market quote will not be 
included; they will not be executed until they reach the price in the 
primary market quote, so the specialist should not be required to cover 
them in his (her) quote sizes.
    The Exchange is now proposing to continue using this criterion, but 
to replace references to the ``primary market bid and offer'' to 
references to the ``NBBO.''

Quote Performance

    This criterion, on which 10% of each specialist evaluation is 
based, consists of two submeasures: (a) Equal or Better Quote 
Performance; and (b) Better Quote Performance.
    Equal or Better Quote Performance calculates for each issue traded, 
the percentage of time in which a specialist's bid or offer is equal to 
or better than the primary market quote with a 500 share market size or 
the primary market size, whichever is less, with a 200 share minimum.
    Better Quote Performance calculates for each issue traded, the 
percentage of time in which a specialist's bid or offer is better than 
the primary market quote with a 500 share market size or the primary 
market size, whichever is less, with a 200 share minimum. The Exchange 
is proposing to continue using this criterion, but to replace 
references to the ``primary market bid and offer'' with references to 
the ``NBBO.''
    In addition, the Exchange has represented that it will submit a 
proposed rule change with the Commission pursuant to rule 19b-4 under 
the Act \6\ by November 15, 1997 that will specify an overall passing 
score for the performance evaluation and individual passing scores for 
each criterion, as well as a request to further extend the pilot beyond 
January 1, 1998.
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    \6\ 17 CFR 240.19b-4
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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.\7\ To 
ensure that specialists fulfill these obligations, it is important that 
the Exchange conduct effective oversight of their performance. The 
PCX's specialist evaluation program is critical to this oversight.
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    \7\ Rule 11b-1, 17 CFR 240.11b-1; PSE rule 5.299f).
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    In its order initially approving the specialist evaluation pilot 
program,\8\ the Commission asked the Exchange to monitor the 
effectiveness of the amended program. Specifically, the Commission 
requested information about the number of specialists who fell into the 
bottom 10% of all registered specialists on their respective trading 
floors in the overall program, whether they subsequently appeared 
before the EAC, and any restrictions placed upon, or further action 
taken against, such specialists. The Commission also requested 
information as to the number of specialists who appeared before the EAC 
as a result of scoring in the bottom 10% in any two out of four 
consecutive quarterly evaluations, whether any restrictions were 
imposed on such specialists, and the results of any formal proceedings 
that were initiated against them.
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    \8\ For a description of the Commission's rationale for 
initially approving the PCX's adoption of its specialist evaluation 
pilot program, see Securities Exchange Act Release No. 37770, supra 
note 3. The discussion in the aforementioned order is incorporated 
by reference into this order.
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    In May 1997, the PCX submitted to the Commission its monitoring 
report regarding its specialist evaluation pilot program. The report 
describes the PCX's experience with the pilot program during the 
initial two quarters of its operation (i.e., the fourth quarter of 1996 
and the first quarter of 1997). In terms of the overall scope of the 
program, the Commission continues to believe that the objective 
measures, together with the floor broker questionnaire, should generate 
sufficiently detailed information to enable the Exchange to make 
accurate assessments of specialist performance. In this regard, the 
increased emphasis on objective criteria under the pilot has been 
useful in identifying how well specialists carry out certain aspects 
(i.e., timeliness of execution, price improvement, and market making 
quality) of their responsibilities as specialists.
    However, in the order initially approving the PCX's pilot program, 
the Commission expressed its concerns about approving a specialist 
evaluation program that contains objective performance criteria 
calculated using the primary market quote. The Commission believed that 
such criteria were more appropriately calculated based on the NBBO. The 
Exchange now proposes to amend the pilot program, beginning with the 
third review period of 1997, to utilize the NBBO instead of the primary 
market quote in the Trading Between the Quote, Book Display Time, and 
Quote Performance criteria. The Commission believes that the NBBO is a 
more appropriate standard in this context in that it will enable the 
Exchange to gauge the performance of PCX specialists in comparison with 
their competitors not only in the primary market, but in the national 
market system as a whole.\9\ The Commission finds that the PCX's 
proposal is responsive to the Commission's request for such an 
amendment.
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    \9\ The Exchange's use of the primary market quote in these 
three measures did not allow for such comparisons to be made in 
instances where the primary market quote is not equal to the NBBO. 
See Id. at n.16.
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    Further, the Commission has stated previously that true relative 
performance standards are the preferable means to evaluate the 
comparative performance of specialists on a national securities 
exchange.\10\ Moreover, the Commission also has

[[Page 36862]]

stated that an effective evaluation program should subject specialists 
who meet minimum performance levels on the overall program, but need 
help or guidance in improving their performance in a particular area, 
to review. While the PCX's specialist evaluation program subjects those 
specialists falling into the bottom 10% of all specialists on his or 
her trading floor to review by the EAC, it does not set a minimum 
performance level on the overall program. In addition, the Exchange has 
not established minimum performance standards for individual 
performance criteria. However, the Commission notes that the Exchange 
has represented that it will establish an overall passing score for the 
evaluation program as well as individual passing scores for each 
performance measure during the course of the pilot.
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    \10\ By relative performance standards the Commission means 
standards that automatically subject specialists that fall below a 
predetermined threshold of performance to a special performance 
review by the appropriate exchange authority. See Securities 
Exchange Act Release No. 28843 (February 1, 1991), 56 FR 5040 
(February 7, 1991); Division of Market Regulation, The October 1987 
Market Break Report (February 1988) at xvii and 4-28 to 4-29.
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    Accordingly, the Commission believes that it is appropriate to 
extend the current pilot program for an additional six-month period, 
until January 1, 1998. This six-month period will allow the Exchange to 
respond to the Commission's continuing concerns with the PCX's 
specialist evaluation program. Moreover, the Commission expects the 
Exchange to conduct an ongoing examination of the parameter ranges and 
corresponding points allotted under each criterion to ensure that they 
continue to be set at appropriate levels.
    The Commission therefore requests that the PCX submit by November 
15, 1997 a proposed rule change pursuant to Rule 19b-4 to revise the 
pilot to adopt a passing score for the overall performance evaluation 
and each criterion thereof. This proposed rule change also should 
include any proposal by the PCX is extend the pilot beyond January 1, 
1998.
    In addition, the Commission requests that the PCX submit a report 
to the Commission, by November 15, 1997, describing its continuing 
experience with the pilot. At a minimum, this report should contain 
data, for the second and third quarters of 1997, on (1) the number of 
registered specialists who scored in the bottom 10% of all registered 
specialists on his or her trading floor in the overall program; (2) the 
number of specialists, who, as a result of scoring in the bottom 10% in 
any one quarterly evaluation, appeared before the EAC, and the type of 
restrictions that were imposed on such specialists (i.e., restriction 
on new allocations or acting as an alternate specialist), or any 
further action was taken against such specialists; (3) the number of 
specialists who, as a result of scoring in the bottom 10% in any two 
out of four consecutive quarterly evaluations, appeared before the EAC, 
whether any restrictions were imposed on such specialists, and whether 
formal proceedings were initiated against such specialists; and (4) the 
number of specialists for who formal proceedings were initiated, the 
results of such proceedings, including a list of any stocks reallocated 
from a particular unit.
    The Commission notes that the Exchange's pilot program only 
modifies the performance criteria of Rule 5.37(a). Consequently, the 
Commission expects the EAC to continue to evaluate the performance of 
specialists during the pilot period in accordance with the standards 
and procedures found in the PCX rules.\11\
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    \11\ In this regard, all specialists falling within the bottom 
10% of specialists on their respective floors in any review period 
are required to meet with the EAC. See also PCX Rule 5.37 (standards 
applicable to specialists falling into the bottom 10% in any two out 
of four review periods, including those pertaining to the initiation 
of formal reallocation proceedings). Moreover, PCX Rule 5.36(d), 
Commentary .03 requires that all specialists falling into the bottom 
10% in a review period must be precluded from acting as alternate 
specialists until their ranking rises above the bottom 10%, unless 
the EAC determines otherwise. In addition, PCX Rule 5.37(b), 
Commentary .01 requires that all such specialists shall not be 
eligible for new allocations until their ranking rises above the 
bottom 10%; however, the EAC may make exceptions if there are 
sufficient mitigating circumstances.
    As also noted in the Commission's order approving the latter 
restriction, findings of ``mitigating circumstances'' should not be 
routine, but should remain the exception and be made only when 
appropriately warranted. See Securities Exchange Act Release No. 
37326 (June 19, 1996), 61 FR 32875 (June 25, 1996) (File No. SR-PSE-
96-13). Consequently, the Commission expects that appropriate action 
in accordance with PCX rules will be taken with regard to those 
specialists falling into the botton 10%.
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    For the reasons discussed above, the Commission finds that the 
PCX's proposal to extend its pilot program is consistent with the 
requirements of Sections 6(b) and 11 of the Act \12\ 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) 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.\13\
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    \12\ 15 U.S.C. 78f(b) and 78k.
    \13\ In approving this rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. Sec. 78c(f).
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    Further, the Commission finds that the proposal is consistent with 
Section 11(b) of the Act \14\ 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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    \14\ 15 U.S.C. 78k(b).
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    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice thereof in the Federal Register. This will permit the pilot 
program to continue both on an uninterrupted basis and with the use of 
the NBBO, instead of the primary market quote, in the calculation of 
the Trading Between the Quote, Book Display Time, and Quote Performance 
criteria. In addition, the rule change that implemented the pilot 
program initially was published in the Federal Register for the full 
comment period, and no comments were received.\15\
    Accordingly, the Commission believes that it is consistent with the 
Act to accelerate approval of the proposed rule change.
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    \15\ See Securities Exchange Act Release 37770, supra note 3.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-PCX-97-19) is approved.
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    \16\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 127 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-17941 Filed 7-8-97; 8:45 am]
BILLING CODE 8010-01-M