[Federal Register Volume 62, Number 175 (Wednesday, September 10, 1997)]
[Notices]
[Pages 47715-47718]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-23955]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39009; File No. SR-NYSE-96-16]


Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change Relating to Amendments 
to Percentage Order Rules 13 and 123A.30

September 3, 1997.

I. Introduction

    On June 28, 1996, the New York Stock Exchange, Inc. (``NYSE'' 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 rules relating to 
percentage orders.
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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. 37495 (July 30, 1996), 61 FR 40699 (August 5, 
1996). No comments were received on the proposal. This order approves 
the proposed rule change.

II. Description

    NYSE Rule 13 defines a percentage order as ``a limited price order 
to buy (or sell) fifty percent of the volume of a specified stock after 
its entry.'' A percentage order is essentially a memorandum entry left 
with a specialist, specifying the total number of shares to be bought 
or sold and the limit price, which becomes a ``live'' order capable of 
execution in one of two ways: (i) all or part of the order can be 
``elected'' as a limit order on the specialist's book based on trades 
in the market; or (ii) all or part of the order can be ``converted'' 
into a limit order to make a bid or offer or to participate directly in 
a trade.

A. The Election Process

1. Current Practice
    Under the election process, as trades occur at the percentage 
order's limit price or better, an equal number of shares of the 
percentage order are ``elected'' and become a limit order on the 
specialist's book. This limit order takes its place behind other limit 
orders on the specialist's book at the same price. The percentage order 
then is reduced by the number of elected shares until the entire order 
has been satisfied.

[[Page 47716]]

    Currently, there are three types of percentage orders: last sale 
percentage orders, straight limit percentage orders,\3\ and buy minus-
sell plus percentage orders.\4\ The Exchange has indicated that most 
percentage orders are entered as last sale percentage orders, meaning 
that they are elected to the book at the price of the elecing sale and 
may be executed at such price, or at a better price.\5\ These orders 
may not, however, be executed at an inferior price to the electing sale 
even if that inferior price is still within the limit price on the 
order.
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    \3\ A straight limit percentage order carries a limit price 
equal to the percentage order limit price.
    \4\ A buy minus-sell plus percentage order operates in the same 
fashion as a straight limit percentage order, except that it places 
the additional requirement that elected portions of buy (sell) 
percentage orders be elected at a price on minus or zero-minus ticks 
(plus or zero plus ticks) from the previous sale.
    \5\ The various types of percentage orders differ only in terms 
of execution, and not the process by which they are elected. See 
supra notes 3 and 4.
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    For example, assume that the specialist receives a last sale 
percentage order to purchase 5,000 shares with a limit price of 30. If 
a trade of 500 shares takes place at 29\1/2\, 500 shares of the 
percentage order would be placed on the specialist's book as a limit 
order at 29\1/2\. This order could be executed at a price of 29\1/2\ or 
lower, but could not be executed at a higher price, even though the 
limit price on the percentage order was 30.
2. Proposed Amendment to the Election Process
    The Exchange is proposing to amend the definition of last sale 
percentage order in Rule 13 to provide that if the order is marked with 
the instruction ``last sale-cumulative volume,'' such orders may be re-
entered on the specialist's book after their initial election at the 
price of subsequent transactions, as long as the price is within the 
limit price on the percentage order. Thus, in the example noted above, 
if there was a subsequent trade of 500 shares at 29\5/8\, 500 shares of 
a percentage order marked last sale-cumulative volume would be elected 
on to the specialist's book at 29\5/8\, and the 500 shares previously 
entered on to the book at 29\1/2\ would be cancelled and reentered at 
29\5/8\, for a total of 1,000 shares of the percentage order on the 
book at 29\5/8\.\6\ If the order were simply marked ``last sale,'' it 
would be handled as today under the current rule.
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    \6\ In the event that a portion of a percentage order is elected 
at the same price as a previously elected, but still unexecuted, 
portion of the same percentage order, the previously-elected portion 
will neither be cancelled nor lose its priority on the limit order 
book. In such situations, however, the subsequently-elected portion 
will not gain priority over previously-entered orders on the book at 
that price. Telephone conversation between Donald Siemer, Director 
of Market Suveillance, NYSE, Mel Hanton, Senior Counsel, NYSE, and 
Jon Kroeper, Attorney, SEC, on August 30, 1996.
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B. The Conversion Process

1. Current Practice
    The second way that a percentage order can be activated into a 
limit order is through the conversion process. Most percentage orders 
contain the additional instruction ``CAP-D.'' ``CAP'' is an acronym 
meaning ``convert and parity,'' which instructs the specialist that he 
or she may convert all or a portion of the order into a limit order, 
and allows the specialist to be on parity with the converted percentage 
order, either to participate directly in a trade or to make a bid or 
offer (``bettering the market''). The ``D'' notation instructs the 
specialist that the order may be converted to participate in 
destabilizing transactions as well as stabilizing transactions.
    The Exchange has stated that, as a practical matter, it views CAP-D 
orders as a necessary adjunct to the standard election procedures 
because they allow the specialist greater flexibility to match the 
order with other buying and selling interest in the market. CAP-D 
orders are subject to a number of restrictions intended to minimize the 
specialist's discretion in handling such orders.\7\
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    \7\ See NYSE Rule 123A.30; Securities Exchange Act Release No. 
24505 (May 22, 1987), 52 FR 20484 (June 1, 1987) (order approving 
amendment to Rule 123A.30 permitting conversion of percentage orders 
on destabilizing ticks under certain restrictions).
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    One such restriction codified in Rule 123A.30 provides that a 
percentage order may be converted into a limit order to make a bid 
(offer), but if a higher bid (lower offer) is subsequently made, the 
converted percentage order bid (offer) is treated as cancelled, and 
reverts to a memorandum entry with the specialist, which is subject to 
further conversion. This means that the bid or offer loses whatever 
priority it has with respect to other limit orders on the specialist's 
book.
    For example, assume that the market is quoted 20-20\1/4\, 10,000 
shares bid and offered, with the bid at 20 representing 10,000 shares 
of a converted percentage order. Under the current rule, if the 
specialist then receives an order to buy 5,000 shares at 20, and an 
order to buy 200 shares at 20\1/8\, when the specialist changes the 
quotation to 20\1/8\-20\1/4\, 200 shares bid and 10,000 offered, the 
converted percentage order bid of 20 for 10,000 is cancelled, and the 
5,000 share order now has priority on the specialist's book at 20. If a 
transaction took place at 20\1/8\, and the quotation reverted to 20-
20\1/4\, the percentage order, although it can be re-converted to add 
to a bid at 20, would have lost its priority on the book.
2. Proposed Amendments to the Conversion Process
    The Exchange is proposing to amend Rule 123A.30 to allow the 
converted percentage order to retain its priority on the book when a 
higher bid (lower offer) is made. However, if a transaction is effected 
at that higher bid (lower offer), and a bid or offer is made that is 
higher (lower) than the price of such transaction, the converted 
percentage order would be cancelled, subject to re-conversion. The 
order would not be cancelled, however, regardless of subsequent trades 
in the market, if it was converted at its maximum limit price.
    In addition, the Exchange is proposing to amend Rule 123A.30 to 
include a provision that a specialist must document the status of a 
converted percentage order on the specialist's book as a limit order at 
the price it was converted.

III. Discussion

    The Commission has considered carefully whether the NYSE's proposal 
is consistent with the Act. Specifically, the Commission has considered 
whether the proposal is consistent with the requirements set forth in 
Sections 6(b) and 11(b) of the Act.\8\ In reviewing previous proposals 
involving percentage orders, the Commission has been concerned whether 
such orders provide the specialist with ``discretion'' in violation of 
Section 11(b) of the Act. Section 11(b) was designed, in part, to 
address potential conflicts of interest that may arise as a result of a 
specialist's dual role as agent and principal in executing stock 
transactions. In particular, Congress intended to prevent specialists 
from unduly influencing market trends through their knowledge of market 
interest from the specialist book and their handling of discretionary 
agency orders.\9\ The Commission has interpreted this section to mean 
that all orders other than market or limit orders are discretionary and 
therefore cannot be accepted by a specialist.\10\
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    \8\ 15 U.S.C. 78f(b) and 78k(b).
    \9\ See H. Rep. No. 1383, 73d Cong., 2d Sess. 22; S. Rep. 792, 
73d Cong., 2d Sess. 18 (1934).
    \10\ See e.g., SEC, Special Study of the Securities Markets, 
H.R. Doc. No. 95, 88th Cong., 1st Sess., Part 2, 72 (1963) 
(``Special Study'') (nothing that ``Section 11(b)* * * prohibits, 
without exception, a specialist's effecting any transaction except 
upon a market or limit order'').
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    The Commission previously has determined that it is appropriate to 
treat

[[Page 47717]]

percentage orders as equivalent to limit orders.\11\ With regard to the 
conversion process in particular, while acknowledging that it permits 
specialists to employ their judgment to a certain extent, the 
Commission believed that the requirements imposed on the specialist 
when converting a percentage order for execution or quotation purposes 
provided sufficiently stringent guidelines to ensure that the 
specialist only will implement the conversion provisions in a manner 
consistent with his or her market making duties and Section 11(b).
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    \11\ See Securities Exchange Act Release No. 24505 (May 22, 
1987), 52 FR 20484 (June 1, 1987) (File No. SR-NYSE-85-1).
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    Furthermore, the Commission previously has determined that the 
NYSE's percentage order rules are consistent with the standards set 
forth under Section 6(b)(5) of the Act. This section requires that the 
rules of an exchange be designed to prevent fraudulent and manipulative 
acts and practices. The Commission determined that the NYSE's 
percentage order rules contain various limiting and protective 
provisions, to ensure that such rules will not increase the possibility 
of specialist abuse of the market.
    As discussed in greater detail below, the Commission finds that the 
proposed rule change, in adding a last sale-cumulative volume 
instruction to the election process and making a minor modification to 
the conversion process, does not adversely impact the protective scheme 
that has been incorporated into the percentage order rules. 
Accordingly, the Commission finds that the proposed rule change is 
consistent with Sections 6(b)(5) and 11(b) of the Act in that it 
neither increases specialists' ability to engage in fraudulent and 
manipulative practices nor allots discretion to specialists in their 
handling of percentage orders.

A. Adoption of the Last Sale-Cumulative Volume Instruction

    Currently, portions of last sale percentage orders only may be 
elected to the specialist's book as limit orders at the price of the 
electing transaction. If the market subsequently moves away from this 
place, such orders will remain on the book without receiving an 
execution.\12\ To address this situation, the Exchange has proposed to 
add a last sale-cumulative volume percentage order instruction option 
to the definition of last sale percentage order in NYSE Rule 13. If a 
percentage order entered with the specialist is marked ``last sale-
cumulative volume,'' a previously-elected portion of a percentage order 
will be cancelled and re-entered at the price of subsequent 
transactions that are within the limit price of the percentage order.
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    \12\ The Commission notes that the floor broker who entered the 
percentage order may instruct the specialist to cancel the elected 
order from the book at any time.
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    The Commission believes that the adoption of the last sale-
cumulative volume instruction is appropriate in that it comports with 
the underlying rationale for the percentage order rule; namely, to 
allow larger-sized orders to trade along with the trend of the market 
without requiring a floor broker to remain in the trading crowd to work 
the order. By cancelling and re-entering previously-elected portions of 
a last sale percentage order at the current market price, the proposed 
instruction will increase the likelihood that such orders will be 
executed in accordance with the trend of the market, instead of 
remaining on the specialist's book at an elected price from which the 
market has moved away. In the same regard, the Commission notes that 
the proposed instruction should facilitate the use of last sale 
percentage orders by floor brokers, as a floor broker will no longer 
have to take the active step of cancelling such orders from the 
specialist's book when the market moves away from the price of the 
electing transaction.\13\ Further, the Commission believes that the 
proposed instruction is appropriate in that it should have the 
beneficial effect of increasing the possibility of interaction between 
last sale percentage orders and contrasided market interest.
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    \13\ The Commission notes, however, that a floor broker 
maintains his or her best execution obligations with regard to any 
percentage order that he or she may leave with a specialist.
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    In addition, the Commission finds that the proposed instruction is 
consistent with the Act in that it does not provide discretion to 
specialists in the handling of last sale percentage orders or increase 
the ability of specialists to engage in fraudulent or manipulative 
activity on the Exchange. In this regard, the process whereby last 
sale-cumulative volume percentage orders are elected and may be 
cancelled from the book and re-entered at the price of subsequent 
transactions is a purely mechanical one, determined solely by the 
application of the proposed instruction to the price of subsequent 
trades on the Exchange. The specialist is not provided with any 
discretion over the process of cancelling or re-entering elected 
orders.
    Finally, the Commission believes that the proposed instruction 
adequately addresses the issue of the priority of pre-existing orders 
on the specialist's book to subsequently-elected portions of percentage 
orders. For example, assume that the market is quoted at 20-20\1/2\, 
1000 shares bid and offered, the bid composed of (in order of priority) 
a 500 share customer order and 500 shares of an elected portion of a 
last sale-cumulative volume percentage order for 5000 shares with a 
limit price of 20\1/2\. The specialist then receives a customer limit 
order to buy 1000 shares at 20 and changes his or her quote to 20-20\1/
4\, 2000 shares bid and 1000 offered. If a market order to sell 500 
shares then enters the market and is executed against the customer 
order to buy 500 shares at 20, an additional 500 shares of the 
percentage order will be elected to the specialist's book. However, 
this subsequently-elected portion of the percentage order will not be 
combined with the previously-elected portion (as would be the case if 
the transaction had occurred at a higher price than 20) and thereby 
gain priority over the customer limit order for 1000 shares at 20. 
Instead, the subsequently-elected portion will be placed at the bottom 
of the book, behind both the previously-elected portion and the 
customer order for 1000 shares in priority. As a result, pre-existing 
customer interest will maintain its priority over subsequently-elected 
percentage orders at the same price.

B. Amendments to the Conversion Process

    Presently, a percentage order to buy (sell) that has been converted 
for purposes of bettering the existing quote must be cancelled and 
revert to a percentage order if a higher bid (lower offer) subsequently 
is made. As the Exchange has noted, while the converted percentage 
order would be subject to re-conversion at the same price, it would 
lose its priority on the specialist's book to other orders at that 
price. The proposed rule change would address this situation by 
requiring that such converted percentage orders remain in the 
specialist's book at their converted price unless a higher bid (lower 
offer) is made, a transaction is effected at that price, and a bid 
(offer) is made at a price higher (lower) than the price of the 
transaction. In such an instance, the converted percentage order would 
be cancelled, subject to reconversion.
    The Commission believes that the proposed change to the conversion 
process is appropriate in that it adequately balances the interest of 
permitting converted percentage orders to retain their priority on the 
specialist's book over subsequently-arriving orders at the same price 
with that of removing

[[Page 47718]]

such converted percentage orders from the book when conditions strongly 
indicate that the market has moved away from the conversion price.\14\ 
Moreover, the Commission finds that the proposal may have the 
additional beneficial effect of increasing the transparency of the 
market. Specifically, the proposal will allow percentage orders to buy 
(sell) to remain on the book in the event of the entry of what may be a 
short-lived higher bid (lower offer) instead of reverting directly to a 
memorandum entry that the specialist may or may not decide to re-
convert for quotation purposes.
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    \14\ At the same time, it should be noted that the Commission 
has previously stated that a specialist can utilize the conversion 
process to enable the percentage order and the specialist trading 
for his or her own account to receive an execution while bypassing 
pre-existing trading crowd and limit order book interest. See SEC, 
Report on the Practice of Preferencing (April 11, 1997) at Part 
II.B.6.
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    Moreover, in approving the adoption of the CAP-D instruction, the 
Commission stated that it ``views as important the cancellation 
provision of the proposed bettering the market rule.'' \15\ The 
significance of such a provision is to provide a cancellation mechanism 
that does not grant any discretion to the specialist when superior-
priced same-sided interest enters the market. Accordingly, the 
Commission believes that the proposed procedure is an appropriate 
replacement for the existing cancellation provision in that it serves 
this same purpose.
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    \15\ See Securities Exchange Act Release No. 24505, supra note 
11.
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    Finally, the Exchange proposes to add to Rule 123A.30 a provision 
that a specialist must document the status of a converted percentage 
order on his or her book as a limit order at the price it was 
converted. The Commission finds that this provision is appropriate in 
that it provides specialists with a clearer statement of their existing 
responsibility to book converted percentage orders.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-NYSE-96-16) is approved.

    \16\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Secretary.
[FR Doc. 97-23955 Filed 9-9-97; 8:45 am]
BILLING CODE 8010-01-M