[Federal Register Volume 62, Number 179 (Tuesday, September 16, 1997)]
[Notices]
[Pages 48686-48688]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-24544]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39035; File No. SR-Amex-97-10]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the American Stock Exchange, Inc. Relating to Amendments to 
Rule 170.01 Relating to Specialists Establishing a Position in 
Specialty Stocks

September 9, 1997.

I. Introduction

    On February 24, 1997, the American Stock Exchange, Inc. (``Amex'' 
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\ the proposed rule to change to permit specialists to 
engage in certain types of transactions by removing existing 
restrictions that currently limit specialists approval when 
establishing or increasing a position in their specialty stocks.\3\ 
Notice of the filing appeared in the Federal Register on May 12, 
1997.\4\ No comment letters were received concerning the proposed rule 
change. This order approves the Amex's proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 38573 (May 5, 1997).
    \4\ FR 25984 (May 12, 1997).
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II. Description of the Proposal

    The Amex, pursuant to Rule 19b-4 of the Act, proposes to amend Amex 
Rule 170.01 (``Rule'') to remove certain restrictions on specialists' 
ability to establish or increase their positions in their specialty 
stocks.

Purpose

    Amex Rule 170 governs specialists' dealings in their specialty 
stocks. In particular, Amex Rule 170.01 describes certain types of 
transactions to establish or increase a specialist's position which are 
not to be effected unless they are ``reasonably necessary to render the 
specialist's position adequate to'' the needs of the market. 
Additionally, these types of transactions require floor official 
approval unless they are conducted in ``less active markets'' where 
such transactions are an essential part of a proper course of dealings 
and where the amount of stock involved and the price change, if any, 
are normal in relation to the market.\5\ Currently, such

[[Page 48687]]

restrictions apply equally to transactions that are beneficial to the 
market by being against the market trend and those that are 
disadvantageous to the market by being with the market trend. The 
Exchange is proposing to apply these restrictions only to those 
transactions that are disadvantageous to the market by being with the 
market trend.
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    \5\ See Amex Rule 104.10(5)(i).
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    Specifically, Amex Rule 170 provides that a specialist is 
affirmatively required to engage in a course of dealings for his own 
account to minimize order disparities and contribute to continuity and 
depth in the market, and is precluded from trading for his own account 
unless such dealing is necessary for the maintenance of a fair and 
orderly market. The price trend of a security should thus be determined 
by incoming orders rather than the specialist's proprietary dealings.
    Commentary .01 to Amex Rule 170 sets forth specific requirements 
which are applicable when a specialist is establishing or increasing a 
position, and provides that a specialist should effect such 
transactions in a reasonable and orderly manner in relation to the 
condition of the general market, the market in the particular stock and 
the adequacy of his position to meet the immediate and reasonably 
anticipated needs of the market. In particular, Amex Rule 170.01(a) 
prohibits a specialist from purchasing stock at a price above the last 
sale in the same trading session, without Floor Official approval. Amex 
Rule 170.01(b) provides that a specialist must obtain Floor Official 
approval prior to effecting the purchases of all or substantially all 
the stock offered on the book at a price equal to the last sale, when 
such offer represents all or substantially all the stock offered in the 
market. Amex Rule 170.01(c) provides that a specialist similarly must 
obtain Floor Official approval prior to supplying all or substantially 
all the stock bid for on the book at a price equal to the last sale. 
Amex Rule 170.01(d) requires the specialist to re-offer or re-bid where 
necessary after effecting the transactions described in paragraphs (a), 
(b) and (c) of the Rule.
    The Amex states that the restrictions contained in paragraphs (b) 
and (c) of the Rule were intended to strike a balance between 
protecting the auction market from unnecessary specialist trading and 
providing immediate liquidity to orders that come to the Floor. The 
Floor Official's function, at the time Rule 170 was adopted, was to 
operate as a control mechanism to ensure that the specialist did not 
trade unnecessarily.
    The Amex contends that although the need to obtain Floor Official 
approval was reasonable in the past, before technology enabled markets 
to move quickly within seconds, it now has the effect, under certain 
circumstances, of reducing liquidity and disadvantaging orders entered 
with the specialist. Accordingly, the Exchange proposes to amend Amex 
Rule 170.01 to provide that a specialist is not required to obtain 
Floor Official approval with respect to the purchase, on a zero minus 
tick, of stock offered on the book, or the sale, on a zero plus tick, 
of stock bid for on the book. A specialist is the buyer and seller of 
last resort, and is expected to step in when there is a disparity 
between supply and demand. In this situation, the Amex contends that a 
specialist would only be purchasing the stock offered because there is 
inadequate demand for the stock.
    In addition, the Amex contends that with the advent of improved 
technology, the Exchange's surveillance systems can now provide an 
adequate substitute for Floor Official Approval in such circumstances. 
In the last few years, the Exchange has developed an automated computer 
program which identifies each instance in which a specialist crosses 
the market (i.e., buys on the offer and sells on the bid). Each of 
these situations can then be individually reviewed by the Exchange 
Trading Analysis staff to determine whether the specialist was acting 
appropriately. With respect to the proposed rule change, the Exchange 
staff would look at how large the specialist's position was prior to 
the transaction, whether there were imbalances in the limit orders on 
the specialist's book which necessitated the transaction, and whether, 
if the market subsequently ``turned around'' the specialist used a 
reasonable amount of the inventory acquired in the transaction to 
offset any imbalance between supply and demand.
    The Amex believes that the proposed change carves out an exception 
to the existing provisions, but would provide a distinct benefit to the 
market by permitting the specialist to satisfy a customer's order more 
expeditiously, while enabling the specialist to enhance the liquidity, 
depth and transparency of the market as the buyer or seller of last 
resort.

III. Commission Findings and Conclusions

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with Section 6(b)(5) of the Act.\6\ The Commission believes 
the proposal is consistent with the Section 6(b)(5) requirements that 
the rules of an exchange be designed to promote just and equitable 
principals of trade, remove impediments to and perfect the mechanism of 
a free and open market, and, in general, protect investors and the 
public interest, promote efficiency, competition and capital 
formation.\7\ The Commission also believes that the proposal is 
consistent with Section 11(b) of the Act and Rule 11b-1 thereunder,\8\ 
which allow exchanges to promulgate rules relating to specialists in 
order to maintain fair and orderly markets.
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    \6\ 15 U.S.C. 78f.
    \7\ 15 U.S.C. 78(c).
    \8\ 15 U.S.C. 78k and 17 CFR 240.11b-1(a)(2).
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    Both the Act and Amex Rules reflect the crucial role played by 
specialists in providing stability, liquidity and continuity in the 
Exchange's auction market. Recognizing the importance of the specialist 
in the auction market, the Act and Amex Rules impose stringent 
obligations upon specialists.\9\ Primary among these obligations are 
the requirements to maintain fair and orderly markets and to restrict 
specialist dealings to those that are ``reasonably necessary'' in order 
to maintain a fair and orderly market.\10\
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    \9\ Rule 11b-1 under the Act, 17 CFR 240.11b-1 and Amex Rule 
170.
    \10\ 17 CFR 240.11b-1(a)(2).
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    The importance of specialist performance to the quality of markets 
was highlighted during the 1987 and 1989 market breaks. In The October 
1987 Market Break Report (``1987 Report''), the Division examined 
specialist performance on the Amex on October 19 and 20, 1987.\11\ The 
Division found that, during periods of the greatest volatility in 1987, 
particularly on October 19, 1987, Amex specialists had to act as the 
primary, or sometimes the only, buyers for many of the specialty stocks 
because of the lack of buying interest by upstairs firms.\12\ The 
increased volume of order flow, coupled with the lack of participation 
on the part of the upstairs firms, resulted in Amex specialists having 
to take large dealer

[[Page 48688]]

positions.\13\ Although many Amex specialists appeared to perform well 
under the adverse conditions, specialist performance during this period 
varied widely.
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    \11\ See 1987 Report, February 1988 at xvii, 4-1.
    \12\ See 1987 Report 4-23 to 4-24 and 4-26, to 4-27. Generally, 
``upstairs firms,'' or block trading desks of large broker dealers 
(as opposed to specialists and other traders on the Amex Floor), 
can, at times, provide an additional source of liquidity for Amex-
listed issues through their trading activities. During the 1987 
market break, however, particularly on October 19, 1987, very little 
buying was effected by upstairs firms, forcing specialists to be the 
contra-side to large blocks of stock.
    \13\ See 1987 Report at 4-48.
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    The Division also examined Amex specialist performance during the 
volatile conditions of October 13 and 16, 1989. The Division found that 
specialist performance during that time was similar in many respects to 
specialist performance during the 1987 market break.\14\ Specifically, 
the Division found that, during these two periods of extreme market 
volatility, specialists were confronted with extraordinary order 
imbalances that required unprecedented capital commitments.\15\ As in 
October 1987, specialists as a whole on October 13, 1989 were 
substantial buyers in the face of heavy selling pressure, although 
performance varied among specialists.
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    \14\ See Market Analysis of October 13 and 16, 1989 (``1989 
Analysis'') at 3-4 and 33-44.
    \15\ See 1987 Report at 4-8 and 1989 Report at 23-26.
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    Both the 1987 Report and the 1989 Analysis reaffirmed the 
importance of specialist participation in countering market trends 
during periods of market volatility. At the same time, the reports 
emphasized the importance the Commission placed on the Amex's ability 
to ensure that all specialists comply with their affirmative and 
negative market making obligations during such periods.\16\
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    \16\ A specialist's dealer responsibilities consist of 
``affirmative'' and ``negative'' obligations. In accordance with 
their affirmative obligations, specialists are obligated to trade 
for their own accounts to minimize order disparities and contribute 
to continuity and depth in the market. Conversely, pursuant to their 
negative obligations, specialists are precluded from trading for 
their own accounts unless such dealing is necessary for the 
maintenance of a fair and orderly market. In view of these 
obligations, the price trend in a security should be determined not 
by specialist trading but by the movements of the incoming orders 
that initiate these trades.
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    The Commission recognizes that market conditions may exist at times 
where it is necessary or desirable to provide specialists with 
additional flexibility in establishing or increasing a position in 
order to facilitate their ability to maintain fair and orderly markets, 
particularly during unusual market conditions. Accordingly, the 
Commission believes that it is appropriate for the Amex to remove those 
provisions of Rule 170.01 that require floor official approval for 
certain specialist purchases on zero-minus ticks and specialist sales 
on zero-plus ticks.\17\ The proposed changes may allow specialists, 
during periods of market volatility, to keep any general price 
movements orderly, thereby furthering the maintenance of fair and 
orderly markets consistent with Sections 6 and 11 of the Act. The 
Commission emphasizes, however, that the expanded flexibility afforded 
to specialists by the proposal merely obviates the current required 
floor official approval for the affected transactions and does not 
reflect that all specialist purchases on zero-minus ticks and sales on 
zero-plus ticks are appropriate. Notably, specialists remain subject to 
their ``negative obligations,'' specifically, the requirement that 
specialists are precluded from trading for their own account unless 
such dealing is necessary for the maintenance of a fair and orderly 
market.\18\
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    \17\ The Commission notes that Rule 170.01 currently only 
requires floor official approval for purchases or sales at a price 
equal to the last sale price when all or substantially all the stock 
offered/bid on the limit order book represents all or substantially 
all the stock offered/bid in the market. Moreover, the rule 
currently does not require floor official approval of such 
transactions if they are effected in ``less active markets'' where 
they are an essential part of a proper course of dealings and where 
the amount of stock involved and the price change, if any, are 
normal in relation to the market.
    \18\ In addition, Amex Rule 170.01 clearly requires that covered 
transactions must be reasonably necessary to render the specialist's 
position adequate to such needs.
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    Finally, the Commission believes that the Amex's established 
surveillance procedures and criteria, including the automated computer 
program which identifies each instance in which a specialist crosses 
the market, should allow the Exchange to monitor specialist compliance 
with Amex Rule 170.01. In addition, the Commission expects the Amex to 
monitor carefully compliance with the procedures of Amex Rule 170 as 
required under Section 19(g) of the Act.\19\
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    \19\ Section 19(g) of the Act requires every self-regulatory 
organization to comply with, and enforce compliance with, the Act, 
the rules thereunder and its own rules.
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    For the foregoing reasons, the Commission finds that the Amex's 
proposal to permit specialists to engage in certain types of 
transactions by removing existing restrictions that currently limit 
specialists when establishing or increasing a position in their 
specialty stocks is consistent with the requirements of the Act and the 
rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-Amex-97-10), as amended, is approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-24544 Filed 9-15-97; 8:45 am]
BILLING CODE 8010-01-M