[Federal Register Volume 63, Number 236 (Wednesday, December 9, 1998)]
[Notices]
[Pages 67966-67969]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-32604]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40722; File No. SR-NYSE-97-09]


Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change and Notice of Filing 
and Order Granting Accelerated Approval to Amendment No. 1 Relating to 
Specialists' Handling of Percentage Orders

November 30, 1998.

I. Introduction

    On March 25, 1997, 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 NYSE Rule 123A.30, 
relating to specialists' handling of 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 the Federal 
Register on May 21, 1997.\3\ No comments were received on the proposal. 
On June 15, 1998, the Exchange submitted Amendment No. 1 to the 
proposed rule change.\4\ This order approves the proposed rule change 
and approves Amendment No. 1 to the proposed rule change on an 
accelerated basis.
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    \3\ See Securities Exchange Act Release No. 38630 (May 13, 
1997), 62 FR 27822.
    \4\ See Letter from James E. Buck, Senior Vice President and 
Secretary, NYSE, to Michael Walinskas, Deputy Associate Director, 
Division of Market Regulation, Commission, dated June 12, 1998 
(``Amendment No. 1''). In Amendment No. 1, the NYSE clarifies that 
its proposal to add the phrase ``or converted'' to the last 
paragraph of NYSE Rule 123A.30 would not change the existing rules 
governing the conversion of percentage orders. Instead, the Exchange 
believes that the issue of whether an executed percentage order was 
``elected'' or ``converted'' to a limit order is irrelevant to its 
proposal to allow such execution to trigger the election of another 
percentage order on the opposite side of the market.
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II. Background and Description of the Proposal

A. Background

    A percentage order is a limited price order to buy or sell 50% of 
the volume of a specified stock after its entry. A percentage order is 
essentially a memorandum entry left with a specialist 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.
1. The Election Process
    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.
    Currently, there are four types of percentage orders; last sale 
percentage orders, straight limit percentage orders,\5\ buy minus-sell 
percentage orders,\6\ and immediate execution or cancel election 
percentage orders.\7\ 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 electing sale and may be 
executed at that price, or at a better price.\8\
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    \5\ A straight limit percentage order carries a limit price 
equal to the percentage order limit price.
    \6\ 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.
    \7\ An immediate execution or cancel election percentage order 
instructs the specialist to execute the elected portion of the 
percentage order immediately in whole or in part at the price of the 
electing transactions. The remaining unexecuted elected portion of 
the percentage order, if any, reverts back to an unelected 
percentage order, subject to subsequent election or conversion. See 
Securities Exchange Act Release No. 39837 (April 8, 1998) 63 FR 
18244 (April 14, 1998) (order approving File No. SR-NYSE-97-38).
    \8\ The various types of percentage orders differ only in terms 
of execution, and not the process by which they are elected. See 
notes 5-7 supra.
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2. The Conversion Process
    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, under certain circumstances, 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.9 
Specifically, under the conversion process, the specialist may convert 
a percentage order into a ``live'' limit order on a destabilizing tick 
only where: (i) the transaction for which the order is being converted 
is for 10,000 shares or more; and (ii) the price at which the converted 
percentage order is to be

[[Page 67967]]

executed is no more than \1/4\ point away from the last sale price; 
provided, however, that this price parameter may be modified, in 
appropriate cases, with the prior approval of a Floor Official and the 
written consent of the broker who entered the order.10
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    \9\ See NYSE Rule 123A.30; Securities Exchange Act Release No. 
24505 (May 22, 1987) 52 FR 20484 (June 1, 1987) (order approving 
File No. SR-NYSE-85-1 to permit conversion of percentage orders on 
destabilizing ticks under certain circumstances).
    \10\ For a more detailed description of the procedures under 
which a percentage order may be converted on a destabilizing tick, 
see Securities Exchange Act Release No. 24505, supra note 9.
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B. Description of the Proposal

    Currently, NYSE Rule 123A.30 provides that percentage orders shall 
not be elected by any portion of volume which results from the 
execution of a previously elected portion of a percentage order. 
According to the Exchange, the intent of this restriction is to prevent 
``chain reaction'' executions of percentage orders whereby executions 
of elected portions of percentage orders trigger additional elections. 
This result would be contrary to the objectives of most investors 
entering percentage orders, who generally want to ``go along'' with the 
overall trend of the market as reflected by other market interest, 
without necessarily leading that trend.
    As currently interpreted, NYSE Rule 123A.30 does not distinguish 
between the election or conversion of percentage orders on the same 
side of the market and the election or conversion of percentage orders 
on opposite sides of the market. The Exchange believes that the 
restriction should be applied only to percentage orders on the same 
side of the market, as ``same side'' orders are the ones to be executed 
along with the market trend.11
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    \11\ For example, buy percentage orders would be elected and 
executed along with other buying interest, and sell percentage 
orders would be elected and executed along with other selling 
interest.
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    The Exchange is proposing to amend NYSE Rule 123A.30 to provide 
that percentage orders held by a specialist may be elected by the 
execution of a previously elected or converted 12 portion of 
a percentage order that is on the opposite side of the 
market.13
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    \12\ See Amendment No. 1, supra note 4.
    \13\ For example, assume that the market is 20 to 20\1/4\, 2,000 
by 2,000, with the 2,000 share offer representing 2,000 ``elected'' 
or ``converted'' shares of a percentage order to sell 10,000 shares. 
The specialist then receives a last sale percentage order to buy 
10,000 shares at a limit price of 20\5/8\ after which he receives 
through SuperDOT an order to buy 1,000 shares at the market. After 
bidding 20\1/16\ on behalf of the SuperDOT order, the specialist 
executes that order against the 2,000 share offer at 20\1/4\. Under 
the current rule, no portion of the buy percentage order would be 
elected, and no additional portion of the sell percentage order 
would be elected. Under the proposed rule change, 1,000 shares of 
the buy percentage order would be elected at 20\1/4\, and would then 
trade the remaining 1,000 share balance of the offer at 20\1/4\. No 
portion of the sell percentage order would be elected since the 
execution of the remaining 1,000 share sell balance would result 
from the execution of a previously elected or converted percentage 
order on the same side of the market.
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    The Exchange also is proposing to amend NYSE Rule 123A.30 to permit 
the specialist to convert a percentage order on a destabilizing tick, 
as otherwise permitted by the rule, when the transaction is 10,000 
shares or more or represents a quantity of stock having a market value 
of $500,000 or more (whichever is less). The Exchange notes that this 
amendment will conform the size of permitted transactions to the 
definition of a ``block'' in NYSE Rule 97.

III. Discussion

    The Commission has considered carefully whether the NYSE's proposal 
is consistent with the Act and the rules and regulations thereunder 
applicable to a national securities exchange.14 
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.15 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.16 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.17 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.18
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    \14\ In approving the proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \15\ 15 U.S.C. 78f(b) and 78k(b).
    \16\ 15 U.S.C. 78k(b).
    \17\ See H. Rep. No. 1383, 73d Cong., 2d Sess. 22; S. Rep. 792, 
73d Cong., 2d Sess. 18 (1934).
    \18\ 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'') (noting 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 percentage orders as equivalent to limit orders.\19\ 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 obligations and Section 
11(b).\20\
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    \19\ See Securities Exchange Act Release No. 24505, supra note 
9.
    \20\ 15 U.S.C. 78k(b).
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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.\21\ 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.
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    \21\ 15 U.S.C. 78f(b)(5).
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    As discussed in greater detail below, the Commission finds that the 
proposed rule change, in allowing a specialist to elect a percentage 
order based on the execution of a previously elected or converted 
percentage order on the opposite side of the market and modifying the 
restrictions pertaining to the conversion of a percentage order on a 
destabilizing tick, 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 \22\ in that it 
neither greatly increases specialists' ability to engage in fraudulent 
and manipulative practices nor allots discretion to specialists in 
their handling of percentage orders.
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    \22\ 15 U.S.C. 78f(b)(5) and 78k(b).
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A. Proposed Modification to the Election Process

    Currently, a percentage order may not be elected based on the 
execution of a previously elected or converted percentage order. For 
purposes of this prohibition, the current rules do not distinguish 
between percentage orders on the same side of the market and those on 
opposite sides of the market. The Exchange's proposal provides that 
percentage orders held by a specialist may be elected by the execution 
of a previously elected or converted portion of a percentage order that 
is on the opposite side of the market.

[[Page 67968]]

    The Commission believes that it is consistent with the Act to allow 
the election of a percentage order based on the execution of a 
percentage order on the opposite side of the market. The Commission 
believes that the proposed rule change is consistent with the 
underlying rationale for the percentage order rule; namely, to allow 
larger-sized orders to trade along with the trend of the market, rather 
than lead that trend. For example, a percentage order cannot elect 
itself by its execution. Instead, independent interest on the same side 
of the market is needed to trigger an election. In addition, the 
Commission anticipates that by allowing the execution of percentage 
orders to trigger the election of percentage orders on the opposite 
side of the market, the proposal should increase the likelihood that 
percentage orders held by the specialist will be elected as limit 
orders and ultimately, executed.
    Moreover, the Commission finds that permitting the election of a 
percentage order based on the execution of a previously elected or 
converted percentage order on the other side of the market is 
consistent with the Act in that it does not provide discretion to 
specialists in the handling of percentage orders. Instead, the 
Commission notes that previously executed percentage orders, regardless 
of whether initially elected or converted, will trigger the election of 
percentage orders on the other side of the market. The specialist is 
not provided any discretion over the process of electing percentage 
orders on the other side of the market, once a previously elected or 
converted percentage order has been executed, in accordance with the 
Exchange's rules.
    Finally, the Commission notes that the Exchange's rules will 
continue to prohibit the election of percentage orders based on the 
execution of percentage orders on the same side of the market. The 
Commission believes that this continued prohibition, which will prevent 
same side percentage orders held by the specialist from being elected 
by the execution of percentage orders, is appropriate.

B. Proposed Modification to the Conversion Process

    The Exchange's proposal also permits the specialist to convert a 
percentage order on a destabilizing tick, as otherwise permitted by the 
rule, when the transaction is 10,000 shares or more or represents a 
quantity of stock having a market value of $500,000 or more (whichever 
is less). NYSE Rule 123A.30 currently provides that the specialist may 
convert a percentage order on a destabilizing tick only where: (i) the 
transaction for which the order is being converted is for 10,000 shares 
or more; and (ii) the price at which the converted percentage order is 
to be executed is no more than \1/4\ point away from the last sale 
price; provided, however, that this price parameter may be modified, in 
appropriate cases, with the prior approval of a Floor Official and the 
written consent of the broker who entered the order.
    The Commission notes that by allowing a specialist to convert an 
order on a destabilizing tick when the transaction being converted is 
for 10,000 shares or more or represents a quantity of stock having a 
market value of $500,000 or more, whichever is less, the proposed 
change will make the size of permitted transactions consistent with the 
definition of a ``block'' transaction in NYSE Rule 97. The Commission 
agrees that the proposed amendment, which will liberalize the 
requirements of NYSE Rule 123A.30, should facilitate conversion of 
percentage orders in stocks where the size of the trade has the 
appropriate market value to qualify as a block transaction, but may not 
have a share size of 10,000 or more. The Commission notes that the 
conversion procedures were intended to allow percentage orders to 
participate immediately with large-sized contra-side orders entering 
the market.\23\ Previously, percentage orders were not eligible for 
execution until an electing transaction had occurred. As a result, all 
or part of a large percentage order was elected for execution in a 
large-size trade's ``after-market,'' where execution of the elected 
portion could disrupt price continuity.\24\ Therefore, the Commission 
believes that amending the conversion rules to parallel the definition 
of a block transaction in NYSE Rule 97 will align the rules more 
closely with the original intent of the conversion procedures.
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    \23\ See Securities Exchange Act Release No. 21704 (February 1, 
1985) 50 FR 5834 (February 12, 1985) (noticing File No. SR-NYSE-85-
1).
    \24\ For example, if the sale of a block of stock results in a 
price decline, the subsequent execution of a large percentage buy 
order elected by the execution of that block transaction could drive 
the price up again. Id.
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    While the proposal will afford specialists greater opportunity to 
convert percentage orders on a destabilizing tick, the Commission 
believes that existing requirements imposed on the specialist when 
converting percentage orders for execution or quotation purposes are 
sufficiently restrictive to ensure that the specialist will act in a 
manner consistent with his market making obligations and Section 11(b) 
of the Act.\25\ In addition, the Commission believes that the limiting 
and protective provisions incorporated into the Exchange's conversion 
procedures should ensure that the proposal will not increase the 
likelihood of fraudulent and manipulative activities by specialists. 
Therefore, the Commission believes that the proposal is consistent with 
Section 6(b)(5) of the Act.\26\
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    \25\ 15 U.S.C. 78k(b).
    \26\ 15 U.S.C. 78f(b)(5).
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    The Commission finds good cause for approving proposed Amendment 
No. 1 prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. In Amendment No. 1, 
the NYSE attempts to clarify its proposal, with respect to the effect 
of the execution of percentage orders previously converted, in response 
to questions raised by Commission staff. As the NYSE's clarification 
does not in any way modify its original proposal, the Commission 
believes that Amendment No. 1 raises no novel issues of regulatory 
concern. Accordingly, the Commission believes that it is consistent 
with Section 6(b)(5) of the Act \27\ to approve Amendment No. 1 to the 
proposed rule change on an accelerated basis.
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    \27\ 15 U.S.C. 78f(b)(5).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1, including whether Amendment No. 1 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of all such filings also will be available for inspection and 
copying at the principal office of the NYSE. All submissions should 
refer to File No. SR-NYSE-97-09 and should be submitted by December 30, 
1998.

[[Page 67969]]

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\28\ that the proposed rule change (SR-NYSE-97-09), as amended, is 
approved.

    \28\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-32604 Filed 12-8-98; 8:45 am]
BILLING CODE 8010-01-M