[Federal Register Volume 64, Number 83 (Friday, April 30, 1999)]
[Notices]
[Pages 23370-23378]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-10806]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41327; File No. SR-PCX-99-07]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to Its Competing 
Specialist Program

April 22, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on March 1, 1999, as amended on April 22, 1993,\3\ the Pacific 
Exchange, Inc. (``PCX'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``Commission'' or ``SEC'') the proposed rule 
change as described in Items I, II and III below, which Items have been 
prepared by the Exchange. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Michael Pierson, Director, Regulatory 
Policy, PCX to Michael Walinskas, Deputy Associate Director, 
Division of Market Regulation, Commission, dated April 22, 1999 
(``Amendment No. 1''). Amendment No. 1 made numerous technical and 
descriptive changes to the filing.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange is proposing to establish a Competing Specialist 
Program on the Exchange. The proposal includes specific procedures for 
Competing Specialists, including procedures for registration, 
withdrawal and participation in the Competing Specialist Program. 
Proposed new

[[Page 23371]]

language is italicized: proposed deletions are in brackets.\4\
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    \4\ On August 21, 1998, the Exchange filed an earlier version of 
this proposal with the Commission. See File No. SR-PCX-98-40. Since 
that time, the Exchange modified the original proposal in several 
respects and accordingly, the Exchange has determined to withdraw 
SR-PCX-98-40 and refile it as modified.
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* * * * *

para.3999  Priority of Bids and Offers

    Rule 5.8(c)(1). When a bid or offer is clearly established as the 
first made at a particular price [regardless of the floor], the maker 
shall be entitled to priority and shall have precedence on the next 
sale at that price, up to the number of shares of stock or principal 
amount of bonds specified in the bid or offer irrespective of the 
number of shares of stock or principal amount of bonds specified in 
such bid or offer. Specialist bids and offers must always yield to 
agency orders being represented at the same price, unless otherwise 
provided in Exchange Rules.
    A member having priority on the floor with a bid or offer may not 
increase the size of his bid or offer if objection is made by another 
member. By placing his order with the specialist he may maintain his 
priority, but in an amount no greater than originally bid for or 
offered by him on the Floor. Orders so placed may be accepted as and 
retain the status of open orders if so designated at the time of 
placement but shall not gain priority over orders existing in the 
Consolidated Limit Order book [specialist's book] at the time the 
member secured the Floor with his original bid or offer.

Priority Among Specialists

    Rule 5.8(c)(2) If two or more specialists are quoting at the NBBO 
and there are no agency orders being represented at the same price, the 
earliest specialist bid or offer at that price will have time priority 
and will be eligible for an execution first up to its specified size. 
When no specialists are quoting at the NBBO, a specialist who is 
representing an order may execute that order in the same security at 
the NBBO or better.
Commentary
    .01--No change.
    .02  The term ``NBBO,'' as used in Rule 5.8(c), refers to the 
national best bid or offer made by an Intermarket Trading System (ITS) 
participant.
    .03  Temporary Rule Applicable to Securities Traded on a Competing 
Specialist Basis. The Exchange intends to reprogram its P/COAST system 
to assure that incoming orders will execute first against any matching 
agency orders in the book and then against any specialist interest at 
the NBBO. Until that systems change has been effected, Exchange 
specialists will be required to manually intervene with orders in their 
custody to assure that quotes for a contra specalist's proprietary 
account with time priority at the NBBO will be honored. If a specialist 
receives an order and is aware that another specialist is disseminating 
a quote for his own account at the NBBO, the specialist receiving the 
order must provide the other specialist with an execution, up to the 
specified size. A specialist whose time priority has been violated may 
demand an execution, up to the quoted size, but must make that demand 
within two minutes after the trade-through has occurred. Otherwise, the 
specialist's right to an execution will be deemed to have been waived.
* * * * *

P/COAST

para. 4153  Pacific Computerized Order Access sysTem

Rule 5.25(a). P/COAST, a securities . . . [No change to remainder of 
this paragraph]
    Member organizations wishing to participate in P/COAST may do so by 
entering, through direct connections between member firms and the 
Exchange or through a floor member on the Exchange floor, market and 
limit orders up to the maximum number of shares in securities traded 
under P/COAST as shall be fixed by the Exchange from time to time. The 
Exchange routes orders to a specialist in one city or the other based 
on arrangements that the specialists have previously made with firms 
that send orders to the Exchange. For orders for which neither 
specialist has made specific arrangements with the firm sending the 
order, the Exchange will generally assure that the orders are 
transmitted to the two specialists on an alternating basis (e.g., the 
first order goes to Specialist A, the next order to Specialist B, the 
next to Specialist A, etc.) Specialists who accept orders pursuant to 
these routing procedures are obligated to represent those orders 
pursuant to Rule 5.29(f).
* * * * *
    Rule 5.25(h). Future Modification of P/COAST. The Exchange intends 
to reprogram P/COAST to assure that incoming orders will execute first 
against any matching agency orders with priority and then against any 
specialist interest with priority. Unfilled portions of such orders 
will default to the specialist who receives them according to 
previously-established routing procedures. P/COAST will continue to 
designate orders for representation by the specialist who has been 
specified to represent them according to pre-defined routing parameters 
(such as because the order-sending firm designated the specialist), 
even if another specialist has priority under Rule 5.8(c). Once P/COAST 
receives a market or marketable limit order, if another specialist in 
that security has a bid or offer with priority at the NBBO, the system 
will ``lock in'' the execution match so that the contra specialist will 
be guaranteed an execution, unless the receiving specialist executes 
the order at a price superior to the NBBO. If the receiving specialist 
moves the order into his or her manual-ex window, then the other 
specialist in the issue will receive a 30-second ``shadow'' message of 
the order on their manual-ex windows if they either have a matching 
limit order or proprietary quote with priority at the NBBO. The contra 
specialists can interact with the receiving specialist's order by 
seeking an execution either by sending an electronic order or calling 
the specialist and vocalizing a bid or offer. For example, assume that 
there are five PCX specialists (A, B, C, D and E) each bidding $20 for 
500 shares for their own accounts. The specialists' quotes have time 
priority in the following order: A, B, C, D, E. There are no agency 
orders to buy at 20 on the PCX, and 20 is the national best bid. E's 
customers sends a market order to the PCX to sell 5,000 shares. The 
order will be represented by E. The order will be displayed for up to 
15 seconds on E's auto-ex window. E may execute the entire order at 20-
1/16. However, the system will lock in A's, B's, C's, D's and E's bids, 
so that if any trades at $20 occur on the PCX, they will be executed in 
time priority order. If E moves the order into the manual-ex window, 
then A, B, C and D will receive a 30-second shadow message of the 
order. Their outstanding bids remain locked in, unless updated so that 
they no longer match with the original order. However, A, B, C and D 
can improve the price or size of their proprietary quotes, and these 
will become locked in, as long as the original order remains in E's 
manual-ex window. To change the example, if A were bidding $20 for 
5,000 shares (with priority, and B, C and D were bidding $19-7/8), E 
can keep the order by filing it at 20-1/16; otherwise, if the order is 
filled at $20, A can fill the entire order. If E moves the order into 
his manual-ex

[[Page 23372]]

window, A will receive a shadow message (but B, C and D will not).
* * * * *

para. 4271  Suspend Trading

    Rule 5.31(b)(1)--No change.
    (i)--No change.
    (ii) to all other specialists trading the security [the specialist 
on the other Floor] who also shall suspend trading,
    (iii)-(iv)--No change.
    Rule 5.31(b)(2)--No change.
    (i)--No change.
    (ii) to all other specialists trading the security [the specialist 
on the other Floor] who also shall suspend trading,
    (iii)-(iv)--No change.
Commentary
    .01 Competing Specialist in an issue may not suspend trading 
pursuant to this rule. All suspensions of trading must be coordinated 
through a regular Specialist
* * * * *

para. 4319  Procedures for the Competing Specialist Program

    Rule 5.35(a) The following are procedures for the Competing 
Specialist Program.
    (1) Only Registered Specialists may act as Competing Specialists. 
For purposes of this Rule, a ``regular Specialist'' is a Registered 
Specialist who is not a Competing Specialist.
    (2) Applications for Registration as a Competing Specialist must be 
directed to the Equity Floor Trading Committee (``EFTC'') in writing 
and must list in order of preference the issue(s) in which the 
applicant intends to compete. The EFTC will consider the following 
factors in reviewing an application:
    (A) financial capability;
    (B) adequacy of staffing on the Floor;
    (C) current recent performance evaluations of the applicant;
    (D) whether the allocation will result in increased competition in 
the issue and/or increased order flow to the Exchange; and
    (E) objections, if any, of the regular Specialists in the issue as 
to whether the issue should be traded on a Competing specialist basis.
    (3) All applicants must be registered as members with the Exchange 
and must meet the net capital requirements of SEC Rule 15c3-1 and the 
capital requirements set forth in Rule 2.2(b) of the Rules of the 
Exchange, and must conform to all other performance requirements and 
standards set forth in the Rules of the Exchange. All applicants who 
control, are controlled by, or are under common control with another 
person engaged in a securities or related business must have and 
maintain appropriate information barriers, pursuant to Rule 4.20, as 
approved by a self-regulatory organization. A Competing Specialist will 
be subject to all the rules and policies applicable to a regular 
Specialist, unless otherwise indicated.
    (4) All applicant organizations, existing or newly created, must 
satisfy the Equity Floor Trading Committee that they have sufficient 
staffing to enable them to fulfill the functions of a specialist in all 
of the issues in which the applicant will be registered as a Competing 
Specialist.
    (5) Order flow not specifically designated for a Competing 
Specialist must be routed to a regular Specialist. However, a firm that 
is affiliated with a Competing Specialist in an issue must designate 
all PCX order flow to that Competing Specialist in that issue.
    (6) In a competitive situation, if the Competing Specialist 
organization that received approval to compete desires to terminate the 
competition by requesting that it be relieved of the stock that is the 
subject of the competition, it must so notify the EFTC at least three 
(3) business days prior to the desired effective date of such 
withdrawal, except in those situations when such notice is not 
practicable.
    (7) Any Competing Specialist that withdraws its registration in an 
issue will be barred from applying to compete in that same issue for a 
period of ninety (90) days following the effective date of withdrawal.
    (8) Notwithstanding the existence of Competing Specialist 
situations, there is only one Exchange market in a security subject to 
competition. Competitors must cooperate with the regular Specialists 
regarding openings and reopenings to ensure that they are unitary.
    (9) All limit orders not immediately executable that are sent a 
Competing Specialist must be entered directly into the Consolidated 
Limit Order Book and be executed according to the Exchange's rules on 
time priority.
    (10) Competing Specialists in an issue may not suspend trading 
pursuant to Rule 5.31(b)(1). All suspensions of trading made must be 
coordinated through a regular Specialist.
    (11) The registration of any Competing Specialist may be suspended 
or terminated by the EFTC upon a determination of any substantial or 
continued failure by such Competing Specialist to engage in dealing in 
accordance with the Constitution and Rules of the Exchange.
    (12) The Exchange will establish an effective date for competition 
to commence. Since the Exchange cannot know what the impact of 
competition will be on its marketplace, it will limit competition 
during the initial phase as follows:
    (A) Any Registered Specialist may apply to become a Competing 
Specialist in a number of issues, not to exceed ten, that has been 
previously established for the program by the EFTC and the Board of 
Governors.
    (B) The EFTC and the Board of Governors will determine the total 
number of Competing Specialists permitted on the Exchange.
    (C) The Exchange will conduct a quarterly review of each Competing 
Specialist on the Exchange. In conducting such reviews, the Exchange 
may consider, among other things, the factors set forth in subsection 
(2), above.
    (13) Once the program has operated for one year, the EFTC will 
evaluate it and make a recommendation to the Board of Governors as to 
whether to continue the program or to modify its terms.

Commentary

    .01  If a particular Specialist is not specified by the P/COAST 
order routing parameters for the receipt of an order, the order must be 
directed to a regular Specialist. However, if a routing firm is 
affiliated with a Competing Specialist, that firm may not route orders 
to another specialist, but must route them to that member firms's 
affiliated specialist, thereby preventing member firms affiliated with 
a specialist from routing non-profitable orders to another specialist 
when market conditions are unfavorable.
    .02  All limit orders must be represented and executed in 
accordance with the rules on time priority on the Exchange. Incoming 
orders are first executed against any contra-side limit orders on the 
Exchange. All market and marketable limit orders are exposed to the 
Specialist for possible price improvement before execution. Specialists 
may execute their designated order flow unless there is contra-side 
limit order eligible for executive on the Exchange or another 
Specialist has a bid or offer with time priority at the NBBO.
* * * * *

[para.4319  Securities Traded on a Competing Specialist Basis

    RULE 5.35(a). The Board of Governors may from time to time 
designate securities to be traded on a competing specialist basis. 
Securities traded on a competing specialist basis will be traded in 
accordance with the provisions of Rule 5.27 through 5.38.]

[[Page 23373]]

[para.4321  Competing Specialist--Definition and Procedure for 
Appointment

    RULE 5.35(b). A competing specialist is a member who is registered 
with the Exchange for the purpose of making transactions as dealer-
specialist on the floor of the Exchange, in securities traded on a 
competing specialist basis, in accordance with the Rules of the 
Exchange. Appointment as a competing specialist shall be made by the 
Floor Trading Committee pursuant to an application which shall include 
such information as is required by the Floor Trading Committee. In 
making such appointments the Floor Trading Committee shall satisfy 
itself as to the applicant's ability to perform the duties of a 
competing specialist and the applicant's financial resources. The Floor 
Trading Committee shall not appoint any person as a competing 
specialist in a security if such person is associated with a member 
firm with which the book broker in such security is also associated. 
The registration of any person as a competing specialist may be 
suspended or terminated by the Floor Trading Committee upon a 
determination of any substantial or continued failure by such competing 
specialist to engage in dealings in accordance with the Constitution 
and Rules of the Exchange.]

[para.4323  Book Broker--Definition and Procedure for Appointment

    RULE 5.35(c). A book broker is a member of the Exchange who has 
been selected by the Floor Trading Committee to operate the book of 
limit orders and to execute odd lot orders and COMEX routed orders in 
securities traded on the Exchange on a competing specialist basis. For 
each security traded on the Exchange on a competing specialist basis, 
the Floor Trading Committee may appoint one book broker on the Los 
Angeles floor of the Exchange and one book broker on the San Francisco 
floor of the Exchange. Application for appointment as a book broker 
shall be made on such form, and shall include such information, as is 
prescribed by the Floor Trading Committee. The appointment of any 
person as book broker may be suspended or terminated by the Floor 
Trading Committee upon a determination that, in its judgment, the 
interest of a fair and orderly market are best served by such action.]

[para.4325  Responsibilty of Book Broker

    RULE 5.35(d). A book broker shall accept any limited order from 
members for placement in the book, including limited orders placed by 
members on a principal basis. All principal orders must be so marked. 
Public orders in the book (agency orders) shall at all times have 
priority and precedence over principal orders in the book at the same 
price of at inferior prices.]

[para.4327  Book Broker Prohibited from Engaging in Principal 
Transactions

    RULE 5.35(e).
    (1). A book broker is prohibited from executing transactions for 
his own account or for the account of his firm. The prohibition of this 
Rule 5.35(e), however, shall not apply to odd lot transactions effected 
to fill odd lot orders, or to round lot transactions to decrease a 
position acquired as a result of the book broker's odd lot transactions 
or error account transactions.
    (2). When a book broker acting as odd lot dealer determines to sell 
a round lot, he shall give the order a competing specialist or another 
member not associated with him for execution, if the transaction would 
establish the price for the execution of odd lot orders the book broker 
holds and make the book broker a buyer on balance.
    (3). When a book broker acting as odd lot dealer determines to buy 
a round lot, he shall give the order to a competing specialist or 
another member not associated with him for execution, if the 
transaction would establish the price for the execution of odd lot 
orders the book broker holds and made the book broker a seller on 
balance.
    (4). If unusual circumstances exist, such as unusual activity in a 
stock with a corresponding increase in the number of orders being 
received and a need for effecting an unusual number of off-setting 
round lot transactions, the off-setting orders may, with the approval 
of a Floor official, despite the provisions of subparagraphs (2) and 
(3) above, be handled by the book broker acting as odd lot dealer. A 
record shall be kept of the circumstances.
    (5). The approval of a Floor Official is required for transactions 
described in paragraphs (2) and (3) when a competing specialist acts as 
a principal on the opposite side of the transaction and such 
transaction is at a price more than one-eight point away from the 
previous sale.
    (6). A book broker acting as odd lot dealer may not, without the 
approval of a Floor Official, effect a transaction or cause a 
transaction to be effected for the account of the book broker which 
would effect any odd lot stop order held by such book broker.]

[para.4329  Maintaining Fair, Orderly, and Competitive Market

    RULE 5.35(f). At the request of a floor broker who holds an order 
for purchase or sale of a security trading on a competing specialist 
basis, or whenever in the book broker's opinion the interests of a fair 
and orderly and competitive market are best served by such action, a 
book broker shall call upon those competing specialists appointed to 
act as such in that security or as many of such competing specialists 
as deemed necessary by the book broker to make bids and/or offers or to 
narrow spreads in existing bids and offers or to take other appropriate 
action, so as to contribute to meeting the standards set forth in Rule 
5.35(g). Whenever called upon by a book broker in accordance with Rule 
5.35(f), a competing specialist shall take reasonable action under the 
circumstances to respond to the book broker's call by providing a 
market or improving upon the market. To the extent practicable, and in 
a form prescribed by the Exchange, the book broker will shall keep a 
record of the responses of competing specialists that provide or 
improve upon a market commensurate with these standards. If 
satisfactory responses are not forthcoming promptly, the book broker 
shall make a record of this fact. Copies of all records kept in 
accordance with this Section shall be forwarded to the Floor Trading 
Committee and the Division of Member Organizations. In addition, in the 
interests of maintaining a fair and orderly and competitive market, a 
request for a quotation may be made at any time of any competing 
specialist by Exchange personnel for the purposes of dissemination over 
any quote reporting system.
Commentary
    .01  Maximum Spreads.
    Without limiting the standards expressed in Rules 5.35(f) and 
5.35(g) a competing specialist, in the course of maintaining a fair and 
orderly market, is expected to conform to the following specific 
standards relating to maximum spreads in the following securities.
    (a) BankAmerica Corporation Common Stock-
    Bidding and/or offering so as to create differences of no more than 
1/2 of $1; provided that, the book broker with the consent of a Floor 
Official, or the Exchange, because of unusual market conditions, may 
determine to increase or decrease the maximum spreads specified above.
    The stated maximum spread is not intended as a limit on the book 
broker's

[[Page 23374]]

power to call for narrower spreads between bids and offers. Depending 
upon market conditions, a book broker may well call for bids and/or 
offers that provide narrower spreads than those stated, and competing 
specialists may be considered to be in derogation of their 
responsibilities under Rules 5.35(f) and 5.35(g) if they do not make 
bids and/or offers that provide narrower spreads.]

[para. 4331  Responsibility of Competing Specialist

    RULE 5.35(g). Transactions of a competing specialist should 
constitute a course of dealings reasonably calculated to contribute to 
the maintenance of a fair and orderly market, and no competing 
specialist should enter into transactions or make bids or offers that 
are inconsistent with such a course of dealings. With respect to 
securities in which he is registered as a competing specialist, a 
competing specialist shall have a continuous obligation to engage, to a 
reasonable degree under the existing circumstances, in dealings for his 
own account when there exists, or it is reasonably anticipated that 
there will exist, a lack of price continuity, a temporary disparity 
between the supply of and the demand for a particular security, or a 
temporary distortion of the price relationships between the Exchange 
and other markets.]

[para. 4333  Acting as Competing Specialist and Floor Broker in 
Same Day

    RULE 5.35(h). A competing specialist is prohibited from acting as a 
floor broker and a competing specialist on the same trading day in any 
security in which the competing specialist is so registered.]

[para. 4335  Applicability of Other Exchange Rules

    RULE 5.35(i). The following Rules of the Exchange relating to 
Dealings upon the Exchange shall apply to book brokers: Rule 1.1, Rule 
4.2, 4.3, Rule 5.1-5.16, 5.20-5.23, 5.27-5.38 (except 5.30(e), 5.32(a), 
5.32(b), 5.33(g), and 5.34(b)) which shall not apply to book brokers, 
and Rule 4.4-4.13, and Rule 5.18, 5.25. The following Rules of the 
Exchange relating to Dealings Upon the Exchange shall apply to 
competing specialists: Rules 1.1; 4.2-4.13; 5.1-5.9; 5.11-5.16; 5.18; 
5.20-5.23; 5.25; 5.27; 5.28(b), (c), (d), (f); 5.29(e); 5.30(a), (d); 
5.33(a), (d), (e), (f); 5.35(a); 5.36; and 5.37. All other Exchange 
Rules shall be applicable to transactions on the Exchange in securities 
traded on a competing specialist basis and to the activities of book 
brokers and competing specialists unless the context clearly indicates 
otherwise.]
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
sections A, B. and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

(1) Purpose
a. Current Practices
    The Exchange currently operates two equity trading floors, one in 
Los Angeles and one in San Francisco. For most of the equity securities 
traded on the Exchange, there are two Registered Specialists \5\ 
continuously making two-sided markets. An order sent to the Exchange is 
routed to a specialist in one city or the other based on arrangements 
that the specialist has previously made. If no specific arrangements 
have been made, the Exchange will generally assure that orders are 
transmitted to the two specialists on an alternating bases (e.g., the 
first order goes to Specialist A, the next order goes to Specialist B, 
the next to Specialist A, and so on).
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    \5\ For purposes of this rule filing, a ``Registered 
Specialist'' is a PCX member who has been appointed and registered 
pursuant to Rule 5.27 to act as a Specialist on the Exchange. A 
``Competing Specialist'' is a Registered Specialist who has been 
approved by the Equity Floor Trading Committee to trade securities 
on a Competing Specialist basis pursuant to proposed PCX Rule 5.35. 
A ``Regular Specialist'' is a Registered Specialist who is not a 
Competing Specialist.
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    The Exchange disseminates a single two-sided quote on the 
Consolidated Quote System (``CQS'') in each security traded on the PCX, 
based on the combined best bids and offers from each city. If the Los 
Angeles specialist is disseminating a bid of $30 for 5,000 shares of 
XYZ and the San Francisco specialist is disseminating a bid of $30 for 
3,000 shares of XYZ, then the Exchange will disseminate a combined bid 
of $30 for 8,000 shares of XYZ.
    The Exchange developed its Consolidated Limit Order Book (``CLOB'') 
in August 1998 for orders that are entered into the Exchange's P/COAST 
trading system.\6\ Incoming orders other than market and marketable 
limit orders are maintained in the CLOB and are represented by the 
specialist designated to represent them. Incoming market and marketable 
limit orders are executed against orders in the CLOB based on price and 
time priority. Before any orders are executed, P/COAST will display 
them to the specialist designated to receive the order for up to 15 
seconds to provide an opportunity for price improvement.\7\ If a 
specialist manually executes a limit order that does not have priority, 
P/COAST will generate a message that a priority violation has been 
committed so that corrective action may be taken. In addition, the 
Exchange's Surveillance Department will receive a report of the 
priority violation.
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    \6\ See generally File No. SR-PCX-99-06. The Commission notes 
that the proposal to implement the CLOB is still pending with the 
Commission.
    P/COAST, the ``Pacific Computerized Order Access SysTem,'' is 
the Exchange's communication, order routing and execution system for 
equity securities. See PCX Rule 5.25(a)-(f).
    \7\ When P/COAST displays an order for possible price 
improvement, the order will appear on the recipient specialist's 
automatic execution window. If another specialist in the issue is 
simultaneously representing an order in the CLOB that is priced at 
the national best bid or offer made by an Intermarket Trading System 
(``ITS'') participant, or ``NBBO,'' that specialist will see a 
``shadow'' record of the order being represented by the other 
specialist and can interact with that order by calling the other 
specialist and vocalizing a bid or offer.
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b. Proposed Competing Specialist Program
    The purpose of the proposed rule change is to expand the Exchange's 
two-specialist system for equity securities by establishing a Competing 
Specialist Program on the Exchange. Under the proposal, Competing 
Specialists will be permitted to compete with Regular Specialists on 
the floor of the Exchange. Like Regular Specialists, Competing 
Specialists in a security will be required to make a two-sided market 
and will be subject to the rights and responsibilities of Regular 
Specialist, subject to certain exceptions discussed below.
    The Exchange's P/COAST system will electronically route each 
incoming order for an equity security to a Regular Specialist or a 
Competing Specialist in that security based on instructions of the firm 
submitting the order. As specified in the Exchange's proposed amendment 
to Rule 5.25(a), specialists who accept orders via P/COAST will be 
obligated to represent those orders pursuant to PCX Rule 5.29(f), which 
states that a specialist is repsonsible for the execution of all orders 
it has accepted.

[[Page 23375]]

    Specialists on the Exchange will be required to execute all orders 
received--whether via the P/COAST system or from a floor broker--in 
accordance with the Exchange's rules on priority. Accordingly, as 
discussed below, a specialist cannot execute incoming market and 
marketable limit orders against its own account until after all limit 
orders priced at or better than the NBBO have been executed, and all 
specialist quotes with time priority at the NBBO have been filled.
    In a few respects, the Regular Specialists in a security will have 
rights and obligations not shared by Competing Specialists. Regular 
Specailists will continue to be responsible for coordinating openings 
and reopenings to ensure they are unitary. Also, Computing Specialists 
who wish to use the ITS to send preopening indications of interest to 
the primary market in a security must send those preopening indications 
through a Regular Specialist (but during trading hours Competing 
Specialists will be able to send outbound ITS commitments and execute 
incoming ITS commitments independently and without the need for a 
Regular Specialist to clear the activity).
    Like Regular Specialists, Competing Specialists will be able to 
enter two-sided quotes into the P/COAST system. The Exchange will 
continue to disseminate a single CQS quote.
    The Exchange believes that having a Competing Specialist Program 
will result in greater competition, tighter bid-ask spreads, and 
greater depth and liquidity on the PCX. As a result, the Exchange 
expects to improve its competitive posture in the industry and expects 
that members' customers will send more order flow to the PCX for 
execution than they currently send.
c. Priority Rule Changes
    The Exchange is also proposing to modify its Priority Rule for 
equity securities, Rule 5.8(c). The existing rule, which will be 
renumbered as Rule 5.8(c)(1), will be amended to provide that 
specialist bids or offers must always yield to agency orders being 
represented at the same price, unless otherwise provided for by rule. 
The exceptions to this general principle would include odd lot oders, 
orders that provide for settlement other than in three days (non-
regular way) and conditional orders (such as all-or-none orders, stop 
orders and market-on-close orders).
    Proposed Rule 5.8(c)(2) will provide that if two or more 
specialists are quoting at the NBBO and there are no agency orders 
being represented at the same price, the earliest bid or offer at that 
price will have time priority and will be eligible for execution first 
up to its specified size. It will further provide that when no 
specialists are quoting at the NBBO, the specialist who is representing 
an order may execute the order in the same security at the NBBO or 
better. The Exchange is also proposing to add a new Commentary .02 to 
the rule, which will provide that the term ``NBBO,'' as used in Rule 
5,8(c), will refer to the national best bid or offer made by an ITS 
participant.
    The provisions of Rules 5.8(c)(1) and 5.8(c)(2) will apply to 
trading in all securities in which there is more than one specialist on 
the PCX. This incudes all securities in which two Regular Specialists 
make a market, whether or not one or more Competing Specialist trades 
the security.\8\
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    \8\ For example, assume that the NBBO is 20 bid to 20\1/8\ 
offered, and Specialist A is bidding 19\3/4\, while Specialist B is 
bidding 19\1/2\. A market order to sell may be directed to 
specialist B for execution, even though Specialist A has a better 
bid, because neither specialist is bidding at the NBBO. Under the 
Competing Specialist Program, Specialist B would execute the order 
at 20 (the national best bid) or better. If Specialist A has been 
bidding 20 (the national best bid), Specialist A would have had 
priority to execute the order, even though it was directed to 
Specialist B.
---------------------------------------------------------------------------

    If a particular specialist is not specified within the P/COAST 
routing parameters for the receipt of an order (such as because the 
specialist has not made prior arrangements with an order-sending firm), 
the order will be directed to a Regular Specialist. However, if a 
routing firm is affiliated with a Competing Specialist, that firm may 
not route orders to another specialist, but must route them to the 
member firm's affiliated specialist, thereby preventing member firms 
affiliated with a specialist from routing non-profitable orders to 
another specialist when market conditions are unfavorable.\9\
---------------------------------------------------------------------------

    \9\ As noted above, however, Rule 5.8(c)(2) will provide that if 
another Specialist is quoting at the NBBO and clearly has 
established priority on the PCX floors, then that Specialist will 
have priority to fill the order despite the fact that the order was 
designated for the affiliated Competing Specialist.
---------------------------------------------------------------------------

    Under the Competing Specialist Program, all limit orders are 
required to be represented and executed according to the rules on time 
priority on the Exchange.\10\ All market and marketable limit orders 
will be exposed to the specialist representing the order for possible 
price improvement before execution. Specialists may execute their 
designated order flow unless there is a matching limit order with 
priority being represented on the Exchange or another specialist has a 
superior quote (with time priority) at the NBBO.
---------------------------------------------------------------------------

    \10\ Time priority is required to be maintained among all orders 
received by the PCX.
---------------------------------------------------------------------------

d. Order Handling
(1) Routing Mechanism
    The Exchange proposes to add new Rule 5.25(h) to reflect that the 
Exchange intends to reprogram P/COAST to assure that incoming orders 
will execute first against any matching agency orders with priority and 
then against any specialist interest with priority. Unfilled portions 
of such orders will default to the specialist who receives them 
according to previously established routing procedures.
    P/COAST will continue to designate orders for representation by the 
specialist who has been specified to represent them according to pre-
defined routing parameters (such as because the order-sending firm 
designated the specialist), even if another specialist has priority 
under Rule 5.8(c)(2). Once 
P/COAST receives a market or marketable limit order, if another 
specialist in that security has a bid or offer with priority at the 
NBBO, the system will ``lock in'' the execution match so that the 
contra specialist will be guaranteed an execution unless the receiving 
specialist executes the order at a price superior to the NBBO. If the 
receiving specialist moves the order into his or her manual-ex window, 
then the other specialists in the issue will receive a 30-second 
``shadow'' message of the order on their manual-ex windows if they 
either have a matching limit order or proprietary quote with priority 
at the NBBO. The contra specialists can interact with the receiving 
specialist's order by seeking an execution either by sending an 
electronic order or calling the specialist and vocalizing a bid or 
offer.
    For example, assume that there are five PCX specialists (A, B, C, D 
and E) each bidding $20 for 500 shares for their own accounts. The 
specialists' quotes have time priority in the following order: A, B, C, 
D, E. There are no agency orders to buy at 20 on the PCX, and 20 is the 
national best bid. E's customer sends a market order to the PCX to sell 
5,000 shares. The order will be represented by E. The order will be 
displayed for up to 15 seconds on E's auto-ex window. E may execute the 
entire order if E improves the price to 20\1/16\. However, the system 
will lock in A's, B's, C's, D's and E's bids, so that if any trades at 
$20 occur on the PCX, they will be executed in time priority order.
    If E moves the order into the manual-ex window, then A, B, C and D 
will receive a 30-second shadow message of the order. Their outstanding 
bids remain locked in, unless updated so that they

[[Page 23376]]

no longer match with the original order. However, A, B, C and D can 
improve the price or size of their proprietary quotes, and these 
improvements in price or size will become locked in, as long as the 
original order remains in E's manual-ex window.
    To change the example, if A were bidding $20 for 5,000 shares (with 
priority, and B, C and D were bidding $19\7/8\), E can keep the order 
by filling it at 20\1/16\; otherwise, if the order is filled at $20, a 
can fill the entire order. If E moves the order into his manual-ex 
window, A will receive a shadow message (but B, C and D will not).
    The Exchange believes that this proposed modification to P/COAST 
will better assure that incoming orders will be executed against PCX 
bids and offers in priority sequence because specialists bids and 
offers at the NBBO will be ``locked in'' systemically. The proposal 
will encourage quote competition among specialists. If specialists are 
quoting at the NBBO with time priority, they will be eligible to trade 
with any incoming order, regardless of who is receiving it. The 
proposal will encourage price improvement because the Competing 
Specialists will be required to quote a letter prices in order to 
retain the order flow received by the Exchange.
    The Exchange has considered changing P/COAST to route orders to the 
specialist with priority at the NBBO, but has concluded that splitting 
orders up into multiple partial orders or routing orders to various 
specialists other than the receiving specialist would not be in the 
customers' best interest. The Exchange further believes that 
implementing such changes would place the Exchange at a competitive 
disadvantage. The Exchange represents that its customers are placing a 
higher premium on turnaround time for executions of their orders. With 
the significant growth of the Exchange's base of on-line customers, the 
PCX anticipates that speed of execution will continue to be a high 
priority for PCX customers. The PCX contends that it is imperative that 
the Exchange devise an order handling method that facilities quick 
executions, avoids unnecessary errors from occurring, and does not 
place PCX specialists at a competitive disadvantage to other exchanges 
and alternative trading systems.
(2) Interim Methodology
    The Exchange proposes to add Commentary .03 to Rule 5.8(c), to 
reflect that until the Exchange has reprogrammed P/COAST to implement 
order routing for the competing specialist program, as described in 
proposed Rule 5.25(h), specialists will need to rely on manual 
procedures to assure that any quotes for a specialist's proprietary 
account with time priority at the NBBO will be honored. In particular, 
if a specialist receives an order an is aware that another specialist 
is disseminating a quote for his own account at the NBBO, the 
specialist receiving the order will be required to provide the other 
specialist with an execution, up to the specified size.\11\
---------------------------------------------------------------------------

    \11\ For example, if Specialist A is bidding $75 (the nations 
best bid, with price and time priority) for 100 shares for his own 
account, and Specialist B receives a market order to sell 5,000 
shares, Specialist B will be required to execute 100 shares of that 
order for Specialist A's account by entering Specialist A's post 
number as the contra side of the trade. Specialist A will then 
receive a report of the executed trade through P/COAST.
---------------------------------------------------------------------------

    The Exchange believes that in some cases, due to system 
limitations, a specialist will be unable to know, at the time of 
receipt of an order, whether a contra specialist has time priority at 
the same price being quoted by the order specialist. As a result, the 
Exchange is proposing to adopt a new Commentary .03 to Rule 5.8(c), 
stating that when two specialists are quoting for their own accounts at 
the NBBO, a specialist whose time priority has been violated may demand 
an execution, up to the quoted size, but must make that demand within 
two minutes after thee trade-through has occurred.\12\ Otherwise, the 
specialist's right to an execution will be deemed to have been 
waived.\13\ Having a two-minute window will assure that members will 
not request relief well after the market has moved and a reasonable 
time to research a trade has passed. It will also serve to ensure that 
PCX specialists trading the same issue will keep each other apprised of 
bids and offers for their own accounts that they intend to invoke when 
competing for the same order flow.
---------------------------------------------------------------------------

    \12\ The Exchange intends to codify this provision as a 
temporary rule that will expire upon the implementation of the P/
COAST changes discussed above. The Exchange anticipates that from 
the time of commencement of programming, these system changes will 
take approximately one year to implement.
    \13\ A similar provision exists in the ITS Rules for orders 
executed out of price priority (but not for orders out of time 
priority at the same price). See, e.g., PCX Rule 5.21(b).
---------------------------------------------------------------------------

e. Procedures for Competing Specialist Program
    The Exchange is proposing to adopt new Rule 5.35(a) for the 
Competing Specialist Program.\14\ Specifically, proposed Rule 
5.35(a)(1) will provide that only Registered Specialists may act as 
Competing Specialist. This requirements is intended to assure that 
Competing Specialists meet the same standards as Registered Specialists 
as required under PCX Rule 5.27. The rule also clarifies that the term 
``regular Specialists'' is a Registered Specialist who is not a 
Competing Specialist.
---------------------------------------------------------------------------

    \14\ Most of these procedures are similar to those set forth in 
the Boston Stock Exchange (``BSE'') Rules, Chapter XV, Section 18, 
which were approved in Exchange Act Release No. 37045 (March 29, 
1996), 61 FR 15318 (April 5, 1996).
---------------------------------------------------------------------------

    Proposed Rule 5.35(a)(2) states that applications for Registration 
as a Competing Specialist must be directed to the Equity Floor Trading 
Committee (``EFTC'') in writing and must list in order of preference 
the issue(s) in which the applicant intends to compete. The EFTC will 
consider the following factors in reviewing an application: (a) 
financial capability; (b) adequacy of staffing on the Floor; (c) 
current and recent performance evaluations of the applicant; (d) 
whether the allocation will result in increased competition in the 
issue and/or increased order flow to the Exchange; and (e) objections, 
if any, of the Regular Specialists in the issue as to whether the issue 
should be traded on a competing specialist basis.\15\
---------------------------------------------------------------------------

    \15\ PCX Rule 11 provides a right of appeal for members or 
member organizations aggrieved by a decision of the EFTC regarding 
the competing specialist program.
---------------------------------------------------------------------------

    Proposed Rule 5.35(a)(3) states that all applicants must be 
registered as members with the Exchange, must meet the net capital 
requirements of SEC Rule 15c3-1 and the capital requirements of PCX 
Rule 2.2(b), and must conform to all other performance requirements and 
standards set forth in the Rules of the Exchange. All applicants who 
control, are controlled by, or are under common control with another 
person engaged in a securities or related business will be required to 
have and maintain appropriate information barriers as approved by a 
self-regulatory organization. A Competing Specialist will be subject to 
to all the rules and policies applicable to a Regular Specialist, 
unless otherwise indicated.
    Proposed Rule 5.35(a)(4) states that all applicant organizations, 
existing or newly created, must satisfy the EFTC that they have 
sufficient staffing to enable them to fulfill the functions of a 
specialist in all of its issues in which the applicant will be 
registered as a Competing Specialist.
    Proposed Rule 5.35(a)(5) states that order flow are specially 
designated for a Competing Specialist must be routed to a Regular 
Specialist. However, a firm that is affiliated with a Competing 
Specialist in an issue must designate all PCX order flow to that 
Competing Specialist in that issue. Commentary .01 to proposed Rule 
5.35 explains that this

[[Page 23377]]

is designed to prevent member firms affiliated from a Competing 
Specialist from routing non-profitable orders to another (unaffiliated) 
specialist when market conditions are unfavorable.
    Proposed Rule 5.35(a)(6) states that if the Competing Specialist 
organization that received approval to compete desires to terminate the 
competition by requesting that it be relieved of the stock in which it 
is competing, it must so notify the EFTC as least three business days 
prior to the desired effective date of such withdrawal, except when 
such notice is not practicable.
    Proposed Rule 5.35(a)(7) states that any Competing Specialist that 
withdraws its registration in an issue will be barred from applying to 
compete in that same issue for a period of 90 days following the 
effective date of withdrawal.
    Proposed Rule 5.35(a)(8) states that Competing Specialists must 
cooperate with the Regular Specialists regarding openings and 
reopenings to ensure that they are unitary. In this regard, the 
procedures note that, notwithstanding the existence of Competing 
Specialist situations, there is only one Exchange market in a security 
subject to competition, meaning that the Exchange will disseminate a 
single quote onto the CQS.
    Proposed Rule 5.35(a)(9) states that all limit orders not 
immediately executable that are sent to a Competing Specialist must be 
entered directly into the CLOB and be executed according to the 
Exchange's rules on time priority. Commentary .02 to proposed Rule 5.35 
further states that incoming orders are first executed against any 
matching limit orders on the Exchange, that all market and marketable 
limit orders are exposed to the specialist for possible price 
improvement before execution, and that specialists may execute their 
designated order flow unless there is a matching limit order eligible 
for execution on the Exchange or another specialist has a bid or offer 
with time priority at the NBBO.
    Proposed Rule 5.35(a)(10) states that all suspensions of trading 
must be coordinated through a Regular Specialist.\16\
---------------------------------------------------------------------------

    \16\ Trading halts are discussed in more detail infra.
---------------------------------------------------------------------------

    Proposed Rule 5.35(a)(11) states that the registration of any 
Competing Specialist may be suspended or terminated by the EFTC upon a 
determination of any substantial or continued failure by that Competing 
Specialist to engage in dealing in accordance with the Constitution and 
Rules of the Exchange.
    Proposed Rule 5.35(a)(12) states that the Exchange will establish 
an effective date for competition to commence, but since the Exchange 
cannot know what the impact of competition will be on its marketplace, 
it will limit competition during the initial phase as follows: (a) any 
Registered Specialist may apply to become a Competing Specialist in a 
number of issues, not to exceed ten, that has been previously 
established for the program by the EFTC and the Board of Governors: (b) 
the EFTC and the Board of Governors will determine the total number of 
Competing Specialists permitted on the Exchange; and (c) the Exchange 
will conduct a quarterly review of each Competing Specialist on the 
Exchange, and in conducting such reviews, the Exchange may consider, 
among other things, the five factors the EFTC considers when reviewing 
an application for registration under the Competing Specialist 
Program.\17\
---------------------------------------------------------------------------

    \17\ The purpose of these reviews is to assure that the new 
program will be operating appropriately, particularly in its early 
phase, so that any problems can be identified and corrected. The 
Exchange anticipates that its staff will provide the EFTC with 
objective data for the EFTC's review and that floor members and 
others will have an opportunity to raise their concerns, if any, in 
the context of these reviews.
---------------------------------------------------------------------------

    Proposed Rule 5.35(a)(13) states that once the program has operated 
for one year, the EFTC will evaluate it and made a recommendation to 
the Board of Governors as to whether to continue the program or to 
modify its terms.
f. Trading Halts and Circuit Breakers
    PCX Rule 5.31(b)(1) currently provides, in part, that when the flow 
of orders in a security traded on both Floors does not allow either 
specialist to maintain an orderly market in such security, either 
specialist may suspend trading, and the specialist who suspends trading 
must notify the specialist on the other Floor who shall also suspend 
trading. Rule 5.31(b)(2) contains similar provisions for securities 
traded only on one Floor. The Exchange is proposing to amend both rules 
to require notification of all specialists trading the security. The 
Exchange also is proposing to add a Commentary to this Rule stating 
that Competing Specialists in an issue may not suspend trading pursuant 
to this Rule, and further that all suspensions of trading must be 
coordinated through a Regular Specialist. The Exchange further proposes 
to add a similar provision to the Procedures for the Competing 
Specialist Program, as new Rule 5.35(a)(11). Finally, the Exchange is 
also proposing to extend its rules on circuit breakers, previously 
approved by the Commission,\18\ to Competing Specialists.
---------------------------------------------------------------------------

    \18\ See PCX Rule 4.22; Securities Exchange Act Release No. 
40418 (September 9, 1998), 63 FR 49624 (September 16, 1998).
---------------------------------------------------------------------------

g. Elimination of Current Rules on Competing Specialists
    In 1976, the Exchange adopted its existing rules on Competing 
Specialists (PCX Rules 5.35(a)--(i)). The Exchange is proposing to 
eliminate those rules and replace them with provisions set forth in 
this proposal, which the Exchange believes to be consistent, in 
general, with the rules of the BSE on Competing Specialists.\19\ The 
Exchange has not applied its existing rules on Competing Specialists 
since approximately 1977.
---------------------------------------------------------------------------

    \19\ See Chapter XV, Section 18, of the BSE Rules; Securities 
Exchange Act Release No. 37045, note 14, supra.
---------------------------------------------------------------------------

(2) Basis
    The proposed rule change is consistent with Section 6(b) of the 
Act,\20\ in general, and furthers the objectives of Section 
6(b)(5),\21\ in particular, in that it is designed to promote just and 
equitable principles of trade, to reflect the mechanism of a free and 
open market and a national market system, and to protect investors and 
the public interest. Specifically, the Exchange believes that the 
proposal, when implemented, will result in greater competition, tighter 
bid-ask spreads, and greater depth and liquidity on the PCX, and 
thereby, will promote those three objectives. The Exchange further 
believes that the proposed rule change and will serve to permit the 
Exchange to compete more effectively for order flow, and thereby will 
serve to promote greater industry-wide competition, and help to perfect 
the mechanism of a free and open market and a national market system.
---------------------------------------------------------------------------

    \20\ 15 U.S.C. 78f(b)
    \21\ 15 U.S.C. 78f(b)(5)
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments on the proposed rule change were neither solicited 
nor received.

[[Page 23378]]

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will--
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change 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-
0609. 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 such filing will also be available for inspection 
and copying at the principal office of the PCX. All submissions should 
refer to File No. SR-PCX-99-07 and should be submitted by June 25, 
1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-10806 Filed 4-29-99; 8:45 am]
BILLING CODE 8010-01-M