[Federal Register Volume 64, Number 120 (Wednesday, June 23, 1999)]
[Notices]
[Pages 33533-33539]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-15967]



[[Page 33533]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41527; File No. SR-Amex-99-08]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the American Stock Exchange LLC 
Relating to the Development of a New Equity Market Structure

June 15, 1999.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on February 16, 1999, the American Stock Exchange 
LLC (``Amex'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commisson'' or ``SEC'') the proposed rule change as 
described in Items I, II and III below, which Items have been prepared 
by the self-regulatory organization. Amex filed an amendment to the 
proposed rule change on May 24, 1999.\3\ 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 William Floyd-Jones, Assistant General 
Counsel, Legal and Regulatory Policy, Amex, to Michael Walinskas, 
Associate Director, Division of Market Regulation, Commission, dated 
May 21, 1999 (``Amendment No. 1''). Amendment No. 1 replaces and 
supersedes the original filing.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The text of the proposed rule change is available at the Office of 
the Secretary, the Amex and at the Commission.

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 self-regulatory organization 
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 self-regulatory organization 
has prepared summaries, set forth in sections A, B and C below, of the 
most significant aspects of such statements.

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

1. Purpose

Introduction

    The Exchange intends to implement a program to change and make its 
equity market operation more competitive (the ``New Equity Market 
Structure''). A key element of the program is the development of a new 
electronic order book for equities incorporating automatic execution 
for electronically delivered orders and transparency of the book up to 
two minimum trading increments (``ticks'') away from the Amex bid and 
offer. In order to integrate traditional auction market processes with 
automatic execution of electronically delivered orders, the Exchange 
will amend it rules to specify that bids and offers in the trading 
crown must be incorporated in the Amex published quote to be eligible 
to interact with marketable electronic orders, and that a bid or offer 
in the quote is not deemed to be accepted by a member on the floor 
until the specialist enters the acceptance into the book.
    To reduce the cost of doing business on the Amex, the Exchange 
intends to prohibit specialists from charging a commission for 
executing orders delivered electronically from off the floor for 
securities traded under the New Equity Market Structure. The Amex will 
waive a portion of its fees imposed on specialists and will share its 
revenue with specialists to effectively offset the specialists' loss of 
floors brokerage with respect to orders delivered electronically from 
off the floor for securities traded under the New Equity Market 
Structure. In addition, the Exchange proposes to eliminate the 
stabilization requirements of Commentaries, .01, .02, and .07 to Rule 
170 and expand the parameters of the ``2, 1, \1/2\ point Rule'' (Rule 
154, Commentary .08) to permit specialists to respond to the needs of 
the fast moving, modern market without unnecessary restrictions.

New Electronic Order Book for Equities

Look at the Book

    Specialists will continue to see the entire limit order book at 
they currently do. In addition, the Exchange will provide trading 
crowds, booths on the trading floor, and upstairs members with 
information regarding limit orders on the book up to two ticks away 
from the Amex displayed quote. Thus, limit order book information for a 
security that trades in minimum increments of \1/16\ will be available 
for up to 12.5 cents away from the Amex best bid and offer. While limit 
order book information currently is available to floor brokers on an 
inquiry basis,\4\ the proposed look at the book will make this 
information available systematically.
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    \4\ Amex Rule 174.
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    For example, assume the Amex quoted market for a stock is 20 to 
20\1/8\, 5,000 by 5,000, and there are limit orders on the book to buy 
2,000 shares at 19\5/16\, buy 1,000 at 19\7/8\ and buy 1,000 at 19\13/
16\. In this example, the look at the book would include the orders to 
buy 2,000 by 19\15/16\ and 1,000 at 19\7/8\. No limit order information 
would be disseminated if the order on the book closest to the Amex bid 
were the order to buy 1,000 at 19\13/16\. For any securities that trade 
in increments smaller than \1/16\ under the New Equity Market 
Structure, the look at the book will remain at two ticks and will 
narrow in dollar terms.
    The Exchange will not include all or none orders, the unelected or 
unconverted portion of percentage orders, orders for non-regular way 
settlement,\5\ and stop orders in the look at the book display. The 
Exchange believes that it would be inappropriate to disseminate 
information regarding all or none orders due to the restriction placed 
on the execution of these orders, and notes that these orders currently 
are not included in the Amex published quote.\6\ Percentage orders 
require either an electing transaction or conversion by the specialist 
into a bid or offer to become capable to execution. Percentage orders, 
consequently, only will be included in the book or displayed in look at 
the book information upon election or conversion.\7\ Non-regular way 
delivery is a fundamentally different proposition from standard 
settlement.\8\ To prevent confusion, therefore, limit orders for non-
regular way settlement will not be commingled with orders for regular 
way delivery in look at the book information. The Exchange also 
believes that the distribution of information regarding the existence 
and location of stop orders should be minimized to reduce opportunities 
for trading abuses.\9\
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    \5\ Orders for delivery on a cash, next day, or seller's option 
basis are non-regular way orders.
    \6\ Amex Rule 131(c). See also Exchange Act Rule 11 Ac1-4(c0(7).
    \7\ Amex Rules 131(n) and 154, Commentary .15.
    \8\ Amex Rule 126(a).
    \9\ ``Gunning'' stop orders, for example, is a practice whereby 
persons with knowledge of the location of stop orders will engage in 
buying or selling designed to elect the stop orders and trigger 
additional buying or selling.

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[[Page 33534]]

Transmission of Orders and Crowd Interest

    Market and limit orders will be transmitted electronically to the 
book from off the floor via CMS (``Common Message Switch'') and from on 
the floor via BARS (``Booth Automated Routing System'').\10\ Floor 
brokers and traders may also drop hard copy limit orders with the 
specialist or stand in the crowd and bid and offer as they do 
currently. Specialist unit personnel will be responsible for entering 
dropped orders and bids and offers from the trading crowd into the book 
or the Amex published quote.
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    \10\ BARS is currently under development.
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    Orders and modifications to orders (e.g., cancellations) that are 
electronically transmitted to the post will be processed automatically. 
For example, limit orders transmitted to the post electronically will 
be automatically filed in the limited order book in appropriate price/
time priority and limit orders that would affect the Amex published 
quote will be automatically incorporated into the Amex published 
quotes.

Automatic Execution

    Market and marketable limit orders entered electronically may 
execute automatically (i.e., without any human intervention) against 
the Amex published quote up to the display size, and such executions 
will be automatically reported to the Tape and to the member firms that 
initiated the orders. Following an automatic execution, the specialist 
will have the ability to manually determine the new Amex published 
quote to assure appropriate representation of book, crowd and 
specialist proprietary interest.\11\ The Exchange believes that 
customers will favor an automatic execution since it will speed reports 
and provide customers with increased control over their orders. Persons 
that do not wish an automatic execution may have their orders entered 
with a request for a ``stop'' and these orders will be ineligible for 
automatic execution.\12\
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    \11\ During the brief period between an automatic execution and 
the time the specialist updates the market, the ``old'' quote will 
be unavailable for trading because the specialist will be in the 
process of revising the Amex published quote.
    \12\ An agreement to ``stop'' stock at a specified price 
constitutes a guarantee by the member who grants the stop to execute 
the order at the stop price or better. See Amex Rule 109.
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    Crowd interest, the specialist's proprietary quote, and orders 
dropped by brokers must be incorporated into the Amex published quote 
to take part in automatic executions. Similarly, crowd interest, the 
specialist's proprietary quote and dropped orders will be firm with 
respect to electronic orders until physically removed form the Amex 
published quote. The Exchange is amending Rules 123 (``Manner of 
Bidding and Offering'') to provide that bids and offers must be 
incorporated into the published quote to preserve their standing with 
respect to incoming electronic orders, and that such bids and offers 
remain firm with respect to electronic orders until physically removed 
from the Amex quote or until an execution takes place.\13\ Trades 
between brokers and traders in the crowd will occur outside the book 
and will be reported to the Tape.
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    \13\ Amex has indicated that bids and offers will also remain 
firm with respect to electronic orders until an execution takes 
place. Telephone call between Michael Ryan, Chief of Staff & Senior 
Legal Officer, Amex, and Michael Walinskas, Associate Director, 
Commission, on June 4, 1999. Disputes regarding bids and offers will 
be resolved by Floor Officials. See Amex Rules 22 and 126(h).
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    The following examples will illustrate how automatic execution will 
work. Assume an Amex published quote of 20 to 20\1/8\, 5,000 by 5,000. 
Assume further that the bid consists exclusively of one order on the 
book, and that an order to sell 3,000 shares at the market is sent 
electronically to the floor. In this case, 3,000 shares would trade 
automatically at 20, the trade would be reported to the Tape, and 
execution reports would be sent to both the buy and sell side member 
firms. Automatic execution will work similarly if the Amex published 
bid consists of both booked limit orders and the specialist's 
proprietary interest. Assume an Amex published quote of 20 to 20\1/8\, 
5,000 by 5,000, with the bid consisting of a 2,000 share limit order 
and the specialist's bid for 3,000 shares. Assume that an order to sell 
3,000 shares at the market is sent electronically to the book. In this 
example, 3,000 shares would trade automatically at 20, the trade would 
be reported to the Tape, the book would automatically allocate 2,000 
shares to the limit order and 1,000 shares to the specialist,\14\ and 
execution reports would be sent to the buy and sell side firms.
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    \14\ Amex Rule 155 provides that a specialist shall give 
precedence to orders on the book.
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    The process will change slightly if the Amex published quote 
includes crowd interest. As before, the book will automatically execute 
eligible incoming electronic orders. The specialist, however, will 
manually allocate the execution on the contra side of the electronic 
order in accordance with the Exchange's rules of precedence. For 
example, assume the market is quoted 20 to 20\1/8\, 5,000, and an order 
to sell 3,000 shares at the market is sent electronically to the floor. 
Also assume that the bid consists of (i) the specialist as principal 
bidding for 1,000 shares, (ii) a broker representing a customer order 
bidding for 1,000 shares, (iii) a limit order on the book to buy 3,000 
shares, and (iv) the broker and book bids are on parity. In this case, 
3,000 shares would trade automatically at 20, the selling firm would 
get a report at 20, and the 3,000 share trade would print 
automatically. The specialist, however, would allocate the fill on the 
buy side of the trade in accordance with the Exchange's current rules 
of precedence.\15\ Thus, in the example above, the specialist would 
allocate 2,000 shares to the order on the book and 1,000 shares to the 
broker in the crowd. Following the allocation, the book would 
automatically generate execution reports to the buy side firms.
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    \15\ Amex Rules 111, Commentary .07; 126(e); and 155.
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    In the event that an incoming executable electronic order is equal 
to or larger than the displayed quote, the incoming order will 
automatically execute to the full extent of the displayed quote, the 
trade will print, the member firm entering the electronic order will 
receive a report for the amount that traded, the specialist will 
manually requote the market, and the unexecuted balance of the incoming 
electronic order will be handled in accordance with the Exchange's 
current auction market processes. For example, assume the market for a 
stock is 20 to 20\1/8\, 5,000 by 5,000, and there are limit orders on 
the book to buy 2,000 at 19\15/16\, by 1,000 to 19\7/8\ and buy 1,000 
at 19\13/16\. Assume further that there is a broker in the crowd 
working a sell order and that an electronic order to sell 7,000 shares 
at the market arrives at the book. The book would automatically execute 
5,000 shares at 20 (the electronic order would sell all 5,000 shares) 
and print the trade. The specialist then would execute the remaining 
2,000 shares of the unexecuted electronic market order given the limit 
orders on the book, the crowd's expressed interest, and the 
specialist's interest and requote the market.
    Automatic execution will be unavailable when the specialist is in 
the process of manually executing a trade. This will occur in 
connection with (i) openings and reopenings, (ii) trades between the 
crowd and the specialist or orders in the book, (iii) trades between 
the specialist and the book, (iv) block trades, (v) the execution of 
queued orders, and (vi) the pendency of

[[Page 33535]]

Intermarket Trading System (``ITS'') commitments.
    The Exchange will preserve its existing procedures for opening and 
reopenings to ensure single price openings.\16\ A single price opening 
involves a balancing of supply and demand to arrive at a single 
consensus price that cannot be achieved by an automatic execution 
against a displayed bid or offer.
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    \16\ Amex Rules 108(a) and 154, Commentary .07.
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    The Exchange's rules currently provide that a trade occurs upon the 
acceptance of a bid or offer.\17\ Due to the speed of automatic 
executions, however, these executions could preempt trades executed in 
the traditional manner if automatic execution were available during the 
processing of such trades. For example, assume a broker walks into a 
crowd, asks for a market, and is told to 20\1/8\, 5,000 by 5,000. 
Assume the broker says ``sell 5,000.'' Under the Exchange's current 
rules, a trade has occurred on the broker's acceptance of the bid. 
However, if automatic execution were available during the processing of 
the trade, it would be possible for an incoming electronic order to hit 
the bid and sell the stock ahead of the broker. For this reason, 
automatic execution will be unavailable while manually executed trades 
are being processed.
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    \17\ Amex Rule 128 (``Contract Made on Acceptance of Bid or 
Offer'').
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    The Exchange, accordingly, is amending Rule 128 to provide that a 
trade does not occur between a broker in the crowd and the specialist 
or another member whose bid or offer is incorporated in the Amex 
published quote until the specialist begins to process the trade.\18\
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    \18\ Amex has indicated that the point at which the specialist 
``begins to process the trade'' means when the specialist has 
accepted the trade and is ready to report it. Telephone call between 
Michael Ryan, Chief of Staff & Senior Legal Officer, Amex, and 
Michael Walinskas, Associate Director, Commission, on June 4, 1999.
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    Automatic execution will be unavailable following automatic 
executions to allow for the inclusion of specialist and crowd interest 
in the Amex published quote. Where there is no crowd interest in the 
Amex published quote, there are no messages in queue that may affect 
the quote, and \19\ the bid or offer is not exhausted, automatic 
execution will be available after a fixed time interval (e.g., 15 
seconds), or immediately after the specialist manually updates the 
market.\20\ In those circumstances where there is crowd interest in the 
published quote, there are messages in queue that may affect the quote, 
or the bid or offer is exhausted, automatic execution will be available 
immediately after the specialist manually updates the market. For 
example, assume the market is 20 to 20\1/8\, 5,000 by 5,000, there is 
no crowd interest in the quote, and an order to sell 3,000 shares at 
the market is automatically executed. If the specialist takes no action 
following this trade and there are no messages in queue that would 
affect the quote, after a fixed time interval (e.g., 15 seconds), the 
Amex published quote would automatically become 20 to 20\1/8\, 2,000 by 
5,000, and automatic execution would become available.
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    \19\ Amex has clarified that the filing should state ``and the 
bid or offer is not exhausted,'' not ``or the bid or offer is not 
exhausted.'' Telephone call between Michael Ryan, Chief or Staff & 
Senior Legal Officer, Amex, and Michael Walinskas, Associate 
Director, Commission, on June 4, 1999.
    \20\ Id.
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    Incoming electronic orders and other messages that may affect the 
quote (e.g., order cancellations) will queue during times when 
automatic execution is unavailable. The specialist will neither have 
access to, nor be advised of the existence of, queued messages until 
the termination of queuing. The book will automatically process order 
cancellations and modifications and away from the market limit orders 
immediately following termination of queuing without manual 
intervention. After the book automatically processes order 
cancellations and modifications and away from the market limit orders, 
the specialist will manually process queued marketable orders to ensure 
maximum possible order interaction. Automatic execution will resume 
once all messages in the queue are processed and a new market is 
disseminated.
    The benefits of manually processing of queued marketable orders are 
illustrated by the following example. Assume the market is 20 to 20\1/
8\, 5,000 by 5,000 and a broker walks into the crowd and sells 5,000 
shares, eliminating the entire Amex published bid. Assume that a market 
order to buy 1,000 shares and a market order to sell 1,000 shares both 
are received electronically by the book while the specialist processes 
the 5,000 share trade, and that the specialist requotes the market 
19\15/16\ to 20\1/16\, 2,000 by 2,000, following the execution of the 
5,000 share trade. If automatic execution were available prior to the 
disposition of the orders in the queue, the two electronic market 
orders would execute sequentially at different prices. To prevent this, 
the specialist will execute queued orders manually to ensure maximum 
potential order interaction. In this example, the specialist would 
pair-off the two orders at 20, requote the market at 19\15/16\ to 20\1/
16\, 2,000 by 2,000, and automatic execution would resume.
    The Exchange anticipates that during heavy trading it may be 
desirable to suspend automatic execution in a particular stock without 
queuing incoming messages. Such action only will be taken with the 
approval of a Floor Official. In addition, it may be necessary to 
suspend automatic execution on a floor-wide basis without queuing 
incoming messages in the event of systems difficulties or unusual 
market conditions. Floor-wide suspension of automatic execution only 
will be authorized by a Senior Floor Official. If automatic execution 
is suspended, orders and messages will be processed by the specialist 
in the same manner as they currently are handled.

Interaction With Other Markets

    The new equity book will not permit automatic executions in 
situations where an away market displays a higher bid or lower offer 
for 200 or more shares. In these situations, the specialist will have 
the option either to manually execute the income order at the better 
price or transmit it to the away market. For example, assume the Amex 
market is 20 to 20\1/8\, 5,000 by 5,000, and an away market is bidding 
20\1/16\ for 200 shares. Assume that the book receives an electronic 
order to sell 200 shares at the market. In this case, the book would 
not execute the electronic order automatically. Instead, the specialist 
either would execute the order at 20\1/16\, or ship it to the away 
market via ITS. Once the incoming order is shipped through ITS as a 
commitment, it can neither be executed on the Amex nor canceled by the 
originating firm until it expires (one minute) or is canceled by the 
receiving market.
    The implementation of the new book will not result in the way ITS 
commitments are handled, and incoming ITS commitments will not receive 
an automatic execution. Similarly, the Exchange proposes to adopt new 
Rule 431 that would prohibit members and member organizations from 
submitting orders for market makers in other markets for automatic 
execution in the Exchange's trading system unless such market affords a 
comparable level of service to Amex specialists. The Exchange believes 
it is appropriate to not provide the new automatic execution service to 
the market in Amex listed stocks that

[[Page 33536]]

excludes Amex specialists from their comparable services.\21\
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    \21\ Amex has clarified that the filing should state that a 
market, not a market maker, would be required to ``afford a 
comparable level of service.'' Telephone call between Michael Ryan, 
Chief of Staff & Senior Legal Officer, Amex, and Michael Walinskas, 
Associate Director, Commission, on June 4, 1999.
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    During the period when there are pending incoming or outgoing ITS 
commitments, the book will not permit automatic executions in order to 
prevent trade throughs and to provide that the market does not change 
during the pendency of the commitments. During these times, incoming 
orders and cancellations (but not additional ITS commitments) will 
queue. Incoming ITS commitments will not queue to allow specialists 
sufficient time to respond to them within their life.
    Specialists will not see queued messages or receive an advice of 
their existence prior to processing except when an ITS commitment is 
received while messages already are in queue (i.e., there is a 
preexisting queue at the time the commitment arrives). In this one 
circumstance, specialists will receive an advice that there are orders 
in queue without any specification as to the contents of the queued 
messages (e.g., whether the messages are buy or sell orders or the size 
of the orders). This advice will permit specialists to process queued 
orders and ITS commitments together in their proper time sequence 
following the conclusion of the event that caused the initial 
suspension of automatic execution. Automatic execution will resume once 
the orders in the queue and the ITS commitment are processed.\22\
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    \22\ The Amex specialist has no control over the execution or 
non-execution of outgoing commitments which may be canceled or 
expire in the receiving ITS market. Specialists, accordingly, will 
be able to manually restore automatic execution and end queuing even 
if outgoing commitments have neither been processed nor expired to 
prevent delays in order handling on the Amex that are beyond the 
Exchange's control.
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Market Surveillance

    The Exchange currently requires specialists to maintain and file 
with the Exchange a paper record of their principal transactions in 
both specialty securities and related derivative securities. This 
record, referred to as the ``191 Book'' after the Exchange Rule that 
requires its preparation, is a three-part form that includes for each 
specialty security opening positions, principal trades, trade times, 
contra broker badge numbers, and tick. In addition, certain actions by 
specialists require Floor Official approval, and these approvals 
traditionally have been memorialized by the Floor Official signing the 
specialist's 191 Book.\23\
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    \23\ For example, see Exchange Rule 170, Commentaries .01, .02 
and .04.
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    Today, the Exchange's regulatory staff go to the trading floor if 
they wish to see specialist trading information in real-time. The new 
equity book, however, will update this procedure and electronically 
provide the Exchange's regulatory personnel with specialist trading 
activity in real-time. The new book also will maintain a record of 
Floor Official approval of specialist transactions. The Exchange, 
accordingly, is amending Rule 191 to eliminate those specialist's 
record keeping requirements that will be captured and maintained by the 
Exchange's new systems.

Pilot and Roll-Out of the New Equity Book

    The Exchange anticipates that it will implement the use of the new 
equity book on a pilot basis during the third quarter of 1999 and that 
providing the look at the book to upstairs members may require 
additional time. The initial pilot will involve a cross section of 
listed stocks and will last for approximately six months. In 
recognition of the fact that Index Share products (e.g., Portfolio 
Depositary Receipts and Index Fund Shares) have trading 
characteristics, and in certain respects trade under rules, that differ 
from those applicable to other products traded under the Exchange's 
equity rules, the New Equity Market Structure and the associated rule 
changes are not intended to be applied to Index Share products.
    The Exchange will use the new equity book for actual trading during 
the pilot phase, and may make changes to the book as the result of 
operational experience or to enhance the system. Following the 
completion of the pilot program and the implementation of any changes 
to the book, the Exchange will commence its floor wide introduction. 
This roll-out will be done in steps to accommodate training and 
technical considerations.

Floor Brokerage

    Specialists will not be permitted to charge commissions upon the 
execution of orders delivered electronically from off the floor for 
securities traded under the New Equity Market Structure. This should 
reduce the cost of doing business on the Exchange and thereby benefit 
investors. Specialists will continue to be able to charge floor 
brokerage on manually delivered orders. The Exchange also is proposing 
to confirm that specialists may charge a commission on hand delivered 
orders when acting as principal if the member leaving the order 
consents. The Exchange proposes to amend Rule 152(c) in order to effect 
these changes.
    The Amex will share its review with the specialists based on a 
specified rate schedule to effectively offset the specialists' loss of 
floor brokerage with respect to orders delivered electronically from 
off the floor of the Exchange. Index Share orders will not be covered 
by this program. Floor brokerage will cease and revenue sharing will 
commence for each equity security on the date such security begins 
trading under the New Equity Market Structure. In addition, any portion 
of the Amex regulatory fee payable by specialists on qualifying trades 
\24\ that does not exceed $1.5 million in any year will be waived by 
the Amex.
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    \24\ Qualifying trades are trades with orders qualifying for 
revenue sharing. Qualifying orders are those delivered 
electronically from off the floor of the Exchange, excluding orders 
for Index Shares.
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Specialist Activity

    The Exchange is proposing to eliminate the stabilization 
requirements of Commentaries .01, .02, and .07 to Rule 170 and expand 
the parameters of the ``2, 1, \1/2\ point Rule'' (Rule 154, Commentary 
.08) to permit specialist to respond to the needs of the fast moving, 
modern market without unnecessary restrictions.
    Specialists are subject to affirmative and negative obligations in 
trading for their account. The affirmative obligation requires them to 
engage in a course of dealing to assist in the maintenance, insofar as 
reasonably practical, of a fair and orderly market in specialty 
securities. This involves engaging in dealing reasonably calculated to 
contribute to the maintenance of price continuity with reasonable 
depth, and to the minimizing of the effect of temporary disparities 
between supply and demand, immediate or reasonably anticipated. The 
negative obligation provides that specialists may not buy or sell a 
specialty security unless such dealings are reasonably necessary to 
permit specialist to maintain a fair and orderly market in such 
security.
    Good specializing involves judgments as to the proper degree of 
continuity and the reasonableness of depth in light of shifting market 
conditions. The price of a stock, overall market trends, company 
specific news, order flow, the specialist's position in a stock and 
overall risk position, among other factors, go into the mix that needs 
to be considered in determining how

[[Page 33537]]

specialists fulfill their affirmative obligations. For these reasons, 
the Exchange (and the Commission) have not developed standardized 
criteria to assess the performance of specialists with respect to their 
affirmative obligations.
    In contrast to the absence of concrete guidelines with respect to 
specialists' affirmative obligations, there are a variety of trading 
rules that circumscribe the ability of specialists to trade and 
therefore, define specialist negative obligations. These rules include 
Amex Rules 126, 154, 155, 170(c), (d) and (e), Commentaries .01, 
through .09 to Rule 170, and 175. Some of these rules are generally 
applicable to members (e.g., Rule 126 which prescribes rules of 
priority, parity and precedence) while other rules are specific to 
specialists (e.g., Rule 155). In particular, Commentaries .01, .02 and 
.07 to Rule 170 identify transactions characterized as 
``destabilizing'' (i.e., purchases on plus or zero-plus ticks and sales 
on minus or zero minus ticks) and circumscribe a specialist's ability 
to trade on destabilizing transactions.
    When Congress first adopted the Exchange Act, Congress delegated to 
the Commission broad authority to regulate specialists. As originally 
enacted, Section 11(b) of the Act provided in part that if the 
Commission were to adopt rules permitting specialists to act as dealer, 
such rules would, ``restrict his dealings so far as practicable, to 
those reasonably necessary to permit him to maintain a fair and orderly 
market.'' In 1937, the Commission issued an interpretation (the 
``Saperstein Interpreation'') with respect to specialists and their 
functions.\25\ It avoided hard and fast rules and defined permitted 
transactions under the statutory standard as those which enhanced price 
continuity and minimized the effects of imbalances between supply and 
demand.
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    \25\ Exchange Act Release No. 1117, March 30, 1937.
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    The Commission did not use its rule making authority under Section 
11(b) until 1964, when it promulgated Rule 11b-1.\26\ The rule was a 
result of the SEC's finding in the Report of Special Study of 
Securities Markets,\27\ and was the product of intensive negotiations 
between the Commission and the primary exchanges. Rule 11b-1 includes 
both the specialist's affirmative and negative obligations.\28\ The 
Exchange adopted paragraphs (b), (c), (d) and Commentaries .01 and .02 
to Rule 170 in January 1965 soon after the adoption of Exchange Act 
Rule 11b-1.
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    \26\ Exchange Act Release Nos. 7432 (September 24, 1964), 29 FR 
13777 (October 6, 1964) (proposing Rule 11b-1); and 7456 (November 
23, 1964), 29 FR 15862 (adopting the Rule).
    \27\ Report of Special Study of Securities Markets of the 
Securities and Exchange Commission, 88th Congress, 1st Session, 
House Document No. 95, 1963 (hereinafter ``Special Study of 
Securities Markets'').
    \28\ In relevant part, Rule 11b-1(a) states:
    (2) The rules of a national securities exchange permitting a 
member of such exchange to register as a specialist and to act as a 
dealer shall include:
    (ii) Requirements, as a condition of a specialist's 
registration, that a specialist engage in a course of dealings for 
his won account to assist in the maintenance, so far as practicable, 
of a fair and orderly market, * * *
    (iii) Provisions restricting his dealings so far as practicable 
to those reasonably necessary to permit him to maintain a fair and 
orderly market * * *.
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    In 1975, Congress amended section 11(b) of the Act and entirely 
deleted the prior statutory limitation on specialist dealing. The 
Senate Committee Report of the legislation stated that the limitation 
on specialist dealing might become unnecessary with the evolution of 
the National Market System and, specifically, ``active competition 
among market makers,'' and the elimination of the specialists ``trading 
advantages.''\29\ Congress, accordingly, gave the SEC flexibility to 
eliminate the restrictions on specialist dealing when the looked-for 
changes in the National Market System occurred. The Commission, 
however, has not substantively amended Rule 11b-1 since its adoption in 
1964.\30\
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    \29\ The Senate Committee Report states:
    The present requirement in Section 11(b) that a specialist's 
dealing must be limited to those transactions `reasonably necessary 
to permit him to maintain a fair and orderly market' would be 
eliminated. This change does not reflect a belief on the Committees' 
part that this present limitation of specialist dealing is 
inappropriate. The change is merely intended to provide the SEC with 
greater flexibility in prescribing a specialist's obligations in a 
national market system. It might well be that with active 
competition among market makers and the elimination of the trading 
advantages specialists now enjoy, such a restriction on specialists' 
dealings would become unnecessary. Because trading patterns and 
market making behavior in the context of a national market system 
cannot now be predicted, it appears appropriate to expand the 
Commission's rulemaking authority in this area so that the 
Commission may define responsibilities and restrict activities of 
specialists in response to changing conditions in the markets.
    Senate Committee Report No. 94-75, page 100 (1975).
    \30\ In 1981, the Commission amended Rule 11b-1 to clarify that 
it also applied to options specialists and to eliminate duplicative 
SRO rule filing requirements. See Exchange Act Release No. 17574 
(February 25, 1981), 46 FR 15134 (March 4, 1981).
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    In 1991, the SEC approved NYSE rule change to permit specialists to 
reduce dealer positions on zero minus or zero plus destabilizing ticks 
without Floor Official approval, and to reduce dealer positions on 
straight plus and minus destabilizing ticks with Floor Official 
approval, provided that the specialist reentered the market following 
the liquidating transaction on the opposite side of the market from the 
liquidating trade.\31\ In 1994, the SEC approved similar rule change 
for the Amex.\32\
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    \31\ See Exchange Act Release No. 29626 (August 29, 1991), 56 FR 
43949 (September 5, 1991) (approving SR-NYSE-91-07). The SEC 
permanently approved the rule changes in 1993. See Exchange Act 
Release No. 31797 (January 23, 1993), 58 FR 7277 (February 5, 1993).
    \32\ See Exchange Act Release No. 33957 (April 22, 1994), 59 FR 
22188 (April 29, 1994) (temporarily approving SR-Amex-92-26). The 
SEC permanently approved the rule changes in 1997. See Exchange Act 
Release No. 38379 (March 10, 1997), 62 FR 13918 (March 24, 1997).
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    It has been almost 25 years since Congress amended the Act to 
eliminate the statutory restriction on specialists dealing, and 
approximately 35 years have elapsed since the adoption of Rule 11b-1 in 
its present form. During this time, there have been tectonic changes to 
securities trading in the U.S., and the two preconditions to the 
elimination of the restrictions on specialist dealing identified by 
Congress, i.e., the ``elimination of specialist trading advantages'' 
and ``active competition among the market makers,'' have occurred. The 
explosion in trading volume, proliferation of trading venues, nearly 
instantaneous dissemination of market information, development of 
electronic order routing and execution facilities, and implementation 
of the consolidated tape have substantially eroded the time and place 
advantage enjoyed by specialists in the mid-1970s and earlier. In 
addition, much of the specialist's perceived trading advantage derived 
from special access to the limit order book.\33\ To the extent that any 
such advantage persists today, it would be significantly eroded in the 
New Equity Market Structure by the proposed ``look at the book.''
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    \33\ See H.R. Report No. 1383.73rd Congress, Second Session, 
April 27, 1934, pages 14 and 15. The Special Study of Securities 
Markets, Part 2 at page 77 states:
    Thus, in executing his brokerage functions, the specialist has a 
powerful tool [the limit order book] available to him only, giving 
him insight into the possible course of the market.
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    Specialists today face substantially greater competition from other 
market makers and liquidity providers than they faced in 1975 when 
Congress struck the restruction on specialist dealing from the Act. 
Off-Board trading restrictions are largely inapplicable to the 
Exchange's current equity list and third market makers and regional 
exchanges now trade substantial portions of the consolidated volume in 
Exchange listed stocks and constitute an even higher percentage of the 
trades. Block positions, derivatives markets and alternative trading 
systems also provide investors with sources of liquidity and

[[Page 33538]]

trading venues for Exchange listed securities that were unavailable or 
undreamed of the mid-1970s. With the erosion of commission income, 
specialists have had to rely increasingly upon trading revenues to 
survive, and rules that impede their ability to trade, but are 
inapplicable to their competitors,\34\ threaten their competitive 
position. In addition, the Exchange's market surveillance capabilities 
have substantially increased in the last quarter entry. The Exchange, 
accordingly, is better able to identify and address inappropriate 
specialist activity when it occurs, and the need for prophylactic 
restrictions on specialists trading has been correspondingly reduced.
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    \34\ In the Release adopting Rule 11b-1, the Commission exempted 
specialists on regional exchanges from the requirements of the Rule. 
See Exchange Act Release no. 7465 (November 23, 1964), 29 FR 15862. 
In 1981, the Commission modified the exemption to apply Rule 11b-1 
to regional exchanges with respect to such of their securities that 
are not listed on the Amex or NYSE. See Exchange Act Release No. 
18157 (October 7, 1981), 46 50639 (October 14, 1981). The regional 
exchanges currently have rules that apply the general specialists 
affirmative and negative obligations to their specialists. They have 
not, however, applied stabilizing rules to their specialists. See 
Philadelphia Stock Exchange Rule 203, Chicago Stock Exchange Article 
XXX, Rule 1, and Pacific Exchange Rules 5.29(f) and 5.33(a).
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    The Exchange believes that the elimination of the stabilization 
rules with respect to securities traded under the New Equity Market 
Structure will benefit investors by enhancing the ability of 
specialists to comply with their affirmative obligations to the modern, 
fast moving market by allowing them flexibility to manage their 
inventory. For example, assume that a specialists is long 5,000 shares 
of a stock that typically trades 50,000 shares per day. A brokerage 
firm publishes an initial ``buy'' recommendation on the stock and there 
is a predictable influx of buy orders. In this situation, the price of 
the stock would rise and the specialist would sell out of inventory to 
supply the demand. If a seller were to enter the market and the 
specialist were permitted to buy on a plus or zero (destabilizing) 
tick, the specialist could replenish its inventory and be in a position 
to better fulfill its affirmative obligations to the market. As matters 
stand now, however, the specialists is precluded from increasing its 
position on a destabilizing tick without obtaining Floor Official 
approval. In the time it would take to locate and obtain Floor Official 
approval, the offered stock would be purchased by another buyer. The 
specialists in the example thus would be unable to effectively manage 
its inventory to respond to changed market conditions.
    It is important to note that the Exchange is not proposing the 
complete elimination of specialist negative obligations (even though 
Congress gave the Commission explicit authority to do so in 1975 in 
contemplation that the changes due to the advent of the National Market 
System would make such restrictions unnecessary). Instead, the Exchange 
is proposing to eliminate trading rules of the sort never applied by 
the Exchange and Commision in the context of specialist affirmative 
obligations. Thus specialists would be permitted under the Exchange's 
proposal to deal for their account without reference to the ``tick'' of 
the trade\35\ and without the time consuming and duplicative review of 
a Floor Official. Specialists, however, would remain subject to the 
general negative obligation that they may not effect a principal 
transaction unless it is reasonably related to the maintenence of a 
fair and orderly market.\36\ Specialists also would remain bound by the 
numerous other rules that circumscribe their dealer activity. Potential 
concerns with inappropriate specialist trading in the absence of the 
stabilizing rules should be addressed by the Exchange's review of 
specialist dealer activity to determine if it complies with the 
negative obligation and other rules applicable to specialist trading.
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    \35\ Specialists would remain subject to the Commission's short 
sale rule notwithstanding the proposed rule change.
    \36\ Amex Rules 170(c) and (d).
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    The Exchange also believes that the trading restrictions of 
Commentary .08 to Rule 154 (which requires specialists to obtain Floor 
Official approval prior to effecting trades at specified variations 
from the last sale) whould be modified to expand the price variations 
that require Floor Official approval. The current two dollar (for 
securities trading at $20 or more per share), one dollar (for 
securities trading between $10 and $20), and half dollar (for 
securities trading below ten dollars per share) price parameters have 
become too restrictive given the increasing speed of trading, and the 
Exchange proposes that the parameters be expanded to three, two and one 
dollar for stocks in the respective price ranges.
2. Basis
    The proposed rule change is consistent with section 6(b) of the Act 
in general and furthers the objectives of section 6(b)(5) in particular 
in that the proposed New Equity Market Structure and assocaited rule 
changes are designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to foster 
cooperation and coordination with person engaged in regulating, 
clearing, settling, processing informaiton with respect to, and 
facilitating transactions in securities, to remove impediment and 
perfect the mechanisms of a free and open market and a national market 
system, and, in general, to protect investors and the public interest. 
The proposed rule change also is consistent with section 11A of the Act 
in that it enhances (i) economically efficient execution of securities 
transactions, (ii) fair competition among brokers and dealers, among 
exchange markets, and between exchange markets and markets other than 
exchange markets, (iii) the availability to brokers, dealers, and 
investors of informaiton with respect to quotations for and 
transactions in securities, (iv) the practicability of brokers 
executing investors' orders in the best market, and (v) an opportunity, 
consistent with the provisions of clauses (i) and (iv), for investors 
orders to be executed without the participation of a dealer.

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

    The Exchange does not beleive 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.

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.

[[Page 33539]]

 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, NW, Washington, DC 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, located at the above address. 
Copies of such filing will also be available for inspection and copying 
at the principal office of the self-regulatory organization. All 
submissions should refer to File No. SR-Amex-99-08 and should be 
submitted by July 14, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\37\
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    \37\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-15967 Filed 6-22-99; 8:45 am]
BILLING CODE 8010-01-M