[Federal Register Volume 65, Number 95 (Tuesday, May 16, 2000)]
[Notices]
[Pages 31200-31205]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-12272]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42767; File No. SR-PCX-99-07]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 2 to the Proposed Rule Change by the Pacific Exchange, 
Inc. Relating to Its Competing Specialist Program

I. Introduction

    On March 1, 1999, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to implement a competing 
specialist program. The

[[Page 31201]]

Exchange amended the proposed rule on April 22, 1999.\3\
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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 (``Division''), Commission, dated 
April 22, 1999 (``Amendment No. 1''). Amendment No. 1 made numerous 
technical and descriptive changes to the filing.
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    The Commission published notice of the proposed rule change in the 
Federal Register on April 30, 1999.\4\ The Commission received nine 
comments. The Exchange filed a second amendment on May 8, 2000.\5\ For 
the reasons discussed below, the Commission is approving the proposed 
rule change as amended.
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    \4\ Securities Exchange Act Release No. 41327 (April 22, 1999), 
64 FR 23370 (April 30, 1999) (``Notice'').
    \5\ See Letter from Michael Pierson, Director, Regulatory 
Policy, PCX, to Belinda Blaine, Associate Director, Division, 
Commission, dated May 8, 2000 (``Amendment No. 2''). Amendment No. 2 
made technical changes to reflect PCX's recent restructuring of its 
equity trading system and rules, discussed recent technology 
upgrades relevant to this filing, and made clarifying changes to 
certain rules.
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II. Description of the Proposal

    The Exchange proposes to implement a competing specialist program 
to allow multiple specialists to make markets in equity securities 
traded on the Exchange. Currently, two specialists continuously make 
markets in most equity securities traded on the Exchange. The proposal 
would allow one or more competing specialists to make markets in a 
security, in addition to the existing ``regular specialists.'' \6\ 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 specialists, subject to certain 
exceptions discussed below. By allowing additional specialists to make 
markets in the most actively traded stocks, the Exchange expects that 
its competing specialist proposal will attract additional order flow to 
the Exchange. The Exchange also believes that a competing specialist 
program will result in greater competition, tighter bid-ask spreads, 
and greater depth and liquidity on the PCX.
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    \6\ Under the proposal, a ``regular specialist'' is a specialist 
registered with the PCX in a security, other than a competing 
specialist in that security. Although PCX rules do not specify a 
minimum number of regular specialists in a security, as a practical 
matter there must be at least one regular specialist in a security 
because regular specialists have certain duties not shared by 
competing specialists.
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A. PCX's Current Order Routing Procedures

    Currently, the P/COAST trading system \7\ typically sends incoming 
orders to a particular specialist based on arrangements that the 
specialist has made with the firm that sent the order to the exchange. 
If a firm has not designated a particular specialist to receive the 
order, the Exchange sends the order to one of the two regular 
specialists on an alternating basis.\8\ A specialist may execute market 
orders it receives against the specialist's own account, unless the 
Exchange's Consolidated Limit Order Book (``CLOB'') contains a limit 
order that is priced at the National Best Bid or Offer (``NBBO'').\9\ 
If the CLOB contains a limit order priced at the NBBO, and a specialist 
receives a market or marketable limit order that would match against 
the order that has priority on the CLOB, the specialist typically must 
execute the incoming order against the CLOB order, unless the 
specialist retains the order by executing the order against its own 
account at a price better than the order that has priority on the 
CLOB.\10\ Other than requiring a specialist to give priority to CLOB 
orders, the existing system permits a specialist to execute its 
designated order flow at the NBBO or better whether or not the 
specialist's quoted bid or offer was priced at the NBBO when it 
received the order.
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    \7\ P/COAST, the ``Pacific Computerized Order Access System,'' 
is the Exchange's communication, order routing, and execution system 
for equity securities. See Rule 7.70.
    \8\ Firms may also send orders to floor brokers for 
representation on the exchange. Currently, floor brokers are not 
required to enter orders they receive into the P/COAST system, and 
they can direct orders they represent to either specialist post 
handling that security.
    \9\ The Exchange has proposed changing several rules to reflect 
its implementation of the CLOB. See Securities Exchange Act Release 
No. 41304 (April 16, 1999), 64 FR 22888 (April 28, 1999).
    \10\ Under certain limited circumstances, a specialist can 
execute an order against its own account even if a same-priced or 
better-priced order is on the CLOB. For example, because an all-or-
none order in the CLOB that is priced at or better than the NBBO 
cannot execute against an incoming market order that is smaller than 
the all-or-none order, a specialist may execute the market order 
against its own account.
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B. Proposed Order Routing Procedures

    Under the Exchange's competing specialist proposal, if one 
specialist disseminates a bid or offer at the NBBO that has time 
priority on the Exchange, and another specialist (a ``contra 
specialist'') in that security receives a market or marketable limit 
order that would match against the first specialist's bid or offer, 
then the specialist with time priority at the NBBO would have the right 
to execute the incoming market or marketable limit order, unless the 
specialist that receives the order executes the entire order at a price 
better than the NBBO. If multiple specialists are quoting at the NBBO, 
then each of those specialists' quotes must be filled in time priority 
sequence before a specialist without time priority can execute an order 
against its own account at the NBBO, unless the specialist who receives 
the order provides price improvement. As today, a specialist could not 
execute an order against its own account at the NBBO until eligible 
orders in the CLOB priced at the NBBO are filled. The priority 
provisions would apply to trading in all securities that have more than 
one specialist on the PCX, including all securities in which two 
regular specialists make a market, whether or not one or more competing 
specialists also trades the security.
    To implement these changes, PCX proposes to modify Rule 7.19(e)(1), 
which governs priority of bids and offers.\11\ The rule currently 
provides, among other things, that bids and offers that are made first 
at a particular price are entitled to priority, and that a member may 
maintain priority by giving the order to a specialist. The existing 
language reflects a time when floor brokers played a more active role 
on the Exchange than is currently the case. The proposed rule change 
would add language stating that specialist bids and offers must always 
yield to agency orders represented at the same price, unless otherwise 
excepted by the rules of the ``Corporation,'' meaning PCX Equities, 
Inc.\12\ The Exchange states that the exception refers to odd lot 
orders, orders that provide for settlement other than in three days 
(non-regular way) and conditional orders (such as all-or-

[[Page 31202]]

none orders, stop orders and market-on-close orders).\13\
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    \11\ In the Notice, Rule 7.19(c)(1) was identified as Rule 
5.8(c). PCX renumbered its equity trading rules as part of a 
restructuring plan that the Commission recently approved. See 
Securities Exchange Act Release No. 42759 (May 5, 2000).
    \12\ Under the PCX equities trading restructuring plan, the 
Exchange is delegating the responsibility to operate PCX's equities 
trading system to PCX Equities, Inc. Rule 1.1(f) of the revised 
rules states that the term ``Corporation'' means PCX Equities, Inc.
    Amendment No. 2 modified the language of several rules published 
in the Notice to replace references to the ``Exchange'' with 
references to the ``Corporation.''
    Under the restructuring plan, firms that trade equities on PCX 
now may hold Equity Trading Privileges (``ETP)'' or Automated System 
Access Privileges. Accordingly, Amendment No. 2 also replaced 
references to ``member'' or ``firm'' with references to ``ETP 
Holder'' or ``ETP Firm.''
    \13\ The proposed rule change would also remove a reference to 
individual floors. The filing further proposes eliminating a 
reference to the ``specialist's book'' that is inconsistent with the 
Exchange's use of a CLOB.
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    The Exchange also proposes to add new Rule 7.19(c)(2), governing 
priority among specialists. The rule would provide that if two or more 
specialists are quoting at the NBBO and there are no agency orders 
being represented at that price, the earliest specialist bid or offer 
at that price will have time priority and be eligible for an execution 
first up to its specified size.\14\ If no specialists are quoting at 
the NBBO, a specialist representing an order may execute that order at 
the NBBO or better.\15\
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    \14\ But see Rule 7.70, discussed below.
    \15\ Proposed Commentary .02 to these rules defines the term 
``NBBO'' as the national best bid or offer made by an Intermarket 
Trading System (``ITS'') participant. As set forth in the Notice, 
proposed Commentary .03 to these rule provided for specialists to 
manually intervene with orders to assure that the priority rules 
would be maintained, until the Exchange reprogrammed the P/COAST 
system to implement the priority rules. Amendment No. 2 eliminated 
proposed Commentary .03, which is now unnecessary.
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    In addition, the Exchange proposes to change other rules to 
describe how the P/COAST system will route orders in the competing 
specialist environment. An addition to Rule 7.70(a),\16\ which 
generally describes P/COAST, states that the Corporation will route 
orders to a specialist in accordance with arrangements that the 
customer has made with that specialist. Absent such arrangements, the 
Corporation will alternate orders between the two regular 
specialists.\17\ The Exchange also proposes to add new Rule 7.70(h)\18\ 
to explain that the P/COAST system will provide that specialists who 
are quoting with time priority at the NBBO will have the right to 
execute incoming orders at the NBBO, up to the size of their quote. A 
specialist designated to receive an order, however, could retain the 
order even if the specialist's quote did not have priority at the NBBO, 
if the specialist improve the price.\19\ The Exchange estimates that it 
will implement this change to P/COAST by September 29, 2000.\20\
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    \16\ In the Notice, Rule 7.70(a) was identified as Rule 5.25(a).
    \17\ But see note 36.
    \18\ In the Notice, Rule 7.70(h) was identified as Rule 5.25(h).
    \19\ Amendment No. 2 clarified Rule 7.70(a) by stating that non-
designated orders would alternate among the two regular specialists. 
The amendment also changed proposed Rule 7.70(h) to eliminate an 
outdated reference to specialists interacting with orders by using 
electronic orders or by vocalizing bids and offers, to eliminate the 
inference that a specialist who has time priority at the NBBO could 
retain priority when increasing the size of its quote, to make a 
clarifying change, and to eliminate language suggesting that the 
rule described a ``future modification'' of P/COAST.
    \20\ See Amemdment No. 2. The Exchange further states that it 
will not permit specialists to act as competing specialists until 
the Exchange has implemented this systems change.
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C. Other Provisions of the Competing Specialist Program

    The Exchange proposes to describe the competing specialist program 
by replacing the existing text of Rule 7.30(a)\21\ with new language. 
Specifically, proposed Rule 7.30(a)(1) would provide that only 
registered specialists may act as competing specialists. Similarly, 
proposed Rule 7.30(a)(3) would provide that all applicant competing 
specialists must be registered as ETP Holders or ETP Firms with the 
Corporation, must meet capital requirements set forth in the 
Commission's and the Corporation's rules, must conform to all other 
performance requirements and standards set forth in the rules of the 
Corporation, and are subject to all the rules and policies applicable 
to a regular specialist, unless otherwise indicated. The Commission 
notes that applicable rules include, among other things, Rule 7.24(a), 
which makes a specialist responsible for the execution of all orders 
that he has accepted. Proposed Rule 7.30(a)(3) also would provide that 
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 as approved by a 
self-regulatory organization.
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    \21\ In the Notice, Rule 7.30(a) was identified as Rule 5.35(a).
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    Proposed Rule 7.30(a)(2) would provide that applications for 
registration as a competing specialist must be directed to the 
Corporation in writing and must list in order of preference the 
issue(s) in which the applicant intends to compete.\22\ The Corporation 
would consider several factors when reviewing an application: financial 
capability; adequacy of staffing; performance evaluations; whether the 
allocation would increase competition in the issue and/or increase 
order flow to the Corporation; and any objections of the regular 
specialists in the issue. \23\ Proposed Rule 7.30(a)(4) also states 
that applicant organizations must demonstrate to the Corporation that 
they have adequate staffing.
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    \22\ As proposed in the Notice, several portions of Rule 7.30(a) 
(identified as Rule 5.35(a) in the Notice) would have delegated 
certain responsibilities regarding competing specialists to the 
Exchange's Equity Floor Trading Committee (``EFTC''). Amendment 2 
replaced reference to the EFTC with references to the 
``Corporation.'' Amendment No. 2 also replaced references to the 
Exchange's Board of Governors with references to the Corporation's 
Board of Directors.
    \23\ In Amendment No. 2, the Exchange added language to Rule 
7.30(a)(2) stating that the denial of an application to register as 
a competing specialist may be appealed pursuant to Rule 10.14(a), 
which provides a right of appeal if the Corporation denies an 
application to serve as a specialist.
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    Proposed Rule 7.30(a)(5) would provide that order flow not 
specifically designated for a competing specialist must be routed to a 
regular specialist, but that an ETP Firm affiliated with a specialist 
in an issue must designate all PCX order flow in that issue to that 
specialist.\24\ Commentary .01 to proposed Rule 7.30(a) explains that 
this is designated to prevent ETP Firms affiliated with a specialist 
from routing non-profitable orders to another (unaffiliated) specialist 
when market conditions are unfavorable.\25\
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    \24\ As originally published in the Notice, proposed Rule 
7.30(a)(5) (identified as Rule 5.35(a)(5) in the Notice) and 
Commentary .01 only applied to firms affiliated with competing 
specialists. Amendment No. 2 modified the proposal to also encompass 
firms affiliated with regular specialists.
    \25\ As discussed above, however, Rule 7.19(c)(2), would provide 
that if another specialist is quoting at the NBBO and clearly has 
established priority on the PCX, then that specialist would have 
priority to fill the order.
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    Proposed Rule 7.30(a)(6) would provide that if a firm wishes to 
withdraw from acting as a competing specialist in a security, it must 
notify the Corporation at least three business days prior to the 
desired effective date of such withdrawal, except when notice is not 
practicable. Also, proposed Rule 7.30(a)(7) would provide 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 7.30(a)(8) would provide that competing specialists 
must cooperate with the regular specialists regarding openings and 
reopenings to ensure that they are unitary.\26\
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    \26\ Competing specialists who wish to use ITS to send 
preopening indications of interest to the primary market in a 
security must send those preopening indications through a regular 
specialist who is an ITS Coordinator. During trading hours, 
competing specialists at times 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; at 
other times an ITS Coordinator will need to be involved. See 
Securities Exchange Act Release No. 42708 (April 20, 2000), 65 FR 
25780 (May 3, 2000). The Exchange states that competing specialists 
will not be permitted to act as an ITS Coordinator.
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    Proposed Rule 7.30(a)(9) would require that if a competing 
specialist receives a limit order that is not immediately executable, 
the competing specialist must enter the order into the CLOB and execute 
it according to the Corporation's rules on time priority.

[[Page 31203]]

This rule reiterates certain of the order routing principles discussed 
above, and clarifies that they apply to competing specialists as well 
as regular specialists. Commentary .02 to proposed Rule 7.30(a) further 
states that incoming orders are first executed against any matching 
limit orders on the Corporation, that all market and marketable limit 
orders are exposed to a 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 Corporation, or another specialist has a bid or offer 
with time priority at the NBBO.
    Proposed Rule 7.30(a)(10) would provide that all suspensions of 
trading must be coordinated through a regular specialist. The exchange 
is also codifying the role of competing specialists in trading halts in 
an amendment to Rule 7.46(b).\27\ Rule 7.46(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 7.46(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 the rule stating that competing specialists in an issue 
may not suspend trading, and that all suspensions of trading must be 
coordinated through a regular specialist. Finally, the Exchange 
proposes to extend its rules on circuit breakers, codified in Rule 
7.47(a)-(b), to competing specialists.
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    \27\ In the Notice, Rule 7.46(b) was identified as Rule 5.31(b).
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    The Exchange is also proposing to add Rule 7.30(a)(11), which would 
provide that the registration of any competing specialist may be 
suspended or terminated by the Corporation upon a determination of any 
substantial or continued failure by that competing specialist to engage 
in dealing in accordance with the bylaws, rules and procedures of the 
Corporation.\28\
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    \28\ Amendment No. 2 revised a reference to the constitution and 
rules of the Exchange.
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    Under proposed Rule 7.30(a)(12), the Corporation will establish an 
effective date for competition to commence, but the Corporation 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 Board of Directors; (b) the Board of 
Directors will determine the total number of competing specialists 
permitted on the Corporation; and (c) the Corporation will conduct a 
quarterly review of each competing specialist, and in conducting such 
reviews, the Corporation may consider, among other things, the five 
factors that it considers when reviewing an application for 
registration as a competing specialist.\29\
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    \29\ The purpose of these reviews is to assure that the new 
program will be operated appropriately, particularly in its early 
phase, so that any problems can be identified and corrected.
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    Proposed Rule 7.30(a)(13) would provide that once the program has 
operated for one year, the Corporation will evaluate it and make a 
recommendation to the Board of Directors as to whether to continue the 
program or to modify its terms.\30\
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    \30\ In the Notice, the Exchange proposed deleting older rules 
for competing specialists, which were codified as Rules 5.35(a)-(i). 
The Exchange had not applied those rules since approximately 1977. 
The Exchange recently deleted those rules as part of its equity 
trading rule restructuring.
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III. Summary of Comments

    The Commission received nine comment letters, all of which were 
from individuals associated with PCX firms, and all of which were 
favorable.\31\ The commenters stated that the proposal would encourage 
quote competition, improve execution speed and quality, improve 
customer service, and provide additional competition to the primary 
market.
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    \31\ See Letters from: Harvey Cloyd, President, Harvey Cloyd & 
Co., dated April 27, 1999; Daniel Turner, President, Rubicon 
Securities, Inc., dated April 27, 1999; David Hultman, Vice 
President, D.A. Davidson & Co., dated May 6, 1999 (``Hultman/
Davidson letter''); Thomas Stephenson, received May 14, 1999; Walter 
Reinsdorf, D.A. Davidson & Co., dated May 20, 1999 (``Reinsdorf/
Davidson letter''); Arnold Staloff, President, Bloom Staloff, dated 
may 28, 1999; Ronald Melville, Ronald E. Melville, Inc., dated May 
25, 1999; Dennis LoPresti, Senior Vice President, Wedbush Morgan 
Securities, dated May 26, 1999; and David Gale, President, Delta 
Dividend Group, Inc., dated June 16, 1999.
    Four of the letters were virtually identical, stating that the 
proposal would encourage quote competition without interfering with 
specialists' efforts to achieve price improvement, would result in 
faster executions due to increased liquidity, and would allow the 
PCX to keep pressure on the primary market. See Wedbush Morgan 
letter, Melville letter, Bloom Staloff letter, Reinsdorf/Davidson 
letter. Other commenters emphasized that the proposal would promote 
the quality of executions. See Delta letter, Stephenson letter. 
Other commenters said that the proposal would allow specialists to 
provide improved service to customers and add depth to the national 
market system. See Hultman/Davidson letter, Rubicon letter, Cloyd 
letter.
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IV. Discussion

    After having carefully reviewed the proposal, the Commission finds 
that the proposed rule change is consistent with the requirements of 
Sections 6(b)(5) and 11A of the Act.\32\ Section 6(b)(5) requires, 
among other things, that the rules of an exchange be 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.\33\ Section 11A of the 
Act promotes, among other things, the development of a national market 
system for securities to assure economically efficient execution of 
securities transactions, and fair competition among brokers and 
dealers, among exchange markets, and markets other than exchange 
markets.\34\
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    \32\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \33\ 15 U.S.C. 78f(b)(5).
    \34\ 15 U.S.C. 78k-1.
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    The Commission finds that the proposal is consistent with those 
sections of the Act. The proposal has the potential to enhance 
competition and increase liquidity by permitting multiple specialists 
to compete for order flow on the Exchange, which may lead to enhanced 
opportunities for price improvement and improved services for 
customers.
    In 1996, the Commission granted permanent approval to the Boston 
Stock Exchange's (``BSE's'') competing specialist program.\35\ The 
BSE's program is similar to the PCX's proposal in that both programs 
permit multiple specialists to make markets in a security, and both 
programs restrict a specialist's ability to execute its designated 
order flow if customer orders have priority on the exchange's 
consolidated limit order book or if other specialists are quoting with 
time priority at the NBBO. The Commission approved the BSE competing 
specialist program on the grounds that the BSE's program was designed 
to improve market making and increase liquidity and competition on 
BSE's trading floor. The Commission also recognized that although the 
BSE program had the potential to increase internalization of orders, it 
was not necessarily inconsistent with a broker-dealer's duty to seek 
best execution of customer limit orders. The Commission emphasized, 
however, that broker-dealers could not

[[Page 31204]]

automatically route their order flow to an affiliated BSE specialist 
without engaging in a regular and rigorous evaluation of execution 
quality.
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    \35\ Securities Exchange Act Release No. 37045 (March 29, 1996), 
61 FR 15318 (April 5, 1996).
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    The Commission similarly finds that the PCX proposal has the 
potential to enhance competition consistent with Sections 6(b)(5) and 
11A of the Act. Permitting additional specialists to make markets in 
each stock on the PCX could potentially bring increased liquidity to 
the Exchange and could allow additional customer limit orders to 
benefit from the protections provided by the CLOB. Moreover, the PCX 
proposal's order routing provisions should give specialists an 
incentive to improve their quotations by providing that a specialist 
quoting with time priority at the NBBO would execute incoming orders 
unless the designated specialist retains the order by providing price 
improvement.\36\ Finally, allowing additional specialists to make 
markets on the PCX should also promote competition among PCX 
specialists in the rates of price improvement they provide, and in the 
quality of their limit order execution guarantees and other services.
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    \36\ The Commission finds that it is generally appropriate for 
the Exchange to route non-designated orders to a regular specialist, 
given that regular specialists have market making responsibilities 
not shared by the competing specialists. That provision is subject 
to the requirement that a specialist quoting with time priority at 
the NBBO has a right to execute incoming orders, regardless of which 
specialist was designated to receive the order, absent price 
improvement.
    The Commission notes that the Exchange has committed to 
implement systems changes, within eighteen months of the 
Commission's approval of this program, so that incoming orders will 
be automatically routed to the specialist with time priority at the 
NBBO.
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    The Commission reiterates that while an automated order routing 
environment is not necessarily inconsistent with the achievement of 
best execution, broker-dealers choosing where to automatically route 
orders must assess periodically the quality of competing markets to 
assure that order flow is directed to markets providing the most 
advantageous terms for their customers' orders. Thus, a broker-dealer 
may not simply employ default order routing to an affiliated PCX 
specialist without undertaking such an evaluation on an ongoing basis. 
A broker-dealer sending orders to the PCX must satisfy itself that its 
routing decision is consistent with its best execution obligations, 
irrespective of the firm's desire to internalize order flow through an 
affiliated PCX specialist. To reach this conclusion, the broker-dealer 
must rigorously and regularly examine the executions likely to be 
obtained for customer orders in the different markets trading the 
security, in addition to any other relevant considerations in routing 
customer orders.\37\
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    \37\ The Commission recognizes that the proposed competing 
specialist program has the potential to increase internalization. 
The Commission will monitor the impact of the competing specialist 
program as part of its ongoing review of market fragmentation. See 
Securities Exchange Act Release No. 42450 (February 23, 2000), 65 FR 
10577 (February 28, 2000).
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    Several other proposed rule changes govern the operations and 
responsibilities of competing specialists. The Commission finds that 
those proposed rules would promote fair and orderly markets by 
providing that competing specialists meet all requirements applicable 
to specialists on the exchange, that competing specialists follow all 
rules applicable to regular specialists (with certain exceptions), that 
competing specialists maintain barriers against the disclosure of 
information to affiliates, and that they cooperate with regular 
specialists during openings, suspensions, and reopenings of trading.
    The remaining proposed rule changes govern the qualifications and 
selection of competing specialists and the implementation of the 
competing specialist program. The Commission finds that those proposed 
rule changes set forth reasonable requirements that will permit the 
Exchange to implement the program in a fair and efficient manner. The 
proposed rule changes would permit the Exchange to evaluate 
applications to serve as competing specialist using factors that are 
relevant and appropriate (e.g., financial capability, adequacy of 
staffing, and performance evaluations) to the question of whether an 
applicant is capable of making a market in a stock and whether adding 
specialists to a stock will benefit the public.\38\ The proposed rules 
should also promote specialist continuity and minimize disruptions to 
the PCX market by restricting a firm's ability to repeatedly start and 
cease making markets as a competing specialist in a security. The 
proposed rules set forth a phase-in plan that should help the Exchange 
implement the competing specialist program with a minimum of disruption 
to existing operations.
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    \38\ The Commission expects that the Exchange will consider all 
permissible factors in assessing applicants and will not be unduly 
influenced by objections of the regular specialist in the issue. 
Indeed, the Exchange may not reject an application to be a competing 
specialist solely because of the objections of the regular 
specialist in the issue.
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    The Commission believes it is consistent with the Act to allow the 
PCX to implement its competing specialist program on a permanent basis. 
Nevertheless, Commission approval of the PCX's competing specialist 
program is not a determination by the Commission that mere default 
routing by a firm to its affiliated competing specialist is consistent 
with a firm's best execution obligations. As noted above, a broker-
dealer associated with a competing specialist must still ensure that 
its order routing decisions are consistent with its best execution 
obligations and assess periodically the quality of competing markets to 
assure that order flow is directed to markets providing the most 
advantageous terms for its customers' orders.
    The Commission finds good cause for approving Amendment No. 2 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. Amendment No. 2 renumbered several rules, made 
necessary technical changes to reflect the recent approved 
restructuring of PCX's equities trading, and clarified aspects of the 
proposed amendments to the Exchange's priority rules. The amendment 
eliminated a proposed commentary to the priority rules that provided 
for specialists to manually intervene with orders, because the 
commentary is unnecessary in light of P/COAST improvements that the 
Exchange is implementing. The amendment modified proposed competing 
specialist rules to state that all firms affiliated with specialists 
must send their PCX orders to that specialist (not just firms 
affiliated with competing specialists). The amendment also clarified 
that firms whose applications to serve as competing specialists are 
denied would have the right of appeal. Finally, Amendment No. 2 sets 
forth the Exchange's commitment to reprogram the P/COAST system within 
eighteen months of the competing specialist program's approval, so that 
the P/COAST system would route incoming orders directly to a specialist 
who is quoting at the NBBO with time priority. Those modifications were 
clarifying in nature and did not change the substance of the Exchange's 
proposal, as it was published in the Notice.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2, including whether it 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

[[Page 31205]]

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. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
Exchange. All submissions should refer to File No. SR-PCX-99-07 and 
should be submitted by June 6, 2000.

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change SR-PCX-99-07, including Amendment No. 2, 
is approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\39\
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    \39\ See 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-12272 Filed 5-15-00; 8:45 am]
BILLING CODE 8010-01-M