[Federal Register Volume 66, Number 128 (Tuesday, July 3, 2001)]
[Notices]
[Pages 35293-35301]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-16672]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44476; File No. SR-BSE-2001-01]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Boston Stock Exchange, Inc. 
Relating to the Trading of Nasdaq Securities on the Floor of the 
Exchange

June 26, 2001.
    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 May 15, 2001, the Boston Stock Exchange, Inc. (``BSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the 
Exchange. On June 15, 2001, the Exchange submitted Amendment No. 1 to 
the proposed rule change.\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 Form 19b-4 dated June 14, 2001 (``Amendment No. 1'').

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[[Page 35294]]

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange seeks to add Chapter XXXV, Trading in Nasdaq 
Securities, to the Rules of the Board of Governors of the Boston Stock 
Exchange (``BSE Rules''). The proposed chapter sets forth rules 
governing the trading of Nasdaq securities on the Exchange. The text of 
the proposed rule change follows in italics.

Chapter XXXV

Trading in Nasdaq Securities

    All of the Rules, Policies, and Procedures, set forth in the Rules 
of the Board of Governors of the Boston Stock Exchange (``Boston Stock 
Exchange Rules''), and elsewhere, shall apply to the trading Nasdaq 
securities in the same way as they do to the trading of non-Nasdaq 
securities, with the addition of the rules set forth in this Chapter 
XXXV, detailed below.

Definitions

    Sec. 1. (a) ``Nasdaq security''--any security listed on the Nasdaq 
National Market or Nasdaq Small Cap Market.
    (b) ``Nasdaq System''--the NASD's Automated Quotation System.
    (c) ``listed security''--a stock or bond, other than a Nasdaq 
security, that has been accepted for trading by the Boston Stock 
Exchange, or any of the other registered securities exchanges in the 
United States.

Order Transmission

    Sec. 2. (a)(i) Each Exchange specialist shall provide direct 
telephone access to the specialist post to Nasdaq System market makers, 
acting in their capacity as market makers, for each Nasdaq security in 
which the market maker is registered as a market maker. Access shall 
include appropriate procedures which assure the timely response to 
telephonic communications. Nasdaq System market makers may use such 
telephone access to transmit orders for execution on the Exchange.
    Any order received on the floor via telephone from a Nasdaq System 
market maker shall be effected in accordance with the rules applicable 
to the making of bids, offers and transactions on the Floor (see 
Chapter II, Dealings on the Exchange, Chapter XV, Specialists). All 
limit orders shall be immediately displayed upon receipt, in accordance 
with Chapter II, Dealings on the Exchange, Section 40, Limit Order 
Display Rule.
    (ii) Exchange specialists may send orders from the Floor for 
execution via telephone to any Nasdaq System market maker in each 
Nasdaq security in which it is registered as specialist. All of the 
Boston Stock Exchange Rules related to the trading of securities shall 
be applicable to bids and offers transmitted via telephone, in the same 
way as they apply to orders transmitted via automated trading systems.
    (iii) Comparisons of transactions effected with a Nasdaq System 
market maker via telephone access will be made pursuant to procedures 
to be established between Nasdaq and the Exchange.
    (b) Orders may be transmitted to a specialist via Nasdaq 
Workstation II (``NWII'') at the election of a Nasdaq market maker 
originating the order. Orders transmitted through NWII may be executed 
by the system automatically or on a manual basis in accordance with the 
provisions of this Chapter XXXV.
    (c) Specialists will have ``Level 3 Service,'' as defined by the 
Nasdaq Unlisted Trading Privileges Plan, on the Nasdaq System. As such, 
specialists will have input and query ability with respect to 
quotations and sizes in securities included in the Nasdaq System. 
Access to the specialist via the Nasdaq System will be limited to floor 
brokers, BSE members, NASD members, NAS non-BSE members (including 
Electronic Communications Networks), and certain other member firms and 
other professionals represented by member firms (``clients''). Clients 
may have access to enter orders to the specialist either 
electronically, through the Nasdaq System, or telephonically. Any order 
received by the specialist telephonically, or verbally in any manner 
other than electronically through the Nasdaq System must be 
memorialized in accordance with Chapter II, Dealings on the Exchange, 
Section 2, Recording of Sales, and Section 15, Record of Orders from 
Offices to Floor.
    (d) Access to the specialist via the Nasdaq System, or electronic 
access, includes
    (i) orders sent by clients through Nasdaq's ACES Pass Thru 
capability (which consolidates orders sent by various client systems to 
the Nasdaq System); \4\
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    \4\ The Commission notes that Amendment No. 1 contained an 
incorrect reference, which BSE intends to correct in a future 
amendment to the proposed rule change.
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    (ii) orders sent by BSE floor brokers directly through the BSE 
Nasdaq trading system (currently Nasdaq Tools); \5\
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    \5\ Id.
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    (iii) orders sent by clients directly into the Nasdaq System and 
routed to the specialist; and,
    (iv) orders sent by Nasdaq and NASD Market Makers through the 
Nasdaq System.

Reporting of Transactions

    Sec. 3. All transactions in Nasdaq securities shall be reported 
through the Automated Confirmation Transaction Reporting Service 
(``ACT''), in accordance with NASD Rule 4630, et. seq., unless other 
arrangements are made with, and approved by, the Exchange. Any 
transaction for which electronic submission into ACT is not possible 
must be reported to the NASD's Market Regulation Department on Form T 
as specified in paragraph (a)(5) of NASD Rule 4632.\6\
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    \6\ Id.
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Trading

    Sec. 4. (a) Automatic Execution of Nasdaq orders. If the specialist 
is quoting at the National Best Bid or Offer (``NBBO'') at the time a 
market or marketable limit order is received, the order shall 
automatically be filled at the NBBO up to the size of the specialist's 
bid or offer. The specialist's bid or offer will be decrementated by 
the size of the execution. In the event that the specialist's bid or 
offer is exhausted, the system will generate a quote at an increment 
away from the NBBO as determined by the specialist from time to time, 
for 100 shares. If the specialist is not quoting at the NBBO at the 
time a market or marketable limit order is received, such order shall 
be automatically filled at the NBBO up to the size of the auto-
execution threshold if the specialist has not, within 20 seconds after 
receipt of the order, complied with the manual execution requirement 
detailed below. The automatic-execution guarantee only applies to 
orders which are equal to or less than the size of the auto-execution 
parameter.
    (b) In Nasdaq securities, the auto-execution parameter must be set 
at 300 shares or greater. For the purposes of this rule, odd-lot orders 
will be considered to be round lot orders for the purposes of rounding 
up to the size of the auto-execution guarantee parameter. An odd-lot 
order shall not increase the size of the execution guarantee to an 
amount greater than the auto-execution parameter. Rather an odd lot 
order would be added to any round lots less than the size of the auto-
execution parameter and the execution guarantee would apply only to 
that number of shares, which would be less than or equal to, but in no 
case greater than, the size of the auto-execution guarantee.

[[Page 35295]]

    (c) In unusual trading situations, specialists may switch from 
automatic execution to manual execution mode. ``Manual execution mode'' 
shall include any instance in which a specialist reduces the auto 
execution threshold below the minimum set forth in paragraph (b) of 
this section 4. For the purposes of this rule, ``unusual trading 
situations'' for Nasdaq securities include the existence of large order 
imbalances or significant price volatility. If a specialist elects to 
switch to manual execution mode based on the existence of unusual 
trading situations, the specialist must (1) document the basis for 
election of a manual execution mode; and (2) in the event that the 
specialist remains in manual execution mode for more than ten minutes, 
seek relief from the requirements of this section 4 from two floor 
officials.
    All automatic execution parameters and practices shall be in 
accordance with NASD Rule IM-2110-02, Trading Ahead of Customer Limit 
Orders, and NASD Rule IM-2110-3, Front Running Policy.
    Sec. 5. Manual Execution of Nasdaq securities. With respect to 
agency market or marketable limit orders in Nasdaq securities which 
have a size equal to or less than the auto execution threshold but 
which are not auto-executed under the provisions of this Chapter, a 
specialist shall be obligated to either (i) manually execute such 
orders at the NBBO in existence when the order is received or better, 
or (ii) act as agent for such orders in seeking to obtain the best 
available price for such orders on a marketplace other than the 
Exchange.

Preopenings/Trading Halts

    Sec. 6. Pre-opening orders in Nasdaq securities must be accepted 
and filled at the Exchange opening trade price. In trading halt 
situations, orders will be executed based on the Exchange reopening 
price. (Note: In the case of a trading halt in a Nasdaq security, 
notice will be provided via the Nasdaq ``NEWS'' frame, in accordance 
with NASD Rule 4120.)

Orders To Buy and Sell the Same Security

    Sec. 7. Pursuant to Chapter II, Section 18, Orders to Buy and Sell 
the Same Security, for cross transactions in Nasdaq securities,\7\ a 
specialist must refrain from interfering at the cross price with an 
agency cross which is to be effected at a price between the 
disseminated Exchange market, unless the specialist is willing to 
better one side of the cross.
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    \7\ Id.
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    When a member has an order to buy and an order to sell an 
equivalent amount of the same security, and both orders are for 5,000 
shares or more and are for accounts other than the accounts of the 
executing member, the member may cross such orders at a price which is 
at or within the prevailing bid or offer. The member's bid or offer 
shall be entitled to priority at such cross price, provided that the 
proposed cross transaction is of a size greater than the aggregate size 
of all of the interest communicated on the Exchange floor at that 
price. Another member may trade with either the bid or offer side of 
the presented cross transaction only to provide a price which is better 
than the cross price as to all or part of such bid or offer. A member 
who is providing a better price to one side of the cross transaction 
must trade with all other market interest having priority at that price 
before trading with any part of the cross transaction.

Dealings on Floor--Hours

    Sec. 8. Pursuant to Chapter I-B, Sec. 2, Dealings on the Floor--
Hours, no member or member organization shall make any bid, offer or 
transaction upon the floor of the Exchange, issue a commitment to trade 
through ITS or send an order for a Nasdaq security to a Nasdaq System 
market maker other than during the hours the Exchange is open for the 
transaction of business. Nasdaq securities will not be eligible to 
participate in the Post Primary Session.

Order Acceptance Guarantee

    Sec. 9. An Order Acceptance Guarantee shall be available to each 
member firm in all Nasdaq securities traded on the Exchange. 
Specialists must accept all agency market and marketable limit orders 
in Nasdaq securities up to and including 1000 shares in accordance with 
this rule. Specialists must accept all agency non-marketable limit 
orders in Nasdaq securities up to and including 10,000 shares for 
placement in the limit order book.
    An Exchange specialist in a Nasdaq security shall only be obligated 
to guarantee execution on the first agency market order placed with him 
by a Floor broker or other Floor member, at any given best bid or 
offer. Subsequent to any such execution, the specialist may, but shall 
not be obligated to, guarantee the execution of such price of other 
orders placed with him.

Specialist's Responsibilities

    Sec. 10. (a) Orderly Markets. In accordance with the 
responsibilities of specialists, as set forth in Chapter XV, 
Specialists, Sec. 2., Responsibilities, in relation to Nasdaq 
securities, an ``orderly market'' is defined as one with regularity and 
reliability of operation manifested by the presence of price continuity 
and depth exhibited by the avoidance of large and unreasonable price 
variations between consecutive sales on the Nasdaq system and the 
avoidance of overall price movements without appropriate accompanying 
volume.
    A specialist in a Nasdaq security is responsible for insuring that 
each opening and reopening price in respect to Nasdaq securities 
reflects a professional assessment of market conditions at the time 
with due consideration being given to the balance of supply and demand 
as reflected by public orders. Additionally, the specialist should 
insure that the opening is not unduly hasty, particularly when at a 
price disparity from the previous close, and that the price reflects a 
thorough and professional assessment of market conditions at the time.
    (b) Best Execution. Specialists dealing in Nasdaq securities shall 
use diligence to ascertain the best market for a particular security 
and provide the customer with a price which is as favorable as possible 
under the prevailing market conditions. Furthermore, no specialist 
shall interject a third party between himself and the best available 
market unless he can demonstrate that the total costs of the resultant 
transactions was better that the prevailing inter-dealer market for the 
security.

Registration of Specialists

    Sec. 11. Specialists who wish to trade Nasdaq securities must be 
registered and qualified by the Exchange. As such, they must first make 
application to and be approved by the Exchange. In addition, and in 
accordance with the requirements set forth in Chapter XV, Specialists; 
Chapter XX, Employees for the Solicitation of Business; Chapter XXV, 
Registration of Member-Corporations; and elsewhere, specialists who 
trade Nasdaq securities will be required to:
    (1) Be associated with an existing or newly created specialist unit 
approved by the Exchange, in accordance with all applicable rules, 
policies and procedures; and,
    (2) Successfully complete the Boston Stock Exchange Floor Exam, 
including

[[Page 35296]]

the sections regarding Nasdaq trading; and,
    (3) Obtain a Series 63, NASAA Uniform State Law Exam, license; and,
    (4) If conducting business with the public, obtain a Series 7, 
General Securities Representtive, license under the sponsorship of a 
NASD registered Broker-Dealer; and,
    (5) Complete a training period as deemed adequate by the Market 
Performance Committee; and,
    (6) Ensure that the specialist unit with which he is associated 
meets all of the Exchange's financial requirements, as set forth in 
Chapter VII, Minimum Amount of Margin on Transactions Made During the 
Course of a Single Day in Accounts of Members, Allied-Members and 
Member-Organizations, Chapter IX, Unissued Securities--Margin 
Requirements, Chapter XXII, Financial Reports and Requirements--
Aggregate Indebtedness--Net Capital, Chapter XXII-A, Blanket and 
Fidelity Bonds, and elsewhere.

Limitations on Specialists

    Sec. 12. Any individual member who is registered as a specialist is 
not permitted to maintain a book, as defined in Chapter XV, 
Specialists, Section 6, The Specialist's Book, in both Nasdaq 
securities and listed securities. Nasdaq securities must comprise a 
separate book which must be solely traded by a separate specialist. A 
specialist who is qualified under the provisions of this Chapter XXXV, 
and the provisions of Chapter XV, Specialists, Section 1, Registration, 
to trade either listed or Nasdaq securities, or both, cannot accept 
orders in, nor effect transactions in, both types of securities, at the 
same time.
    Nothing in this section shall preclude any duly qualified 
specialist from occasionally substituting for, or acting as an 
alternate for, another specialist in either listed or Nasdaq 
securities, in accordance with Article XVI of the Constitution of the 
Boston Stock Exchange, Officers and Associates, Section 7, Alternatives 
for Members Absent. A specialist substituting for another specialist in 
accordance with the provisions of this section will be permitted to 
trade both Nasdaq and listed securities at the same time, during the 
period of substitution. In the case of an extended or permanent absence 
of a specialist qualified to trade Nasdaq securities, the firm from 
which the specialist is absent must promptly notify the Exchange and 
make arrangements to permanently replace the absent specialist in a 
reasonable amount of time, as determined by the Exchange. The Exchange 
reserves the right to temporarily reassign some or all of the Nasdaq 
securities comprising an absent specialist's book in the event that a 
firm does not make suitable or timely arrangements for the replacement 
of the absent specialist.

Floor Clerks

    Sec. 13. A qualified clerk under the control and supervision of a 
specialist may assist the specialist, in accordance with Chapter I-B, 
Section 3, Dealings on Floor--Persons.

Odd-Lots and Odd-Lot Dealers

    Sec. 14. Notwithstanding any of the requirements regarding Odd-Lots 
and Odd-Lot dealers set forth in Chapter XII, Odd-lot Dealers in 
Securities the Primary Market for Which is on Another Exchange, Chapter 
XIII, Odd-Lot Dealers in Fully Listed Securities Having a Primary 
Market on this Exchange, Chapter II, Dealings on the Exchange, Chapter 
V, Units of Delivery--Payment for Deliveries--Transfers, a member or 
member organization registered as a specialist in a Nasdaq security 
shall automatically be registered as the Odd-Lot Dealer in such 
security. Market orders will be accepted for execution as an odd-lot 
based on the best bid disseminated pursuant to SEC Rule 11Ac1-1 on a 
sell order, or the best offer disseminated pursuant to SEC Rule 11Ac1-1 
on a buy order in effect at the time the order is presented at the 
specialist post, provided the order is for a number of shares less than 
full lot in said stock.

Synchronization of Business Clocks

    Sec. 15. In accordance with NASD Rule 6953, each specialist trading 
Nasdaq securities shall synchronize his business clocks with a time 
source as specified by Nasdaq.

Capital and Equity Requirements

    Sec. 16. Pursuant to Chapter XXII, Financial Reports and 
Requirements--Aggregate Indebtedness--Net Capital, Section 2, Capital 
and Equity Requirements, each member firm involved in the trading of 
Nasdaq securities shall maintain a liquidating equity for each 
specialist account of not less than $200,000 in cash or securities. 
This equity requirement, as well as all other provisions of the section 
(including capital maintenance requirements), applies to each 
specialist account, without regard to the number of specialist accounts 
per firm.

Margin Procedures

    Sec. 17. The Boston Stock Exchange Clearing Corporation will 
provide margin financing for approved specialists dealing in Nasdaq 
securities, subject to the requirements and guidelines set forth in 
Chapter VIII, Minimum Amount of Margin on Transactions Made During the 
Course of a Single Day in Accounts of Members, Allied-Members, and 
Member-Organizations. For the purposes of this rule, transactions in 
Nasdaq securities will be considered to have been effected on the 
Boston Stock Exchange, and Nasdaq securities will be considered to be 
classified as stocks.

Limitations on Trading Nasdaq Securities

    Sec. 18. (a) Minimum Number of Nasdaq securities. The first 
specialist in a firm will be required to register in and trade at least 
20 Nasdaq securities. A specialist associated with a member firm, and 
associated with another specialist registered in the minimum number of 
BSE traded stocks shall register and act as specialist in not less than 
15 Nasdaq securities.
    (b) Minimum Holding Period for Nasdaq securities. Any stock awarded 
or assigned to a specialist must be held by the specialist for at least 
6 months (excluding unprotected allocations), and the specialist is 
required to actively trade and maintain a market in each security in 
which he is registered.

Application Procedure

    Sec . 19. Specialists are required to apply for registration in 
Nasdaq securities by utilizing either the UTP Form or the Add/Drop 
Form, depending on the status of the security being applied for. The 
allocation process will take place as specified elsewhere in this 
chapter.
    Consistent with general Exchange stock allocation procedures, a 
specialist who first requests registration in an established Nasdaq 
security will generally be allocated that security, except where the 
performance of the specialist has been called into question. In that 
event, the Stock Allocation Committee may elect to competitively 
allocate that security.

New Listing or New UTP

    Sec. 20. A specialist may apply to trade a newly admitted Nasdaq 
security, pursuant to the Nasdaq UTP plan (which permits trading of UTP 
admitted securities) as well as those newly dually listed. Such 
application will be subject to the allocation process.

Allocation of Nasdaq Securities

    Sec. 21. The following procedures regarding the initial allocation 
of Nasdaq securities are designed to ensure an equitable representation 
of

[[Page 35297]]

member support of Nasdaq securities trading on the Boston Stock 
Exchange. They are structured so as to protect the firms who have 
established Nasdaq operations on the floor of the Exchange, while at 
the same time providing an opportunity for new interest and growth of 
this program in the foreseeable future from firms seeking to trade 
Nasdaq securities on the Exchange through meaningful stock allocations. 
Priority for admittance will be based on the date that the new firm 
becomes qualified to trade Nasdaq securities on the Exchange, as 
determined by Exchange staff. These procedures will remain in place for 
a two-year maturation period, following approval and commencement of 
trading. At the conclusion of this period, the Exchange will review the 
process and establish permanent Nasdaq security allocation procedures.
    It should be understood that the registration rights to any Nasdaq 
securities awarded under this program through the allocation process 
may be transferred, rescinded or withdrawn by the Exchange. The initial 
two-year maturation period, by design, may entail the reallocation of 
an ``unprotected'' security. Further, any such specialist unit must 
continuously maintain fair and equitable markets in all issues assigned 
to it and may not for any reason transfer, sell or otherwise shift the 
benefit or responsibilities for trading securities awarded to it to 
another member firm. The Exchange will promptly initiate steps to 
reassign such trading privileges as deemed necessary if such 
circumstances arise. A minimum six-month holding period will be 
strictly enforced. The intent of this program is to establish 
competitive and liquid markets through solid support and a sustained 
commitment by its members.

    Note: A firm may swap allocated stocks, with other existing and 
established BSE Nasdaq trading participants, in accordance with 
Section 25 of this Chapter XXXV. Further, in limited and exceptional 
circumstances, a member firm may petition the Executive Committee of 
the Exchange for permission to sell or otherwise transfer its Nasdaq 
trading privileges to another member firm prior to the end of the 
mandated six-month holding period. The responsibility to provide 
sufficient and justifiable reasons to seek such approval will be on 
the member firm registrant and must overcome the intent of this 
allocation process for a sustained commitment by such member. 
(Factors will include length of time trading, number of issues in 
each category and whether the proposed transferee is a new 
applicant.) The Executive Committee will evaluate any such request 
on its merits, and will ultimately base its decision on its 
determination of whether such a transfer is in the best interests of 
the Exchange.* The Executive Committee's decision in such a case 
shall be final.

    *Under certain circumstances, the Exchange (Executive Committee 
or its designated representative) may temporarily reassign some or 
all of the securities in question until an acceptable arrangement 
can be reached.

Allocation Procedures

    Any member firm currently trading listed securities on the Exchange 
may apply for Nasdaq trading privileges, but may not drop listed 
securities in order to seek allocation of Nasdaq securities. The 
Exchange's goal is to establish a new product, which will expand the 
number of stocks available for execution on the BSE, rather than to 
replace or substitute its current market for listed securities.
    The following procedures pertaining to the allocation of Nasdaq 
securities apply on a member firm basis, regardless of the number of 
specialists trading Nasdaq securities within a particular firm. The 
minimum number of stocks per book pursuant to this Chapter XXXV, Sec 
18, will be 20 for the first specialist in a member firm and 15 for 
subsequent specialists in that same member firm. The initial allocation 
of Nasdaq securities will be limited to those member firms approved by 
the Exchange as of commencement date, and will be limited to those 
firms for the first 30 days.
    Following this initial allocation, other firms may apply for Nasdaq 
securities, provided that they have met all of the requirements and 
have been approved by the Exchange to trade Nasdaq securities, as set 
forth in this Chapter XXXV, and elsewhere. The procedures for the 
allocation of Nasdaq securities will be based in part on the trading 
volume in Nasdaq securities and are as follows:

    Note: The determination of which securities fall within the 
categories below (i.e., the top 100, top 300, etc.) will be based on 
the ranking on Nasdaq securities by the National Association of 
Securities Dealers, and published on the appropriate Nasdaq website 
as of the end of the preceding calendar quarter.

    After the initial 30-day period, commencing on a date the Exchange 
specifies as the official start date of the trading of Nasdaq 
securities on the floor of the Exchange (``start date''), other 
qualified firms may apply for allocation of Nasdaq securities from the 
pool of unallocated securities. After an ensuing 30-day period (i.e. 60 
days from the start date), each firm who is actively trading Nasdaq 
securities at the time a new firm applies for allocation (``existing 
firm'') of Nasdaq securities may protect (``freeze'') securities 
registered to it within the rankings noted below and at the times as 
specified below. The remaining (``unprotected'') securities that the 
firm is trading will be available for re-allocation to a new firm 
(including any new firms which commenced trading 30 days after the 
start date), although no new firm may take more than 30% from within 
each of the four rankings of any one existing firm's (``unprotected'') 
securities available for allocation. Thus, existing firms will not have 
their entire inventory, above the securities it has frozen, subject to 
reallocation at any one time, by any one firm. Notwithstanding this 30% 
provision, a new firm may seek reallocation of the at least one 
uprotected secrity for an existing firm, if 30% of the existing 
unprotected securities is less than one, and provided that the number 
of unprotected securities exceeds the freeze limits as set forth below. 
An existing firm will be able to freeze securities each time a new firm 
applies for allocation during the first six months of Nasdaq trading, 
according to the following restrictions:

Category 1--10 securities of the top 100
Category 2--20 securities from those rated 101-300
Category 3--20 securities from those rated 301-500
Category 4--20 securities from those rated 501 and above

    Note: After the initial allocation of securities to those firms 
which are initially participating in the trading of Nasdaq 
securities, the Exchange reserves the right to reallocate any number 
of securities above 25 per firm which the firm has been initially 
allocated from the top 100 ranked securities, if it determines that 
it is in the best interest of the Exchange and the overall Nasdaq 
program.

    As an example, assume four firms initially apply for, and receive 
allocations as follows:

------------------------------------------------------------------------
                  Category                      1      2      3      4
------------------------------------------------------------------------
Firm A......................................     25     25     25     25
Firm B......................................     20     25     20     20
Firm C......................................     25     20     20     20
Firm D......................................     25     50    100      0
------------------------------------------------------------------------

    If Firm E applies for allocations during this initial six month 
period, Firm A can freeze 10 of the securities it has been allocated 
from the top 100 and 20 from each of the three remaining categories. 
Thus 15 securities from category 1, and 5 securities from categories 2, 
3, and 4 would be available to Firm E. However, due to the 30% 
restriction, only 5 securities (30%  x  15 unprotected) from category 1 
and 2 securities from categories 2, 3, and 4 could be reallocated from 
Firm A.

[[Page 35298]]

    Firm B would be able to freeze 10 of the 20 securities which it had 
been allocated from the top 100, although only 3 of the unprotected 
securities could be reallocated to Firm E. Likewise, Firm B would be 
able to freeze 20 of the securities which it had been allocated from 
category 2, and could lose up to 30%, or 2 securities from category 2 
to Firm E. Categories 3 and 4 would be protected.
    Firm C would be able to freeze all of the securities it has been 
allocated in categories 2, 3, and 4 but could lose 5 of the 15 
unprotected securities in category 1.
    Firm D would be able to freeze 10 of the securities it has been 
allocated from the top 100 (category 1). 30% of 30, or 9 securities, 
would be available from category 2, and 24 securities from category 3 
would be available.

    Note: Firm E, and any subsequent new firms applying for 
allocation, can not exceed the same restriction levels as set forth 
above (i.e., 10 of the top 100 or 20 from categories 2, 3, or 4) in 
total from the composite of issues drafted from the allocated but 
unprotected portions of existing Nasdaq books. It could however, 
request additional allocation from the remaining ``unallocated'' 
issues in any category. The 
intent here is to maintain an equitable distribution of protected 
stocks among the participants during this initial period of 
reallocations to new firms.

    Now, assume Firm G is approved and applies for allocation one month 
after Firm E. Firms A through E would all be subject to reallocation 
under the same guidelines as above. Firms A-E would not be exempt from 
any future allocations, but would be able to freeze the prescribed 
amount of securities each time a new firm applies for allocation. Firm 
G, likewise, is subject to future allocations under the same 
guidelines.

    Note: In the event an existing firm seeks additional allocations 
at any point during the two-year maturation period, notice will 
automatically be given to all other existing firms of the allocation 
request, allowing the other existing firms the opportunity to 
compete for allocation in the requested securities, within a 
prescribed time frame. The intent of this provision is to ensure 
fairness to all firms during maturation and evaluation stages of the 
Nasdaq stock allocation process. Additionally, no existing firm will 
be permitted to seek reallocation of unprotected securities from any 
other existing firm(s).

    After the first six months from commencement of trading, and at 
each six-month anniversary interval through the remainder of the two-
year maturation period, firms will be able to freeze an additional 
number of securities, as established by the Exchange, within each 
category. As the example below indicates these additional protective 
limits will depend upon the remaining number of unprotected securities 
available in each category.

Category 1--3 additional securities within the top 100
Category 2--6 additional securities from those rated 101-300
Category 3--6 additional securities from those rated 301-500
Category 4--6 additional securities from those rated 501 and above

    In certain, limited circumstances, an existing specialist may 
object to the re-allocation of a particular unprotected security or 
securities. In such a case, both the existing firm and the new firm 
will be asked to present to the Market Performance Committee (``MPC'') 
their reasons for objecting to or supporting the allocation request. 
Existing firms will not be permitted to make blanket objections to 
having their unprotected securities reallocated, and they will be 
required to set forth tangible rationale justifying their objections. 
Likewise, new firms must justify their allocation requests. The firms 
will be allowed to present any documentation, testimonials or other 
relevant evidence supporting their position which they feel would 
benefit the MPC in their determination of whether the security[ies] in 
question should be allocated as requested, including, but not limited 
to, reasons based on market quality, payment for order flow, customer 
relationships, or other factors considered to be in the best interests 
of the Exchange's markets. The MPC will, based on the presentations and 
evidence, ultimately decide whether or not a particular security[ies] 
should be allocated to the new firm. The decision of the MPC can be 
appealed to the Board of Governors of the Exchange, whose decision 
shall be final. During the allocation request period, and any 
subsequent periods of committee deliberations and/or appeals, the 
security[ies] in question shall remain in the control of, and actively 
traded by, the existing firm.
    The Exchange may limit the frequency and dates for allocation to 
additional participants in order to evaluate the impact of 
reallocations during this two-year maturation period. Although more 
than one new firm may be approved to begin trading Nasdaq securities on 
the floor of the Exchange at the same time, the first firm to be 
approved, chronologically, will be the first allowed to seek 
reallocation of securities from existing forms. Any such reallocation 
which may take place will result in new compositions of existing firm's 
books. Subsequently approved new firms may seek reallocations from the 
newly composed books of the existing firms. In this way, existing firms 
are further protected from the possible burden of contemporaneous 
reallocations. The Exchange will monitor the effectiveness of the 
program in order to ensure that no disruption of markets will result 
from frequent reallocations among member firm specialists, and reserves 
the right to alter this stock allocation process at any time.
    Finally, in the event that the number of protected securities 
(i.e., 10 firms with 10 each in the top 100) matches the limit within a 
particular category prior to the two year maturation period, the 
Exchange may re-evaluate those remaining securities unprotected to 
provide some form of meaningful competitive allocation process to 
ensure continued growth of this program. Following the two-year period 
the Exchange will examine its overall program to ensure competitive 
quality markets are maintained. All allocations regardless of the class 
or category of registration are subject to review by the Exchange 
pursuant to its Specialist Performance Evaluation Program (``SPEP'').

Criteria for Stock Allocation Committee To Consider During Nasdaq 
Security Allocation

    Sec. 22. In considering the allocation of Nasdaq securities, the 
Stock Allocation Committee shall consider the following factors, among 
other, giving proper weight to each of these measures as it sees fit, 
while maintaining consistency with previous decisions:

 Specialist Performance (SPEP)
 Specialist experience generally
 Specialist experience trading Nasdaq securities
 Specialist contributions to the market quality of the Boston 
Stock Exchange
 Specialist's reputation as to quality to executions
 Length of time elapsed since last allocation to specialist
 ``Quality'' of Nasdaq securities in specialist's book, in 
terms of volume, liquidity and volatility
 Specialist's reasons for seeking to trade the security, as set 
forth in his application and/or supplemental materials
 Documented marketing concerns of specialists form, e.g., order 
flow arrangements which are contingent on the retention of certain 
securities
 Market Quality criteria as set forth under the requirements of 
SEC Rules 11Ac1-5 and 11Ac1-6

[[Page 35299]]

Change in Listing Status of Nasdaq Security

    Sec. 23. (a) If a company which has its security solely registered 
as a Nasdaq security transfers to become an exchange listed security, 
or in the event of a merger of a Nasdaq security company with a listed 
security company whereby the listed company is the ``survivor'' of the 
merger, the firm whose specialist was registered in the Nasdaq security 
shall be given preference to register to trade the listed security 
(subject to acceptable performance), provided that:
    (1) the firm is eligible to trade, and currently registered in at 
least the minimum number of, as well as involved in the trading of, 
listed securities on the Exchange;
    (2) no other member firm is currently registered in and trading the 
listed security of the surviving company. If another member firm is 
currently registered in the surviving company's listed security, that 
member firm will be allowed to continue to trade the security, whether 
registered as a primary or a competing specialist. The firm who 
originally traded the Nasdaq security of the company which was not a 
survivor of a merger, or which transferred its status and became an 
exchange listed security, will be eligible to apply as a competing 
specialist in that security, provided that all of the other 
requirements related to the trading of listed securities on the floor 
of the Exchange are met.
    (b) In the event that a company changes its status from a listed 
security to become registered as a Nasdaq security, allocation 
preference will be provided to the firm which traded the listed 
security prior to its status change, provided that the firm is eligible 
to trade, and engaged in the trading of, Nasdaq securities. If the firm 
is not eligible to trade the newly registered Nasdaq security, the 
security's allocation will be subject to standard allocation procedures 
as outlined in this section, including, if necessary, deliberation and 
determination of allocation by the Stock Allocation Committee.

Merger of Two Nasdaq Securities

    Sec. 24. In the event of a merger of two companies whose securities 
are both registered as Nasdaq securities, with the resultant company's 
security remaining registered as a Nasdaq security, the surviving 
company's security shall be subject to Exchange allocation procedures 
governing such actions. As such, if two separate member firms are 
registered in the separate Nasdaq securities prior to the merger, the 
allocation of the resultant security shall be subject to the following:
    (1) If the surviving company remains in control of the newly formed 
or merged company, as determined by Exchange staff, the member firm, 
which was originally registered in the security of the surviving 
company, shall retain that security.
    (2) If Exchange staff cannot determine the control of the surviving 
company, the Stock Allocation Committee, taking all relevant factors 
into consideration, shall determine the allocation of the security of 
the surviving company.

Swapping Stocks

    Sec. 25. Specialists shall be permitted to swap stocks on an ``as 
requested'' basis, subject to the following:
    (1) Specialists who are interested in swapping stocks with another 
specialist are responsible for initiating and engaging in negotiations 
to arrange for the swap.
    (2) Swapping of stocks must take place between two separate 
specialist firms.
    (3) Specialists, may swap up to three stocks every six months, and 
must retain any swapped stocks for at least six months.
    (4) Swapping for the intention of circumventing assignment, 
reassignment or any other procedures regarding Nasdaq securities is 
strictly forbidden.
    (5) All swap arrangements must be submitted to the MPC for review, 
on the Stock Swap Agreement form.
    (6) Repetitive stock swaps between two or more firms, or otherwise, 
for stock retention or any other purpose, are forbidden.

Specialist Request to Deregister in a Nasdaq Security

    Sec. 26. Generally, a specialist will be permitted to drop an 
allocated Nasdaq security, provided that a period of at least six 
months has elapsed since the original assignment. If a specialist is 
approved for deregistration in a Nasdaq security, the effective date of 
the deregistration will be no earlier than 5 days after notice is 
provided to all order sending firms and other floor specialists 
registered to trade Nasdaq securities that the specialist is 
deregistering in such security.

Disciplinary Action

    Sec. 27. As detailed in Chapter XV, Dealer Specialists, Section 17, 
Specialist Performance Evaluation Program, one possible sanction in the 
Exchange's disciplinary system regarding poor performance of 
specialists is the temporary or permanent cancellation of a 
specialist's registration in one or more securities. Should this occur, 
the MPC will temporarily assign the security[ies] affected to another 
specialist. If the disciplinary action is, or becomes, permanent, the 
security[ies] will be available for assignment under the current stock 
allocation procedures.

Short Sales

    Sec. 28. No specialist shall effect a short sale for the account of 
a customer or for his own account in a Nasdaq security at or below the 
current best (inside) bid when the current best (inside) bid is below 
the preceding best (inside) bid in the security.
    The provisions of this rule shall not apply to short sales by 
specialists that are in furtherance of the specialist's bona fide 
market making activities. Bona fide market making activity does not 
include activity that is unrelated to market making functions, such as 
index arbitrage and risk arbitrage that is independent from a member's 
market making functions. In the event that a short sale does occur 
pursuant to this bona fide market making exception, the burden is on 
the specialist to show that such sale was in furtherance of their bona 
fide market making activities. 

Discussion

    Any activity by a specialist which is designed to circumvent this 
Short Sale rule through indirect actions, such as executions with other 
specialists or the facilitation of customer orders while being 
protected from loss are antithetical to the purposes of this rule, as 
are any manipulative type actions. For example, it would be considered 
a manipulative act, and in violation of this rule if either of the 
following occurred:
    (1) A specialist alone at the inside best bid lowered its bid and 
then raised it to create an ``up-bid'' for the purpose of facilitating 
a short sale.
    (2) A specialist with a long position raised its bid above the 
inside bid and then lowered it to create a ``down-bid'' for the purpose 
of precluding other market participants from selling short.
    (3) a specialist agrees with another specialist or a customer to 
raise its bid in order to effect a short sale for the other party and 
is protected against loss on the trade or any other executions effected 
at its new bid price.
    (4) a specialist entered into an agreement with another market 
participant or customer whereby it uses its exemption from this rule to 
sell short at successively lower prices, accumulating a short position, 
and subsequently offsetting those sales through a transaction at a 
prearranged

[[Page 35300]]

price, for the purpose of avoiding compliance with this rule, and with 
the understanding that the specialist would be guaranteed against 
losses on those trades.

Non-Liability of Exchange

    Sec. 29. In accordance with Article IX, Section 10 of the Exchange 
Constitution, the Exchange shall not be liable for any loss sustained 
by a member or member organization resulting from the use of, or 
reliance on, the system through which the Exchange provides its members 
access to trade Nasdaq securities. Generally, a loss pertaining to an 
order that is entered through the BSE Nasdaq trading system that does 
not appear on a saved file will be absorbed by the entering member 
organization. A loss pertaining to an order that is entered through the 
BSE Nasdaq trading system which was designated for a particular 
specialist's post and which does appear on a saved file within the 
system will generally be absorbed by the specialist.

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 place 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
    According to the Exchange, the purpose of the proposed rule change 
is to set forth rules regarding the trading of certain over-the-counter 
(``OTC'') securities, Nasdaq securities, on the floor of the Exchange, 
pursuant to unlisted trading privileges (``UTP'') under Section 12(f) 
of the Act.\8\ To facilitate this process, the Exchange is proposing to 
add Chapter XXXV to the BSE Rules. The rules set forth in Chapter XXXV 
specifically govern the trading of Nasdaq securities, with references 
to various sections of other Exchange rules relating to the trading of 
equity securities, as well as references to selected NASD rules, where 
appropriate. Included within the Chapter are provisions for a two-year 
maturing Nasdaq stock allocation process, designed so as to provide 
meaningful allocation opportunities for firms that wish to become 
members of the Exchange and trade Nasdaq securities throughout the two-
year maturation period. The following series of provisions appear in 
Chapter XXXV.
---------------------------------------------------------------------------

    \8\ 15 U.S.C. 78l(f).
---------------------------------------------------------------------------

    Section 1: defines various terminology used throughout the Chapter 
XXXV;
    Section 2: discusses how orders for Nasdaq securities are to be 
transmitted to and from Exchange specialists. This section references 
other sections of the BSE Rules related to order display rules. 
Additionally, this section addresses the telephonic transmission of 
orders;
    Section 3: references NASD Rule 4630, and sets forth the reporting 
requirements for Nasdaq securities transactions;
    Sections 4 & 5: address automatic and manual execution of Nasdaq 
securities, and sets the minimum size parameter for automatic 
execution;
    Section 6: discusses preopening orders and trading halts;
    Section 7: discusses how cross transactions in Nasdaq securities 
are to be handled, with references to other BSE rules;
    Section 8: designates the hours of business for the trading of 
Nasdaq securities on the floor of the Exchange, pursuant to Exchange 
rule;
    Section 9: sets forth the parameters and conditions for guaranteed 
order acceptance and execution;
    Section 10: pursuant to Exchange and NASD rules, designates various 
specialist responsibilities regarding orderly markets and best 
execution practices;
    Section 11: in accordance with other Exchange rules, sets forth the 
registration requirements for Nasdaq specialists;
    Section 12: discusses, in light of other Exchange Rules, 
limitations on specialists;
    Section 13: discusses, in light of other Exchange Rules, 
limitations on floor clerks;
    Section 14: addresses odd-lot orders and dealers, in reference to 
other similar Exchange rules;
    Section 15: discusses the synchronization of business clocks, in 
concert with NASD Rule 6953;
    Section 16: pursuant to Exchange rules, sets forth minimum capital 
and equity requirements for Nasdaq specialists;
    Section 17: references existing BSE rules regarding margin 
procedures for all specialists;
    Section 18: sets forth limitations on the number of Nasdaq 
securities held by a specialist, and the amount of time a specialist 
must hold and actively trade a Nasdaq security;
    Sections 19 & 20: explain the application procedure for 
registration in Nasdaq securities;
    Section 21: sets forth the Exchange's procedures regarding the 
allocation of Nasdaq securities. The procedures are designed to cover 
the initial two-year period of Nasdaq trading on the floor of the 
Exchange. At the conclusion of the two-year period, the Exchange 
intends to re-examine the process and adopt permanent Nasdaq stock 
allocation procedures;
    Section 22: lists the criteria which the Stock Allocation Committee 
can consider during Nasdaq security allocation;
    Sections 23 & 24: discuss the procedures to be followed in the 
event that a Nasdaq security experiences certain corporate actions, or 
changes its listing status;
    Section 25: explains the limitations on the swapping of Nasdaq 
securities between specialists;
    Section 26: sets forth requirements for a specialist regarding 
deregistering in a Nasdaq security;
    Section 27: references another Exchange rule in explaining possible 
disciplinary action in relation to the trading of Nasdaq securities;
    Section 28: sets forth the Exchange's Short Sale Rule regarding 
Nasdaq securities; and
    Section 29: explains the Exchange's liability limitations regarding 
the trading system used for the trading of Nasdaq securities.
2. Basis
    The Exchange believes that the basis for the proposed rule change 
is Section 6(b)(5) \9\ of the Act, along with Sections 6(b)(8),\10\ 
11A,\11\ and 12(f) \12\ of the Act. Specifically, the Exchange believes 
that the proposed rule change is consistent with Section 6(b)(5) \13\ 
of the Act because permitting BSE specialists to trade eligible Nasdaq 
securities will promote just and equitable principles of trade and 
facilitate transactions in securities, thereby removing impediments to 
and perfecting the mechanism of a free and open market in a manner 
consistent with the protection of investors and the public interest.
---------------------------------------------------------------------------

    \9\ 15 U.S.C. 78f(b)(5).
    \10\ 15 U.S.C. 78f(b)(8).
    \11\ 15 U.S.C. 78k-1.
    \12\ 15 U.S.C. 78l(f).
    \13\ 15 U.S.C. 78f(b)(5).

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[[Page 35301]]

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

    The Exchange does not believe that the proposed rule change will 
impose any inappropriate burden on competition.

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

    The Exchange has neither solicited nor received comments on the 
proposed rule change.

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, 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 at 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-BSE-2001-01 and 
should be submitted by July 24, 2001.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority \14\.
---------------------------------------------------------------------------

    \14\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-16672 Filed 7-2-01; 8:45 am]
BILLING CODE 8010-01-M