[Federal Register Volume 60, Number 5 (Monday, January 9, 1995)]
[Notices]
[Pages 2406-2409]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-387]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35187; File No. SR-BSE-94-12]


Self-Regulatory Organizations; Boston Stock Exchange, Inc.; Order 
Approving Proposed Rule Change and Amendment No. 1 to Proposed Rule 
Change Relating to its Specialist Performance Evaluation Program

December 30, 1994.

I. Introduction

    On October 3, 1994, the Boston Stock Exchange, Inc. (``BSE'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to extend its Specialist 
Performance Evaluation Program (``SPEP'' or ``Evaluation Program''), 
which currently incorporates objective measures of specialist 
performance, for an additional twelve-month period.\3\ On October 6, 
1994, the Exchange submitted Amendment No. 1 to the proposed rule 
change in order to correct certain typographical errors.

    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1991).
    \3\The Commission initially approved the BSE's SPEP pilot 
program in Securities Exchange Act Release No. 22993 (March 10, 
1986), 51 FR 8298 (March 14, 1986) (File No. SR-BSE-84-04). The 
Commission subsequently extended the pilot program in Securities 
Exchange Act Release Nos. 26162 (October 6, 1988), 53 FR 40301 
(October 14, 1988) (File No. SR-BSE-87-06); 27656 (January 30, 
1990), 55 FR 4296 (February 7, 1990) (File No. SR-BSE-90-01); 28919 
(February 26, 1991), 56 FR 9990 (March 8, 1991) (File No. SR-BSE-91-
01); and 30401 (February 24, 1992), 57 FR 7413 (March 2, 1992) (File 
No. SR-BSE-92-01). The BSE was permitted to incorporate objective 
measures of specialist performance into its pilot program in 
Securities Exchange Act Release No. 31890 (February 19, 1993), 58 FR 
11647 (February 26, 1993) (File No. SR-BSE-92-04) (``February 1993 
Approval Order''), at which point the initial pilot program ceased 
to exist as a separate program. Commission approval of the BSE's 
current SPEP pilot program expires on December 31, 1994. See 
Securities Exchange Act Release No. 33341 (December 15, 1993), 58 FR 
67875 (December 22, 1993) (File No. SR-BSE-93-16) (``December 1993 
Approval Order'').
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    The proposed rule change, together with Amendment No. 1, was 
published for comment in Securities Exchange Act Release No. 34819 
(October 11, 1994), 59 FR 52327 (October 17, 1994). No comments were 
received on the proposal. This order approves proposed rule change, 
including Amendment No. 1.

II. Description of the Proposal

    The Exchange proposes to extend its Specialist Performance 
Evaluation [[Page 2407]] Program to incorporate objective measures of 
specialist performance.\4\ The current pilot program uses the BEACON 
system\5\ to assess how well a specialist handles market and marketable 
limit orders routed to him for execution. For each specialist, a record 
of all action taken on relevant BEACON orders is accumulated in a 
special file, from which the four calculations described below are run.

    \4\See February 1993 Approval Order, supra, note 3. In addition 
to the substantive changes discussed below, SPEP was moved to Ch. 
XV, 2156 of the BSE Rules.
    \5\BEACON is the BSE's automated order-routing and execution 
system. Of all incoming BEACON orders, SPEP collects data for 
regular buy and sell market and marketable limit orders only. Thus 
BEACON orders with qualifiers (e.g., buy minus or sell plus, market-
on-close, stop, stop limit, all or none, etc.) and crosses are 
excluded from analysis.
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    First, Turnaround Time measures the average number of seconds from 
the receipt of a guaranteed market or marketable limit order (i.e., for 
1299 shares or less) in BEACON until it is executed (in whole or in 
part), stopped or cancelled.\6\ Time continues to accumulate if the 
specialist just moves an order from the auto-ex screen to the manual 
one, until that order is executed (in whole or in part), stopped or 
cancelled.

    \6\Data collection starts when the stock opens on the primary 
market. Blocks of time are excluded in the event of trading halts, 
BEACON system failure, etc.
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    Second, Holding Orders Without Action measures the number of market 
and marketable limit orders which are neither executed, stopped nor 
cancelled within twenty-five seconds. This measure differs from 
Turnaround Time in that orders of all sizes (including those already 
counted toward Turnaround Time) are analyzed.\7\

    \7\The same exclusions apply for Holding Orders Without Action 
as for Turnaround Time. See supra, note 6.
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    Third, Trading Between the Quote measures the number of market and 
marketable limit orders that are executed between the best consolidated 
bid and offer where the spread is greater than 1/8th.
    Fourth, Executions in Size Greater than Best Bid and Offer 
(``BBO'') measures the number of market and marketable limit orders 
which exceed, and are executed in a size larger than, BBO size.
    For each of the above measures, including the revised 
questionnaire, the specialist receives a raw score. A ten point grading 
scale is then applied to ranges of raw scores. In computing the overall 
program score, the measures are assigned the following weights: 
Turnaround Time, 15%; Holding Orders Without Action, 15%; Trading 
Between the Quote, 25%; Executions in Size Greater than BBO, 25%; 
Questionnaire, 20%.
    At the same time as it incorporated the objective measures 
described above, the Exchange also revised the conditions for 
performance review. For each measure, the Evaluation Program states at 
what score specialist performance is deemed to be adequate.\8\ A 
specialist who is deficient in the same one objective measure, for two 
out of three consecutive review periods, is required to appear before 
the Performance Improvement Action Committee.\9\ The purpose of this 
meeting is to discuss, informally, possible methods of improving the 
specialist's performance.

    \8\A specialist is deficient in any individual objective measure 
or the overall program if he scores below certain minimum 
performance levels, as set forth below. Thus for his performance to 
be deemed adequate, a specialist must receive the following scores:
    Overall Evaluation--at or above weighted score of 5.80
    Turnaround Time--below 21.0 seconds (8 points)
    Holding Orders Without Action--below 21% (7 points)
    Trading Between the Quote--at or above 26% (5 points)
    Executions Greater than BBO--at or above 76% (6 points)
    Questionnaire--at or above weighted score of 50 (4 points)
    \9\In the event a specialist receives a deficient score on the 
questionnaire alone, the Exchange staff reviews the deficient 
questionnaire to determine if there is sufficient reason to warrant 
informing the Performance Improvement Action Committee of potential 
performance problems.
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    If the specialist does not improve in the next review period, he is 
referred to the Market Performance Committee. The Market Performance 
Committee is directed to take such actions as it deems necessary and 
appropriate to address the deficient score. These actions include 
suspending a specialist's trading account, suspending his alternate 
specialist account privilege,\10\ or reallocating his specialty 
stocks.\11\

    \10\Alternate specialists provide added liquidity to the market, 
by promising to trade up to a certain amount of shares, on the 
request of the primary specialist. A specialist must apply for the 
privilege of being an alternate.
    \11\The possible performance improvement actions are described 
in the BSE Rules under SPEP's Supplemental Material. This 
Supplemental Material is intended to provide specialists with 
adequate notice of the consequences of poor performance. It does not 
articulate any new substantive standards.
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    Finally, the BSE also incorporated modified relative rankings into 
its Evaluation Program. Exchange staff reviews the performance of any 
specialists whose scores place them in the bottom ten percent of all 
BSE units.\12\ In addition, a specialist who is deficient on the 
overall program score, for two out of three consecutive review periods, 
is required to appear before the Market Performance Committee, with the 
same possible consequences as above.\13\

    \12\In the event a specialist ranked in the bottom ten percent 
does not fall below the threshold for the overall program score, the 
Exchange staff reviews the performance of the specialist to 
determine if there is sufficient reason to warrant informing the 
Performance Improvement Action Committee of potential performance 
problems.
    \13\See supra, text accompanying notes 10-11.
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    The BSE has requested a twelve-month extension of the current pilot 
program to enable the Exchange to evaluate further the appropriateness 
of the measures and their respective weights, as well as the 
effectiveness of the overall evaluation program. The BSE believes that 
the proposed rule change will promote just and equitable principles of 
trade and aid in the perfection of a free and open market and a 
national market system. The Exchange states that the SPEP results weigh 
heavily in stock allocation decisions and, as a result, specialists are 
encouraged to improve their market quality and administrative duties.

III. Discussion

    The Commission believes that specialists play a crucial role in 
providing stability, liquidity and continuity to the trading of stocks. 
Among the obligations imposed upon specialists by the Exchange, and by 
the Act and the rules thereunder, is the maintenance of fair and 
orderly markets in their designated securities.\14\ To ensure that 
specialists fulfill these obligations, it is important that the 
Exchange conduct effective oversight of their performance. The BSE's 
Specialist Performance Evaluation Program is critical to this 
oversight.

    \14\Rule 11b-1, 17 CFR 240.11b-1 (1991); Ch. XV, 2155.01 of the 
BSE Rules.
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    In its order approving the incorporation of objective measures of 
performance,\15\ the Commission asked the Exchange to monitor the 
effectiveness of the amended Evaluation Program. Specifically, the 
Commission requested information about the number of specialists who 
fell below acceptable levels of performance for each objective measure, 
the questionnaire and the overall program; and about the specific 
measures in which each such specialist was deficient. The Commission 
also requested information about the number of specialists who, as a 
result of each [[Page 2408]] condition for review,\16\ were referred to 
the Performance Improvement Action Committee and/or the Market 
Performance Committee; and about the type of action taken with respect 
to each such deficient specialist.

    \15\For a description of the Commission's rationale for 
approving the incorporation of objective measures of performance 
into the BSE's SPEP on a pilot basis, see February 1993 Approval 
Order, supra, note 3. The discussion in the aforementioned order is 
incorporated by reference into this order.
    \16\See supra, notes 8-13 and accompanying text.
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    In September 1993, and October 1994, the BSE submitted to the 
Commission monitoring reports regarding its amended Evaluation Program. 
The reports describe the BSE's experience with the pilot program during 
1993 and the first two review periods of 1994. In terms of the overall 
scope of the Evaluation Program, the Commission continues to believe 
that objective measures, together with a floor broker questionnaire, 
should generate sufficiently detailed information to enable the 
Exchange to make accurate assessments of specialist performance. Based 
on results from several review periods, the BSE appears to have 
implemented its BEACON criteria and generated data to assess, in a 
quantitative way, how well specialists carry out certain aspects (i.e., 
timeliness of execution, price improvement and market depth) of their 
responsibilities as specialists.
    The Commission also has reviewed the BSE's experience with its 
minimum adequate performance thresholds. Based on the number of 
specialists who surpassed acceptable levels of performance for each 
measure (and on an informal comparison of the floor-wide average to the 
minimum threshold), it appears that these standards have been helpful 
in identifying some specialists with potential performance problems, as 
well as providing an incentive for improved market making performance.
    Finally, based on the information provided in the BSE's monitoring 
reports, the Commission finds that the Exchange applied its conditions 
for review fairly and consistently. The Commission continues to believe 
that, taking the Evaluation Program as a whole, most potential 
performance problems should be brought to the attention of the 
appropriate committee. In terms of the BSE's response to the 
deficiencies it identified, the Commission notes that the monitoring 
reports only cover a limited time period; accordingly, it is too soon 
for the Commission to reach any definitive conclusion about the 
effectiveness of the performance improvement actions. Nevertheless, the 
BSE should examine its Evaluation Program to ensure that adequate 
corrective actions are taken with respect to each deficient specialist.
    In conclusion, the Commission believes that the BSE has taken a 
good first step toward developing a more effective Specialist 
Performance Evaluation Program. Accordingly, the Commission believes 
that it is appropriate to extend the current pilot program for an 
additional twelve-month period, expiring December 31, 1995. This 
twelve-month period will allow the Exchange to respond to the 
Commission's concerns about the Evaluation Program, as set forth below. 
First, the Commission suggests that the BSE consider incorporating 
additional objective criteria, so that the Exchange can conduct and 
even more thorough analysis of specialist performance.\17\ At the same 
time, the BSE should assess whether each measure, as well as the 
questionnaire, is assigned an appropriate weight.\18\ Moreover, the 
Commission strongly encourages the Exchange to conduct an ongoing 
examination of its minimum adequate performance thresholds, in order to 
ensure that they continue to be set at appropriate levels. The 
Commission also continues to believe that relative performance rankings 
that subject the bottom ten percent of all specialists units to review 
by an Exchange committee are an important part of an effective 
Evaluation Program. Finally, the BSE should closely monitor the 
conditions for review and should take steps to ensure that all 
specialists whose performance is deficient and/or diverges widely from 
the best units will be subject to meaningful review. In the 
Commission's opinion, a meaningful review process would ensure that 
adequate corrective actions are taken with respect to each deficient 
specialist. The Commission would have difficulty granting permanent 
approval to an Evaluation Program that did not include a satisfactory 
response to the concerns described above.

    \17\For example, the BSE could develop additional measures of 
market depth, such as how often the specialist's quote exceeds 500 
shares or how often the BSE quote, in size, is larger than the BBO 
(excluding quotes for 100 shares). Another possible objective 
criteria could measure quote performance (i.e., how often the BSE 
specialist's quote, in price, is alone at or tied with the BBO).
    \18\In this regard, because of the substantial overlap between 
Turnaround Time and Holding Orders Without Action, the Commission 
recommends that the BSE consider either having only one measure in 
this category (i.e., timeliness of execution) or reducing the 
weights of the existing measures, which together account for the 
current Evaluation Program.
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    The Commission therefore requests that the BSE submit a report to 
the Commission, by June 1, 1995, describing its experience with the 
pilot. At a minimum, this report should contain data, for the last 
review period of 1994 and the first review period of 1995, on (1) the 
number of specialists who fell below acceptable levels of performance 
for each objective measure,\19\ the questionnaire and the overall 
program, and the specific measures in which each such specialist was 
deficient; (2) the number of specialists who, as a result of the 
objective measures, appeared before the Performance Improvement Action 
Committee for informal counseling; (3) the number of such specialists 
then referred to the Market Performance Committee and the type of 
action taken; (4) the number of specialists who, as a result of the 
overall program, appeared before the Market Performance Committee and 
the type of action taken; (5) the number of specialists who, as a 
result of the questionnaire or falling in the bottom ten percent, were 
referred by the Exchange staff to the Performance Improvement Action 
Committee and the type of action taken (this should include the number 
of specialists then referred to the Market Performance Committee and 
the type of action taken by that Committee); and (6) a list of stocks 
reallocated due to substandard performance and the particular unit 
involved. Any requests to modify this pilot, to extend its 
effectiveness or to seek permanent approval for the Evaluation Program 
should be submitted to the Commission by July 31, 1995, as a proposed 
rule change pursuant to Section 19(b) of the Act.

    \19\For each objective measure, the Commission also requests 
that the BSE provide the mean and median scores.
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IV. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposed rule change is consistent with the requirements of Sections 6 
and 11 of the Act and the rules and regulations thereunder applicable 
to a national securities exchange. In particular, the Commission 
believes the proposal is consistent with the Section 6(b)(5)\20\ 
requirement that the rules of the Exchange be designed to promote just 
and equitable principles of trade, to remove impediments to and perfect 
the mechanism of a free and open market and a national market system, 
and, in general, to protect investors and the public interest.

    \20\15 U.S.C. 78f(b)(5) (1988).
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    Further, the Commission finds that the proposal is consistent with 
Section 11(b) of the Act,\21\ and Rule 11b-1 thereunder,\22\ which 
allow securities exchanges to promulgate rules relating to specialists 
in order to maintain fair and orderly markets and to remove 
[[Page 2409]] impediments to and perfect the mechanism of a national 
market system.

    \21\15 U.S.C. 78k(b) (1988).
    \22\17 CFR 240.11b-1 (1991).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\23\ that the proposed rule change (SR-BSE-94-12) is approved on a 
pilot basis until December 31, 1995.

    \23\15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\24\

    \24\17 CFR 200.30-3(a)(12) (1991).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-387 Filed 1-6-95; 8:45 am]
BILLING CODE 8010-01-M