Document ID: SEC-2007-1510-0001
Agency: sec
Document Type: Notice
Title: NYSE Rule 104 governs specialist dealings and includes, among other things, restrictions upon specialists ability to trade as dealer in the stocks in which he or she is registered. Under NYSE Rule 104(a), specialists are not permitted to effect transactions on the Exchange for their proprietary accounts in any security in which the specialist is registered, ``unless such dealings are reasonably ne
Posted Date: 2007-11-05T05:00Z

[Federal Register: November 5, 2007 (Volume 72, Number 213)]
[Notices]               
[Page 62504-62506]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05no07-85]                         

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56711; File No. SR-NYSE-2007-83]

 
 Self-Regulatory Organizations; New York Stock Exchange LLC; 
Order Granting Approval of Proposed Rule Change Relating to NYSE Rule 
104.10 (``Dealings by Specialists'')

October 26, 2007.
    On September 14, 2007, the New York Stock Exchange LLC (``NYSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``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 (i) extend the duration of its pilot program 
applicable to ``Conditional Transactions'' as defined in NYSE Rule 
104.10 (``Dealings by Specialists'') to March 31, 2008 \3\; (ii) remove 
the ``active securities'' \4\ limitation on Conditional Transactions 
that establish or increase a specialist's position and reach across the 
market to transact with the NYSE's published quote; and (iii) make 
certain conforming changes to NYSE Rule 104.10(5). The proposed rule 
change was published for comment in the Federal Register on September 
25, 2007.\5\ The Commission received no comments on the proposal. This 
order approves the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ A ``Conditional Transaction'' is defined as a specialist 
transaction in an active security that establishes or increases a 
position and reaches across the market to trade as the contra-side 
to the Exchange published bid or offer. See NYSE Rule 104.10(6)(ii) 
(which is renumbered pursuant to this proposal as NYSE Rule 
106.10(6)(i)).
    \4\ Original NYSE Rule 104.10(6)(i) defines ``active 
securities'' as: (a) Securities comprising the S&P 500 Index; (b) 
securities traded on the Exchange during the first five trading days 
following their initial public offering; and (c) securities that 
have been designated as ``active'' by a Floor Official pursuant to 
the parameters set forth in the rule. In general, a governing Floor 
Official may designate a security as ``active'' by determining, 
among other things, that the security in question has exhibited 
substantially greater than normal trading volume and is likely to 
continue to sustain such higher volume during the remainder of the 
trading session.
    \5\ See Securities Exchange Act Release No. 56455 (September 18, 
2007), 72 FR 54499 (``Notice'').
---------------------------------------------------------------------------

I. Description of the Proposal

    NYSE Rule 104 governs specialist dealings and includes, among other 
things, restrictions upon specialists' ability to trade as dealer in 
the stocks in which he or she is registered. Under NYSE Rule 104(a), 
specialists are not permitted to effect transactions on the Exchange 
for their proprietary accounts in any security in which the specialist 
is registered, ``unless such dealings are reasonably necessary to 
permit such specialist to maintain a fair and orderly market * * *.'' 
This restriction is known as the ``negative obligation.'' In 
particular, NYSE Rules 104.10(5) and (6) expand upon the negative 
obligation with respect to specific types of proprietary transactions.
    In December 2006, as part of extensive amendments to its specialist 
stabilization rules, the Exchange implemented a pilot program allowing 
specialists to execute transactions in active securities that establish 
or increase a position and reach across the market to trade as the 
contra-side to the Exchange published bid or offer (Conditional 
Transactions) without restriction as to price or Floor Official 
approval, provided that the specialist appropriately re-enters on the 
opposite side of the market in a size commensurate with the 
specialist's Conditional Transaction.\6\ NYSE issued guidelines called 
``Price Participation Points'' (``PPPs'') that identify the price at or 
before which a specialist is expected to re-enter the market after 
effecting one or more Conditional Transactions. PPPs are minimum 
guidelines only and compliance with them does not guarantee that a 
specialist is meeting its obligations. Under the pilot program, certain 
Conditional Transactions require the specialist to immediately re-
enter, or re-enter as the specialist's next available quoting or 
trading action, regardless of the PPP.\7\ For example, immediate re-
entry may be required based on the price and/or volume of the 
specialist's Conditional Transaction(s) in reference to the market in 
the security at the time of such trading. The fact that there may have 
been one or more independent trades following the specialist's 
Conditional Transaction does not, by itself, eliminate the need for 
immediate re-entry when otherwise appropriate. In addition, immediate 
re-entry is required after a Conditional Transaction: (a) Of 10,000 
shares or more or a quantity of stock with a market value of $200,000 
or more; and (b) which exceeds 50% of the published bid or offer size 
(as relevant).\8\
---------------------------------------------------------------------------

    \6\ See Securities Exchange Act Release No. 54860 (December 1, 
2006), 71 FR 71221 (December 8, 2006) (SR-NYSE-2006-76). The 
operation of the pilot was subsequently extended two times, first 
until September 30, 2007 and then until the earlier of (i) December 
31, 2007 or (ii) the approval by the Commission of this proposed 
rule change. See Securities Exchange Act Release Nos. 55995 (June 
29, 2007), 72 FR 37288 (July 9, 2007) (SR-NYSE-2007-58); and 56554 
(September 27, 2007), 72 FR 56419 (October 3, 2007) (SR-NYSE-2007-
84).
    \7\ See NYSE Rule 106.10(6)(iv) (which is renumbered pursuant to 
the proposal as NYSE Rule 106.10(6)(iii)).
    \8\ See NYSE Rule 106.10(6)(iv)(c)(I) and (II) (which are 
renumbered pursuant to the proposal as NYSE Rule 
106.10(6)(iii)(c)(I) and (II)).
---------------------------------------------------------------------------

    Specialists currently are not permitted to establish or increase a 
position in ``inactive securities'' \9\ by reaching across the market 
to purchase the offer at a price that is above the last sale price on 
the Exchange or sell to the bid at a price that below the last sale 
price on the Exchange, unless such specialist trade is reasonably 
necessary to render the specialist's position adequate to the immediate 
and reasonably anticipated needs of the market and approved by a Floor 
Official. Further, for inactive securities, specialists currently are 
not permitted to purchase more than 50% of the stock offered at a price 
that is equal to the last sale price when the last sale price was 
higher than the last differently priced regular way sale, unless such 
trade is approved by a Floor Official. Specialists must re-enter the 
market when reasonably necessary after effecting such trades.\10\
---------------------------------------------------------------------------

    \9\ ``Inactive securities'' are securities that do not fall 
within NYSE's definition of active securities. See supra note 4.
    \10\ See NYSE Rule 106.10(5)(b)(I).
---------------------------------------------------------------------------

    The Exchange is now proposing to extend its pilot program 
applicable to Conditional Transactions to March 31, 2008 and remove the 
``active securities'' restriction included in the pilot, enabling 
specialists to execute Conditional Transactions in all securities 
traded on the NYSE.\11\ The Exchange will continue to apply its PPP 
guidelines, and specialists will continue to be required to meet the 
re-entry obligations of NYSE Rule 104.10(6). In

[[Page 62505]]

addition, specialists will continue to be subject to their negative 
obligation.
---------------------------------------------------------------------------

    \11\ During the pilot, the restrictions currently in effect for 
inactive securities pursuant to NYSE Rule 106.10(5)(b) will be 
suspended.
---------------------------------------------------------------------------

II. Discussion and Commission Findings

    After careful consideration, the Commission finds that the proposed 
rule change is consistent with the requirements of the Act and the 
rules and regulations thereunder applicable to a national securities 
exchange \12\ and, in particular, the requirements of Section 6 of the 
Act.\13\ Specifically, the Commission finds that the proposed rule 
change is consistent with Section 6(b)(5) of the Act,\14\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to promote just and equitable principles of trade, 
to foster cooperation and coordination with persons engaged in 
regulating, clearing, settling, and processing information with respect 
to, and facilitating transactions in securities, 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. Finally, the Commission believes the proposal is consistent 
with the principles set forth in Section 11A of the Act \15\ and the 
requirements of Rule 11b-1 under the Act.\16\
---------------------------------------------------------------------------

    \12\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \13\ 15 U.S.C. 78f.
    \14\ 15 U.S.C. 78f(b)(5).
    \15\ 15 U.S.C. 78k-1.
    \16\ 17 CFR 240.11b-1.
---------------------------------------------------------------------------

    Specialists' dealer activities are governed, in part, by the 
negative and affirmative trading obligations. Rule 11b-1 under the Act 
requires exchanges that permit members to register as specialists to 
have rules governing specialists' dealer transactions so that their 
proprietary trades conform to the negative and affirmative obligations. 
The negative obligations as set forth in Rule 11b-1 under the Act 
require that a specialist's dealings be restricted, so far as 
practicable, to those reasonably necessary to permit a fair and orderly 
market.\17\ The affirmative obligation as set forth in Rule 11b-1 under 
the Act requires a specialist to engage in a course of dealings for its 
own account to assist in the maintenance, so far as practicable, of a 
fair and orderly market.\18\ NYSE has adopted these obligations in its 
Rule 104, which includes restrictions on when specialists may effect 
certain transactions.
---------------------------------------------------------------------------

    \17\ 17 CFR 240.11b-1(a)(2)(iii).
    \18\ 17 CFR 240.11b-1(a)(2)(ii).
---------------------------------------------------------------------------

    In connection with the Commission's approval of amendments to the 
Exchange's stabilization rules, including the implementation of 
Exchange's current pilot program for Conditional Transactions, the 
Commission eliminated the trade-by-trade standard previously applied to 
specialist trades for the purpose of determining whether such trade was 
``reasonably necessary'' in accordance with the negative 
obligation.\19\ The Commission noted that increased automation and 
competition--both within the Hybrid Market and in the markets 
generally--are significant factors, among others, that affect the 
ability of specialists to make trade-by-trade analysis regarding their 
negative obligation, and found that permitting specialists to consider 
the reasonable necessity of their transactions under negative 
obligations without a transaction-by-transaction test was appropriate 
and consistent with the Act. The Commission emphasized, however, that 
specialists must continue to comply with the negative obligation, and 
assess their need to trade and limit their proprietary trades to those 
reasonably necessary to allow the specialists to maintain a fair and 
orderly market.\20\
---------------------------------------------------------------------------

    \19\ See Securities Exchange Act Release No. 54860, supra note 
6, at 71228. Previously, specialists were required to comply with 
the negative obligation on a transaction-by-transaction basis 
pursuant to a 1937 Commission interpretation known as the 
``Saperstein Interpretation.'' See Securities Exchange Act Release 
No. 1117, 1937 SEC LEXIS 357 (March 30, 1937). See also Securities 
Exchange Act Release No. 54860, supra note 6, at 71227 for a 
discussion of the Saperstein Interpretation. Specifically, in the 
Saperstein Interpretation, the Commission stated that the negative 
obligation ``prohibits all transactions for the account of a 
specialist, excepting only such transactions as are properly a part 
of a course of dealings reasonably necessary to permit the 
specialist to maintain a fair and orderly market * * *.'' Further, 
the interpretation stated that each transaction by a specialist for 
its own account must meet the test of reasonable necessity, making 
clear that a specialist must comply with the rule on a transaction-
by-transaction basis. See Securities Exchange Act Release No. 1117, 
supra, at 3-4.
    \20\ See Securities Exchange Act Release No. 54860, supra note 
6, at 71228.
---------------------------------------------------------------------------

    NYSE is now proposing to (i) extend the duration of its pilot 
program applicable to Conditional Transactions to March 31, 2008; (ii) 
remove the ``active securities'' limitation on Conditional Transactions 
that establish or increase a specialist's position and reach across the 
market to transact with the NYSE's published quote; and (iii) make 
certain conforming changes to NYSE Rule 104.10(5). NYSE specialists 
would remain subject to the negative obligation and would be required 
to appropriately re-enter the market after a Conditional Transaction is 
executed and, for certain Conditional Transactions, the specialist must 
re-enter immediately following the trade. In addition, the Exchange's 
PPP guidelines would continue to apply.
    NYSE believes that the specialists are critical to its market 
structure, and that they perform an important function in the 
marketplace. Specifically, NYSE believes that, by committing capital, 
specialists provide market depth, lower market volatility, and reduce 
overall execution costs for investors. NYSE also believes that 
specialists bridge gaps between supply and demand, and help to maintain 
a fair and orderly market. Furthermore, the Exchange believes that 
advances in technology have virtually obviated the specialists' time 
and place advantage, and states that the rate of trading participation 
by specialists in specialist stocks has been significantly reduced. As 
a result, the Exchange believes that the basis for concern over 
specialist conflicts of interest (and the consequent ability of 
specialists to trade to the detriment of the public) is also 
diminished. NYSE highlights that the proposal does not in any way 
reduce the obligations imposed on its specialists pursuant to NYSE Rule 
104 to re-enter a transaction on the opposite side of the market or 
alter their negative obligation. The Exchange believes that these 
factors support their proposal to extend the ability of the specialist 
to effect Conditional Transactions to all securities, and that 
providing specialists such ability would allow them to more effectively 
meet their affirmative and negative obligations by giving them the 
tools to better manage the inventory of their account.\21\
---------------------------------------------------------------------------

    \21\ In addition, the Exchange provided data which it contends 
evidences that the original stabilization pilot had no discernable 
adverse impact on liquidity or market quality. See Securities 
Exchange Act Release No. 56455, supra note 5 at 54501-2. See also 
Appendices 3A, 3B, and 3C, which are available at the Commission's 
Web site at http://www.sec.gov/rules/sro/nyse/2007/34-56455appendix3.pdf
.

---------------------------------------------------------------------------

    NYSE has committed to provide the Commission with statistics 
related to market quality, specialist trading activity, and sample 
statistics on an ongoing monthly basis.\22\ The

[[Page 62506]]

Commission believes that this data will be important in helping it 
analyze the impact of this proposed rule change, and in determining 
whether to extend the operation of this rule or to approve this rule on 
a permanent basis.
---------------------------------------------------------------------------

    \22\ Specifically, the Exchange has agreed to provide sample 
statistics, including the daily Consolidated Tape volume in shares, 
daily number of trades, daily high-low volatility in basis points, 
and daily close price in dollars. In addition, the Exchange will 
calculate the specialist profit on round-trip Hit Bid and Take Offer 
(``HB/TO'') executions, by measuring the specialist profit on HB/TO 
activity by taking the round-trip trading profits for all HB/TO 
trades where the specialist executes an offsetting trade within 30 
seconds. In cases where the volume of the offsetting execution is 
less than the size of the HB/TO execution, the calculation will only 
include profits realized within the 30-second window. The Exchange 
will further calculate the quote-based specialist re-entry ratio, 
and each re-entry price level will be categorized and reported 
separately. The categories will be in cent intervals at 0, 1, 2, 3, 
4, and 5 or more cents. The time window for these calculations will 
also be in 30 seconds. Finally, the Exchange has agreed to provide 
the Commission with data related to the average realized spread on 
specialist HB/TO executions using the formula set forth in Rule 605 
of Regulation NMS under the Act. 17 CFR 242.605. Specifically, the 
average realized spread should be a share-weighted average of 
realized spreads. For specialist buys, the spread will be double the 
amount of the difference between the execution price and the 
midpoint of the consolidated best bid and offer five minutes after 
the time of HB/TO execution. For specialist sells, the spread will 
be double the amount of the difference between the midpoint of the 
consolidated best bid and offer five minutes after the time of HB/TO 
execution and the execution price. The Exchange has also committed 
to maintain average measures for each stock-day during a particular 
month in order to provide such information to the Commission upon 
request.
---------------------------------------------------------------------------

    The Commission continues to believe that the provisions governing 
Conditional Transactions may reflect an appropriate balance between the 
needs of specialists and other market participants in today's fast 
moving markets.\23\ The Commission notes that specialists continue to 
be subject to the negative obligation, which requires that their 
proprietary trading be limited to that reasonably necessary to maintain 
a fair and orderly market. In approving the expansion of the pilot 
program beyond active securities, the Commission continues to recognize 
the potential conflicts of interest presented when a specialist engages 
in aggressive trading activity such as reaching across the market to 
trade with the NYSE bid or offer while increasing its position, 
particularly in the case of less liquid securities. Also, the proposed 
rule change represents a further shift in the role and obligations of 
specialists at the Exchange. As such, the Commission is approving the 
proposed expansion of the scope of the pilot, enabling specialists to 
execute Conditional Transactions in all securities traded on the NYSE, 
and the proposed extension of the duration of the pilot until March 31, 
2008.
---------------------------------------------------------------------------

    \23\ See Securities Exchange Act Release No. 54860, supra note 
6, at 71229.
---------------------------------------------------------------------------

    The Commission emphasizes that the extension of the pilot to all 
securities in no way relieves specialists of their obligations under 
federal securities laws or NYSE rules. A specialist's ability to effect 
proprietary transactions remains limited under the Act and the 
Exchange's rules and specialists must still determine whether their 
transactions are reasonably necessary. The Commission notes that the 
Exchange is obligated to surveil its specialists to ensure their 
compliance with the Act and NYSE rules, and the Exchange has stated 
that NYSE Regulation believes that it has appropriate surveillance 
procedures in place to surveil for compliance with the negative 
obligations.
    For the reasons discussed above, the Commission finds that the 
proposed rule change is consistent with the Act.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-NYSE-2007-83), be and hereby 
is, approved on a temporary basis until March 31, 2008.
---------------------------------------------------------------------------

    \24\ 15 U.S.C. 78s(b)(2).
    \25\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-21633 Filed 11-2-07; 8:45 am]

BILLING CODE 8011-01-P