Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by New York Stock Exchange, Inc., Relating to Near Neighbor Approach to Measuring Specialist Performance

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35661; File No. SR-NYSE-95-05]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by New York Stock Exchange, Inc., Relating to Near Neighbor

Approach to Measuring Specialist Performance

May 2, 1995.

Pursuant to Section 19(b) (1) of the Securities Exchange Act of

1934 (``Act''), 15 U.S.C. 78s(b) (1), notice is hereby given that on

February 28, 1995, the New York Stock Exchange, Inc. (``NYSE'' or

``Exchange'') filed with the Securities and Exchange Commission

(``Commission'') the proposed rule change as described in Items I, II

and III below, which Items have been prepared by the self-regulatory

organization. The Commission is publishing this notice to

[[Page 22594]] solicit comments on the proposed rule change from

interested persons.

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

of the Proposed Rule Change

The proposed rule change, to be implemented on a fifteen month

pilot basis,\1\ consists of adopting a new approach to measuring

specialist performance that would compare certain performance measures

of a given stock (price continuity, depth, quotation spread and capital

utilization) to those of its ``near neighbors,'' i.e., stocks that have

certain similar characteristics.

\1\See letter from James Buck, NYSE, to Katherine Simmons, SEC,

dated March 7, 1995.

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II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the self-regulatory organization

included statements concerning the purpose of and basis for the

proposed rule change and discussed any comments it received on the

proposed rule change. The text of these statements may be examined at

the places specified in Item IV below. The self-regulatory organization

has prepared summaries, set forth in Sections A, B, and C below, of the

most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

1. Purpose

In recent years, the Exchange has sought to create objective

measures of market quality and specialist performance. The Securities

and Exchange Commission has also encouraged the Exchange ``to develop

relative, objective standards of performance for evaluating

specialists.''\2\ The Exchange has responded, in part, by implementing

on a pilot basis the capital utilization measure of specialist

performance, which measures the dollar value of a specialist's

proprietary trading\3\ in relation to the total dollar value of shares

traded in the specialist's stocks.\4\

\2\See Division of Market Regulation, 088SEC, The October 1987

Market Break (February 1988), at p. xvii.

\3\See infra note 8.

\4\The Commission approved the capital utilization measure of

specialist performance on a one-year pilot basis in Securities

Exchange Act Release No. 33369 (December 23, 1993), 58 FR 69431

(December 30, 1993). The Commission approved a six-month extension

to the pilot program in Securities Exchange Act Release No. 35175

(December 29, 1994), 60 FR 2167 (January 6, 1995) (extending pilot

through June 30, 1995).

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The Exchange has continued its efforts to develop additional

objective measures of specialist performance over the past several

years, and has retained consultants from the Massachusetts Institute of

Technology to assist in this endeavor. Working with the consultants,

the Exchange has developed a new approach to evaluating specialist

performance that compares the performance in a stock over ``rolling''

three-month periods to the performance of stocks with similar trading

characteristics (``near neighbors''). The market quality measures are

price continuity,\5\ market depth,\6\ quotation spread,\7\ and

specialist capital utilization.\8\

\5\Continuity, the change in price from trade to trade, is

measured by the percentage of trades with a change of \1/8\ point or

less from the previous trade.

\6\Depth, the maximum price change over a 3,000-share sequence

of trades, is measured by the percentage of depth sequences with a

high/low range of \1/8\ point or less.

\7\Spread, the difference between the bid price and the ask

price, is measured by the percentage of reported quotations with a

spread of \1/4\ point or less.

\8\A capital utilization percentage is derived for each

specialist unit by dividing the average daily dollar value of the

unit's stabilizing purchases and sales by the average daily total

dollar value of shares traded in the unit's stocks. Capital

utilization is measured two ways: (1) using stabilizing dealer

volume; and (2) using stabilizing plus reliquifying dealer volume.

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As with the capital utilization measure, stocks would continue to

be separated into three broad stock categories: (1) stocks in the top

200 stocks in the S&P 500 Stock Index and other stocks that are as

active; (2) the remaining component stocks of the S&P 500 Index and

stocks among the 500 most active stocks on the Exchange; and (3) all

other stocks. A number of securities are excluded, as with the capital

utilization measure.\9\

\9\The following stocks are excluded from the current capital

utilization measure and the near neighbor analysis: foreign stocks,

preferred stocks, warrants, when issued stocks, IPOs (for the first

60 days), closed-end funds, stocks selling for $5 and under, stocks

with less than 2,000 shares average daily trading volume, and stocks

that have been delisted for more than six months. The following

stocks are excluded from near neighbor analysis and as discussed

below are being proposed to be excluded from the capital utilization

measure in this rule filing: stocks with two classes of shares,

merger/acquisition stocks if there was a significant impact on the

price or volume, and stocks which have been delisted for more than

half of the examination period. See infra note 13.

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Each month, each of the specialist unit's eligible stocks is

classified as belonging to one of the three broad categories noted

above. A determination is then made for each individual stock (the

``target stock'') as to which other stocks are statistically similar to

it (its ``near neighbors''), based on certain market characteristics.

The characteristics that are used in this determination are price, non-

block volume, daily high low range, and the dollar value of the stock's

``float'' (i.e., shares that are available for trading that are not

closely held).\10\ A statistical formula is applied to each stock's

four market characteristics to determine its statistical ``distance''

from the target stock. Stocks with distances of 1.000 or less are

considered to be ``near neighbors'' of the target stock. Stocks with

distances greater than 1.000 are considered to be too different to be

considered ``near neighbors'' of the target stock.\11\

\10\A stock will be considered ``similar'' to a target stock if:

(1) the median average daily price is within 30% of a target stock

under $20, or within $6 of a target stock between $20 and $60, or

within 10% of a target stock above $60; (2) the median daily non-

block volume (i.e., trades under 25,000 shares) is within 30% of the

target stock; (3) the median daily high-low range equals the median

high-low range of the target stock +/- 7.5% of:

i. 30% of the price for a target stock under $20

ii. $6 for a target stock between $20 and $60,

iii. 10% of the price for a target stock above $60 and (4) the

market value of the float is within 30% of the target stock.

\11\if there are more than 20 stocks with distances of 1.000 or

less, only the 20 stocks that are closest to the target stock are

used in the analysis.

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For all stocks with three or more near neighbors, a single

weighted\12\ average performance percentage combining the results for

all the near neighbors is calculated for each market quality measure.

Then, using statistical techniques involving standard deviations, each

target stocks' actual performance in the market quality measures listed

above is compared to the combined performance of its near neighbors.

\12\The weight of a near neighbor stock decreases as its

distance from the target stock increases. If a stock's distance from

the target stock is less than 0.500, then its weight is 1.000. If a

stock's distance from the target stock is greater than 0.500, then

its weight is less than 1.000.

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When a comparison with its near neighbors is made, the target stock

is then placed into one of the three groups: a stock whose performance

is statistically significantly poorer than the mean performance of the

near neighbor stocks is classified in the ``Below Mean'' group; a stock

whose performance is statistically similar to the mean performance is

classified in the ``Mean'' group; and a stock whose performance is

statistically significantly better than the mean is classified in the

``Above Mean'' group. Stocks that have fewer than three near neighbors

are automatically classified in the ``Mean'' group. An additional

analysis is performed on the stocks in the ``Mean'' group to highlight

those stocks that have relatively high performance even though that

performance is statistically similar [[Page 22595]] to the calculated

average of their near neighbors. A ``Mean'' group stock will be

considered to have ``relatively high performance'' if its performance

percentage is in the top quartile of all stocks in its stock category

(i.e., top 200, next 300, or other).

Each specialist unit would receive three reports each month

containing the results of the near neighbor analyses for the three most

recent months combined. These would include: (1) A Stock Detail Report

for each stock that provides market data and performance information

about the stock and each of the other stocks that were identified as

its ``near neighbors,'' (2) a Stock Summary Report that lists each

stock and provides data on the performance of the target stock and the

average performance of its near neighbors, as well as whether the

target stock's performance is ``Below Mean,'' ``Mean,'' or ``Above

Mean,'' for each performance measure, and (3) a Specialist Unit Summary

Report that shows, for each performance measure and within each stock

category, the number of stocks that are in each group classification,

and the percentage of the unit's total stocks that are in each group

classification. The Unit Summary Report also shows the percentage of

the unit's ``Mean'' group stocks that had high performance percentages.

The Allocation Committee would receive only the summary data

appearing on the Specialist Unit Summary Report, which will be updated

each month (covering the three most recent months) upon the

distribution of the reports to the specialist units. The Allocation

Committee would not receive performance data for individual stocks. The

Allocation Committee would also receive a list of each unit's stocks

that had fewer than three near neighbors and were automatically

classified in the ``Mean'' group. Included with each stock will be its

percentage of the unit's total dollar value of shares traded.

The Exchange is proposing that this new approach to measuring

specialist performance be implemented on a fifteen month pilot basis.

During the pilot period, the Exchange will continue to study the near

neighbor methodology with a view toward recommending such enhancements

or modifications as may be appropriate as experience is gained with

this approach to evaluating specialist performance.

The Exchange is also proposing the following modifications to the

specialist capital utilization performance measure to ensure

commonality between it and near neighbor: (1) Exclusion of stocks with

two classes of shares (e.g., Class A & Class B), ``merger/acquisition''

stocks if there was a significant impact on the price or volume, and

stocks that have been delisted for more than half of the examination

period;\13\ and (2) reduction of the performance review period from a

``rolling'' 12 months to a rolling three months. With respect to the

new exclusion for stocks with two classes of shares and stocks subject

to merger and acquisition activity that significantly impacts the price

or volume of the subject security, the Exchange believes the stocks'

trading patterns to be such that they cannot reasonably be compared to

other stocks that do not trade in the same manner. The performance

review period is proposed to be reduced to a rolling three month period

in order to give more prompt feedback of performance changes.

\13\The rule filing and Amendment No. 1, see supra note 1,

propose to exclude stocks which have been delisted for more than six

months based upon the current rolling twelve month performance

review period. However, because the Exchange is proposing to change

the review period to a rolling three month period, the Exchange will

amend the filing to provide that stocks which have been delisted for

more that half the review period will be excluded. Conversation

between Don Siemer, NYSE, and Katherine Simmons, SEC, May 1, 1995.

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2. Statutory Basis

The basis under Act for this proposed rule change is the

requirement under Section 6(b)(5) of the Act that an Exchange have

rules that are 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. The Exchange believes that the

proposed rule change is consistent with these requirements in that

developing objective measures of specialist performance using a near

neighbor approach would help perfect the mechanism of a free and open

market.

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 that is not necessary or

appropriate in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants or Others

The Exchange has neither solicited nor received written 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 publication of this notice in the Federal

Register or within such other 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 the 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. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

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. Sec. 552, will be available for inspection and copying at

the Commission's Public Reference Section, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of such filing will also be available

for inspection and copying at the principal office of the NYSE. All

submissions should refer to File No. SR-NYSE-95-05 and should be

submitted by May 30, 1995.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 95-11230 Filed 5-5-95; 8:45 am]

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