Self-Regulatory Organizations; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change by the Boston Stock Exchange, Inc. Relating to Its Specialist Performance Evaluation Program

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38182; File No. SR-BSE-96-13]

Self-Regulatory Organizations; Notice of Filing and Order

Granting Accelerated Approval of Proposed Rule Change by the Boston

Stock Exchange, Inc. Relating to Its Specialist Performance Evaluation

Program

January 17, 1997.

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 January 6, 1997,\3\ the Boston Stock Exchange, Inc. (``BSE'' or

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

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

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

organization. The Commission is publishing this notice to solicit

comments on the proposed rule change from interested persons and to

grant accelerated approval to the proposed rule change.

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\1\ 15 U.S.C. 78s(b)(1).

\2\ 17 CFR 240.19b-4.

\3\ On January 6 and January 10, 1997, the BSE filed Amendment

Nos. 1 and 2, respectively, with the Commission, the substance of

which have been incorporated into this notice.

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

of the Proposed Rule Change

The BSE seeks a twelve-month extension of its Specialist

Performance Evaluation Program (``SPEP'').\4\

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\4\ 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 exit as a separate program. The current pilot program was

subsequently extended in Securities Exchange Act Release Nos. 33341,

(December 15, 1993) 58 FR 67875 (December 22, 1993) (``December 1993

Approval Order''); 35187 (December 30, 1994), 60 FR 2406 (January 9,

1995); and 36668 (January 2, 1996), 61 FR 672 (January 9, 1996)

(January 1996 Approval Order) (Pilot extended until December 31,

1996).

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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 III 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

The purpose of the proposed rule change is to request an extension

of the Exchange's SPEP pilot program. The evaluation program, using the

BEACON

[[Page 3932]]

system,\5\ looks at all incoming orders routed to a specialist for

execution. A record of all action on these orders is accumulated in a

separate file from which four calculations are run.

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\5\ BEACON is the BSE's automated order-routing and execution

system. BEACON provides a guarantee of execution for market and

marketable limit orders up to and including 1,299 shares. In

addition, BEACON can be used to transmit orders not subject to

automatic execution. See BSE Rules, Ch. XXXIII, Secs. 2654-55.

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Section criteria for eligible orders include regular buy and sell

market and marketable limit orders only. Orders marked buy minus or

sell plus are excluded, as are crosses and all orders with qualifiers

(e.q., market-on-close, stop, stop limit, all or none, etc.). The order

entry date must equal the order execution date.

For each of the measures, including the Specialist Performance

Evaluation Questionnaire (``SPEQ''), a ten point scale will be applied

to a range of scores. Based on the raw score for each measure, the

respective specialist will receive an associated score between one and

ten points, which will be weighted as indicated for each measure.

The first measure is Turnaround Time, which calculates the average

number of seconds for all eligible orders based on the number of

seconds between the receipt of a guaranteed market or marketable limit

order in BEACON (i.e., for 1299 shares or less) and the execution,

partial execution, stopping or cancellation of the order. An order that

is moved from the auto-ex screen to the manual screen will accumulate

time until executed, partially executed, stopped or cancelled. This

calculation will not be in effect until the individual stock has opened

on the primary market. Certain situations, such as trading halts and

periods where the BEACON system is off auto-ex floorwide, will result

in blocks of time being excluded from the calculation. A specialist who

averaged a raw score of twenty-five (25) seconds will receive seven

points because it falls in the twenty-one (21) to twenty-five (25)

second range. This calculation will comprise 20% of the overall

evaluation program.

Turnaround Time

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

Time in seconds Points

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

1-10.......................................................... 10

11-15......................................................... 9

16-20......................................................... 8

21-25......................................................... 7

26-30......................................................... 6

31-35......................................................... 5

36-40......................................................... 4

41-45......................................................... 3

46-50......................................................... 2

51 and up..................................................... 1

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The second measure is Holding Orders Without Action, which measures

the number of market and marketable limit orders (all sizes included)

\6\ that are held without action for greater than twenty-five (25)

seconds. As in the Turnaround Time calculation, a stop, cancellation,

execution or partial execution stops the clock. The same exclusions

which apply in the Turnaround Time calculation also apply here.\7\

Thus, if a specialist receives a total of 100 market and marketable

limit orders and holds ten of them for more than twenty-five seconds,

his or her raw score of 10% would receive nine points as it falls in

the six to ten percent range. This calculation will comprise 5% of the

overall evaluation program.

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\6\ Unlike Turnaround Time, Holding Orders Without Action is not

limited to those orders guaranteed automatic execution through

BEACON.

\7\ The Holding Orders Without Action calculation will not be in

effect until the individual stock has opened on the primary market.

In addition, certain situations, such as trading halts and periods

where the BEACON system is off auto-ex floorwide, will result in

blocks of time being excluded from the Holding Orders Without Action

calculation. See December 1993 Approval Order.

Holding Orders Without Action

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

Percentage of orders Points

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

0-5........................................................... 10

6-10.......................................................... 9

11-15......................................................... 8

16-20......................................................... 7

21-25......................................................... 6

26-30......................................................... 5

31-35......................................................... 4

36-40......................................................... 3

41-45......................................................... 2

46 and up..................................................... 1

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This third measure is Trading Between the Quote, which 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

\1/8\th. Thus, if a specialist receives ten market and marketable limit

orders where the spread between the best consolidated bid and offer is

greater than \1/8\th, and such specialist executes five of the orders

between the bid and offer, his or her raw score would be 50% and would

receive nine points as it falls in the 46 to 50 percent range. This

calculation will comprise 35% of the overall evaluation program.

Trading Between the Quote

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

Percentage of orders Points

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

51 and up..................................................... 10

46-50......................................................... 9

41-45......................................................... 8

36-40......................................................... 7

31-35......................................................... 6

26-30......................................................... 5

21-25......................................................... 4

16-20......................................................... 3

11-15......................................................... 2

0-10.......................................................... 1

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The fourth measure is Executions in Size Greater than BBO, which

measures the number of market and marketable limit orders which exceed

the BBO size and are executed in a size larger than the BBO size. Thus,

if a specialist receives a total of ten market and marketable limit

orders which exceed the BBO size and executes nine of the orders in

sizes larger than the BBO size, his or her raw score would be 90% and

would receive eight points as it falls in the 86 to 90 percent range.

This calculation will comprise 35% of the overall evaluation program.

Executions in Size Greater Than BBO

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

Percentage of orders Points

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

96-100........................................................ 10

91-95......................................................... 9

86-90......................................................... 8

81-85......................................................... 7

76-80......................................................... 6

71-75......................................................... 5

66-70......................................................... 4

61-65......................................................... 3

56-50......................................................... 2

55 and below.................................................. 1

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

The fifth measure is the SPEQ.\8\ The minimum acceptable raw score

for each question is 4.5. Thus, if a specialist receives a raw score of

4.5 for each question for a weighted raw score (based on the weights

for each question within the questionnaire) of 50.0052, he or she would

receive four points as it falls in the 50 to 54 weighted score range.

The questionnaire will comprise 5% of the overall evaluation program.

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\8\ Several changes were made to the SPEQ in view of the

adoption of the objective measures which have made some questions

obsolete. See the January 1996 Approval Order.

Questionnaire

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

Weighted raw score Points

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

83 and above.................................................. 10

77-82......................................................... 9

72-76......................................................... 8

66-71......................................................... 7

[[Page 3933]]

61-65......................................................... 6

55-60......................................................... 5

50-54......................................................... 4

44-49......................................................... 3

38-43......................................................... 2

37 and below.................................................. 1

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

Using the examples from each measure above, the following weighted

point totals would result in an overall program score of 8.0:

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

Weighted

Measure Points points

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

Turnaround Time (20%)............................... 7 1.40

Holding Orders Without Action (5%).................. 9 0.45

Trading Between the Quote (35%)..................... 9 3.15

Executions in Size BBO (35%)............ 8 2.80

Questionnaire (5%).................................. 4 0.20

----------

....... 8.00

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Any specialist who is deficient \9\ in any one of the objective

measures for any review period will be required to appear before the

Performance Improvement Action Committee (``PIAC'') to discuss ways of

improving performance. If performance does not improve in the

subsequent period, the specialist will appear before the Market

Performance Committee (``MPC'') for appropriate action, as described

below.\10\

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\9\ A specialist is deficient in any measure if he or she scores

below the minimum adequate performance thresholds set forth below.

See infra text accompanying note 10.

\10\ The SEC notes that, in the event a specialist's performance

does not improve, the Supplemental Material to the SPEP authorizes

the MPC to take the following actions: suspending the specialist's

trading account privilege, suspending his or her alternate

specialist account privilege, or reallocating his or her specialty

stocks. See BSE Rules, Ch. XV, para. 2156.10-2156.60.

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Any specialist who falls below the threshold level for the overall

evaluation program for any review period will be required to appear

before the MPC, which will take action to address the deficient

performance as provided for in the Supplemental Material to the

SPEP.\11\ A specialist who is ranked in the bottom 10% of the overall

evaluation program but who is above the threshold level for the overall

program will be subject to staff review to determine if there is

sufficient reason to warrant informing the PIAC of potential

performance problems.

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\11\ See supra note 8.

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The following threshold scores have been set at which a specialist

will be deemed to have adequately performed: \12\

\12\ A specialist who receives a score that is below a minimum

adequate performance threshold will be deemed to be deficient in

that measure. See supra note 7.

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Overall Evaluation Score--at or above weighted score of 6.70

Turnaround Time--below 21.0 seconds (8 points)

Holding Orders Without Action--below 21.0% (7 points)

Trading Between the Quote--at or above 31.0% (6 points)

Executions in Size > BBO--at or above 81.0% (7 points)

Questionnaire--at or above weighted score of 50.0 (4 points)

Due to the subjectiveness of the questionnaire, a specialist who is

deficient on the questionnaire alone will be subject to review by

Exchange staff to determine if there is sufficient reason to warrant

informing the PIAC of potential performance problems. However, a

deficient score on the questionnaire may result in a performance

improvement action when it lowers the overall program score below 6.70.

The Exchange requests an extension of the current pilot program

through December 31, 1997. This approximate twelve-month period will

enable the Exchange to further evaluate the appropriateness of the

measures and their respective weights, as well as the effectiveness of

the overall evaluation program.

2. Statutory Basis

Section 6(b)(5) of the Act \13\ is the basis of the proposed rule

change in 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, thereby promoting just and

equitable principles of trade and aiding in the perfection of a free

and open market and a national market system.

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\13\ 15 U.S.C. 78f(b)(5).

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

The Exchange does not believe that the proposed rule change will

impose any burden on competition.

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

Rule Change Received From Members, Participants or Other

No written comments were either solicited or received.

III. 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 provision

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-96-13 and

should be submitted by February 18, 1997.

IV. Commission's Findings and Order Granting Accelerated Approval of

Proposed Rule Change

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 promulgated 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 SPEP is critical to this oversight.

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\14\ Rule 11b-1, 17 CFR 240.11b-1; BSE Rules Ch. XV, para.

2155.01.

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In its 1993 order approving the incorporation of objective measures

of performance,\15\ the Commission asked the Exchange to monitor the

effectiveness of the amended SPEP. 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 condition for review, were referred to the PIAC and/or the MPC;

and about the type of action taken with respect to each such deficient

specialist. In September

[[Page 3934]]

1993, October 1994, December 1995 and January 1997, the BSE submitted

to the Commission monitoring reports regarding its amended SPEP. The

reports describe the BSE's experience with the pilot program during

1993, 1994, 1994 and the first two periods of 1996.

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\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.

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In its January 1996 Approval Order extending the pilot program, the

Commission set forth concerns with the pilot program. The Commission

reviewed the BSE's experience with its minimum adequate performance

thresholds and noted that the acceptable levels of performance had not

been revised since the beginning of the pilot and should be reviewed.

The Commission also stated that taking the SPEP as a whole, most

potential performance problems needed to be brought to the attention of

the appropriate committee and that the BSE should examine its SPEP to

ensure that adequate corrective actions are taken with respect to each

deficient specialist. The BSE addressed these concerns and certain

changes to the SPEP were approved by the Commission, as discussed in

more detail below. However, the Commission believes that the Exchange

should continue to monitor these concerns.

In terms of the overall scope of the SPEP, 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. In this regard, the objective criteria have been useful in

identifying how well specialist carry out certain aspects (i.e.,

timeliness of execution, price improvement and market depth) of their

responsibilities as specialists. In conclusion, although the Commission

believes the BSE should evaluate means to strengthen its performance

oversight program, the pilot has been a positive first step towards

developing a more effective SPEP. Accordingly, the Commission believes

that it is appropriate to extend the pilot program for an approximate

twelve-month period, expiring December 31, 1997.

This period will allow the Exchange to respond to the Commission's

continuing concerns about the SPEP. First, the Commission expects the

BSE to continue to evaluate the incorporation of additional objective

criteria,\16\ so that the Exchange can conduct a thorough analysis of

specialist performance.\17\ At the same time, the BSE should continue

to assess whether each measure, as well as the questionnaire, is

assigned an appropriate weight.\18\ In addition, the Commission expects

the Exchange to continue to conduct an on-going examination of its

minimum adequate performance thresholds, in order to ensure that they

continue to be set at appropriate levels.\19\ The Commission also

continues to believe that relative performance rankings that subject

the bottom 10% of all specialist units to review by an Exchange

committee are an important part of an effective evaluation program. The

BSE should continue to 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.\20\ The Commission would have

difficulty granting permanent approval to a SPEP that did not include a

satisfactory response to the concerns described above.

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\16\ The Commission notes that in a previous rule change

proposal, the Exchange stated it was currently engaged in an effort

to develop other measures of performance for inclusion in the SPEP

and hoped to file for modification to the program in the near

future. See Securities Exchange Act Release No. 37581 (August 19,

1996), 61 FR 43797 (August 26, 1996) (August 1996 Release). No new

objective performance measures have been added at this time.

\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\ The Commission had recommended in its January 1996 Approval

Order that the BSE consider either having only one measure out of

the Turnaround Time and Holding Orders Without Action categories or

reducing the weights of the existing measures, which together

accounted for 30% of the current SPEP, because of the substantial

overlap between those two measures. In response to this

recommendation, the BSE did reduce the weights of these two measures

to 25% of the overall program. In addition, the decrease in these

two categories, as well as a decrease in the weight of the SPEQ to

5%, enabled the Exchange to increase the weight of each of the other

objective criteria from 25% to 35%. See August 1996 Release.

\19\ In response to this recommendation, which was also included

in the January 1996 Approval Order, the BSE revised some of the

minimum adequate performance levels. The revised levels provide a

higher benchmark for acceptable specialist performance on the

Exchange, which in turn benefits the execution of public orders on

the BSE and further the protection of investors. See August 1996

Release.

\20\ In response to these comments, the BSE revised its review

process by tightening the standards for committee review for

substandard specialist performance both in the overall program and

in individual measures. The criteria for PIAC review for substandard

performance in any one objective measure was reduced from two out of

three consecutive review periods to any one review period. The

criteria for MPC review of substandard performance in any one

objective measure was reduced from three out of four consecutive

review periods to two out of three consecutive review periods, while

MPC review for substandard overall performance was reduced from two

out of three consecutive review periods to any one review period.

See August 1996 Release.

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The Commission therefore requests that the BSE submit a report to

the Commission, by September 17, 1997, describing its experience with

the pilot. At a minimum, this report should contain data, for the last

review period of 1996 and the first two review periods of 1997, on (1)

the number of specialists who fell below acceptable levels of

performance for each objective measure,\21\ 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 PIAC for informal

counseling; (3) the number of such specialists then referred to the MPC

and the type of action taken; (4) the number of specialists who, as a

result of the overall program, appeared before the MPC and the type of

action taken; (5) the number of specialists who, as a result of the

questionnaire or falling in the bottom 10% were referred by the

Exchange staff to the PIAC and the type of action taken (this should

include the number of specialists then referred to the MPC 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. The report also should discuss the specific action taken by

the BSE to develop additional objective measures and address the other

concerns noted above. Any requests to modify this pilot, to extend its

effectiveness or to seek permanent approval for the SPEP should be

submitted to the Commission by September 17, 1997, as a proposed rule

change pursuant to Section 19(b) of the Act.

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\21\ For each objective measure, the Commission also requests

that the BSE provide the mean and median scores.

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For the reasons discussed above, the Commission finds that the

BSE's proposal to extend its SPEP pilot program until December 31, 1997

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. Specifically, the Commission finds that the

proposed rule change is consistent with the Section 6(b)(5) \22\

requirement that the rules of the

[[Page 3935]]

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.

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\22\ 15 U.S.C. 78f(b)(5).

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Further, the Commission finds that the proposal is consistent with

Section 11(b) of the Act \23\ and Rule 11b-1 thereunder \24\ which

allow securities exchanges to promulgate rules relating to specialists

in order to maintain fair and orderly markets and to remove impediments

to and perfect the mechanism of a national market system.

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\23\ 15 U.S.C. 78k(b).

\23\ 17 CFR 240.11b-1.

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The Commission finds good cause for approving the proposed rule

change prior to the thirtieth day after the date of publication of

notice thereof in the Federal Register. This will permit the pilot

program to continue and allow the BSE time to consider improvements to

its program. In addition, the rule change that implemented the pilot

program was published in the Federal Register for the full comment

period, and no comments were received.\25\ Accordingly, the Commission

believes that it is consistent with the Act to accelerate approval of

the proposed rule change.

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\25\ See February 1993 Approval Order, supra note 3.

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It is therefore ordered, pursuant to Section 19(b)(2) of the Act

\26\ that the proposed rule change (File No. SR-BSE-96-13) is hereby

approved on a pilot basis until December 31, 1997.

\26\ 15 U.S.C. 78s(b)(2).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\27\

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\27\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97-1818 Filed 1-24-97; 8:45 am]

BILLING CODE 8010-01-M