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. 34-39730; File No. SR-BSE-97-09]

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

March 6, 1998.

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 December 17, 1997, 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.

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

Substance of the Proposed Rule Change

The Exchange seeks to amend its specialist performance evaluation

program (``SPEP'') pilot with the addition of several objective

measures, the deletion of the floor broker questionnaire, a change from

using trade statistics to using share statistics for the price

improvement and depth measures, a readjusted point system, readjusted

threshold levels and/or weights for all of the measures, and a change

in the review period for the program from tri-annual to quarterly. The

proposed pilot program is intended to expire on December 31, 1998.\3\

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\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. 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); 36668 (January 2, 1996), 61 FR 672 (January 9,

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

31, 1996); and 38128 (January 17, 1997), FR (January, 1997) (Pilot

extended until December 31, 1997).

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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

Since the inception of the pilot program in February 1993, the

Exchange has continuously reviewed and fine-tuned the SPEP to ensure

that its specialists are providing competitive and quality executions.

In addition to looking for new objective measures of performance, the

Exchange has periodically changed the threshold levels and weights of

the existing measures. After an extensive review of overall Exchange

performance in the areas of price improvement and depth, areas which

the Exchange's Market Performance Committee and Board of Governors has

determined are critical to market quality, the Exchange is proposing to

measure price improvement in three categories covering all market

spreads (the current program focuses only on greater than eighth

spreads) and to heavily weight both the price improvement and depth

measures.

As occurs under the current program, only regular way,

unconditioned buy and sell market and marketable limit orders will

qualify for inclusion in the program, blocks of time will be excluded

from the program in the event of trading halts and system problems

which impact the validity of quotes; orders will be eligible for

measurement only if received after the primary market opens the stock;

stocks subject to competition will be included in the program; the same

staff and committee review time frames and available actions will

apply; and quarterly results will continue to be used in allocating

stocks.

The Exchange seeks to change the review periods from tri-annual to

quarterly, with each period beginning January, April, July, and

October. The Exchange believes that these shortened review periods will

permit a more frequent review process and a faster response to evident

performance, as well as enable specialists to address potential low

performance areas more efficiently.

Turnaround Time, which measures the average number of seconds from

the receipt of an order for 1299 shares or less in BEACON until it is

executed (in whole or in part), stopped or canceled, will remain

unchanged. Holding Orders Without Action, which measures the percentage

of orders (all order sizes included) which are neither executed (in

whole or in part), stopped nor canceled within twenty-five seconds,

[[Page 12848]]

will also remain unchanged. However, the point system and weights for

these two measures will be modified as described below.

The existing Trading Between the Quote measure is being replaced by

three separate price improvement measures. Each of these categories

will measure the percentage of shares \4\ executed at a price better

than the displayed national best bid or offer (``NBBO'') price at the

time the order is received. A separate category of orders will be

measures for less than one-eighth spreads, one-eighth spreads, and

greater than one-eighth spreads. Qualification in a category will be

based on the spread at the time the order is received.

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\4\ The Commission notes that the current Trading Between the

Quote criterion measures a specialist's performance in terms of

trades, not shares.

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The existing Executions in Size Greater than the Best Bid and Offer

(``BBO'') is being renamed as ``Depth'' and modified to measure shares

rather than trades. This calculation will measure the percentage of

shares exceeding the displayed NBBO size which are executed at or

better than the displayed NBBO price.\5\ Only orders which at the time

of receipt exceed the displayed NBBO size will qualify for this

measure. An additional depth measure is being added to the program,

called ``Added Depth,'' which will measure the number of shares

executed by each specialist at the displayed NBBO price in excess of

the displayed NBBO size at the time the order is received, as a

percentage of the total number of shares executed by all specialists at

the displayed NBBO price in excess of the displayed NBBO price.\6\ This

measure will also include only those orders that exceed the displayed

NBBO at the time of receipt of the order, and will provide the raw

score percentage attributable to each specialist relative to all other

specialists being evaluated.

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\5\ For example, assume the NBBO size is 500 shares displayed

and the BSE specialist receives an order for 1200 shares. Under the

current test, if the specialist executed 700 shares at the NBBO

price, he would effectively receive credit for executing the whole

order at the NBBO or better even though part of the order may have

been executed at a price inferior to the NBBO. (He would receive

credit for 1 trade out of 1 trade, or 100%). Under the proposed

revised test, measured in terms of shares versus trades, if the

specialist executed 600 shares at the NBBO price, the specialist

would receive credit for 600 shares out of 1200 shares, or 50%. If

the specialist executed 900 shares at the NBBO price, he would

receive credit for 900 out of 1200, or 75%.

\6\ For example assume the NBBO size is 500 shares displayed and

the BSE specialist receives an order for 1200 shares, and that the

specialist executes 600 shares at the displayed NBBO price.

Calculate how many shares over the NBBO size the specialist executed

by subtracting 500 from 600; the specialist has 100 shares of

``added depth.'' Then calculate the added depth for each qualifying

order for each specialist, add the added depth for each specialist

for each qualifying order, and total the added depth for all

specialists combined. Next, you compare each specialist's added

depth to the overall added depth for the floor to arrive at the

percentage for each specialist relative to the other specialists.

For example: 100 added depth for specialist A 10,000 added

depth for all specialists = 10% added depth for specialist A.

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The Specialist Performance Evaluation Questionnaire (``SPEQ''),

which has been a part of the Exchange's performance evaluation program

since 1984, is being eliminated. For some time now, it has been the

Market Performance Committee's and BSE staff's view that the

Questionnaire is too subjective to have any meaningful value in the

overall performance of a specialist. Over time, its weight has been

significantly reduced in the overall evaluation program. The Committee

intends to redevelop the questionnaire and reintroduce it at some point

in the future, possibly as a tool to aid the Committee in effectively

assessing the performance of specialists required to appear as a result

of deficient performance in the objective measures and overall program.

The current ten point scale that is applied to the raw scores for

each measure is also being changed in an effort to better differentiate

among scores. Ranges of scores will be given points of either 0, 5, 10,

15 or 20 points, with 5 points being at the threshold level for each

measure. Specialists who fall below the threshold level will receive 0

points, whereas under the current scale can be given for unacceptable

performance. The Exchange believes that these changes will provide an

incentive to specialists to improve lower levels of performance and

will reward those specialists who are significantly outperforming their

peers.

The proposed range point scales for each of the measures is as

follows:

1. Turnaround Time

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

Time in seconds Points

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

>=21.0........................................................ 0

16.0-20.9..................................................... 5

11.0-15.9..................................................... 10

0-10.9........................................................ 15

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

2. Holding Orders Without Action

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

Percentage of orders Points

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

>=21.0........................................................ 0

16.0-20.9..................................................... 5

11.0-15.9..................................................... 10

6.0-10.9...................................................... 15

0-5.9......................................................... 20

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

3. Price Improvement (=10.0........................................................ 20

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

4. Price Improvement (\1/8\ Spreads)

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

Percentage of orders Points

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

=30.0........................................................ 20

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

5. Price Improvement (>\1/8\ Spreads)

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

Percentage of orders Points

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

=45.0........................................................ 20

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

6. Depth

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

Percentage of orders Points

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

=90.0........................................................ 20

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

7. Added Depth

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

Percentage of orders Points

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

=6.0......................................................... 20

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

The following minimum threshold levels have been set, at which a

Specialist will be deemed to have adequately performed:

Overall Program--at or above weighted score of 5.00

Turnaround Time--below 21.0 seconds (5 points)

Holding Orders Without Action--below 21.0% (5 points)

[[Page 12849]]

Price Improvement (\1/8\--at or above 25.0% (5 points)

Depth--at or above 75.0% (5 points)

Added Depth--at or above 1.0% (5 points)

Assuming that a specialist performed at the above minimum threshold

levels for each measure, the breakdown of weighted points would be as

follows:

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

Weight Weighted

Measure (percent) Points points

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

Turnaround Time........................ 5 5 0.25

Holding Orders Without Action.......... 5 5 0.25

Price Improvement (\1/8\)............. 15 5 0.75

Depth.................................. 20 5 1.00

Added Depth............................ 20 5 1.00

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Overall Weighted Score........... ......... ......... 5.00

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

The Exchange is requesting accelerated approval of the proposed

rule change pursuant to Section 19(b)(2) of the Act. The Exchange

believes that such action is appropriate in that the existing

Specialist Performance Evaluation Program's heavily weighted objective

measure regarding price improvement in greater than one-eighth markets

has become obsolete as the sole determinant of price improvement

statistics. That category alone accounts for only ten percent of the

Exchange's overall trade volume. The Exchange also believes that the

current program's use of trade data is less effective than using share

data will be because share data will present a better overall picture

of execution quality. In addition, the Exchange believes that the

proposed changes will create a more meaningful and effective overall

program for evaluating its specialists, with the heavily weighted

market quality measures for price improvement and depth. Finally, the

Exchange seeks to implement this amended program as soon as possible

and has informed its specialists that such changes have been proposed

to the Commission for approval on an accelerated basis, and has begun

making the system programming changes necessary to accumulate,

calculate and store statistics for the program.

2. Statutory Basis

The Exchange believes that the statutory basis for the proposed

rule change is Section 6(b)(5) of the Act,\7\ in that it is designed to

promote just and equitable principles of trade; to foster cooperation

and coordination with persons engaged in regulating, clearing,

settling, 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; and is not

designed to permit unfair discrimination between customers, issuers,

brokers and dealers.

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\7\ 15 USC. 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 Others

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, 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.

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-97-09 and

should be submitted by April 6, 1998.

IV. Commission's Findings and Order Granting Accelerated Approval

of Proposed Rule Change

For the reasons discussed below, the Commission finds that the

BSE's proposal to extend the revised SPEP pilot program until December

31, 1998 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) \8\

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.

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\8\ 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 \9\ and Rule 11b-1 thereunder \10\ 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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\9\ 15 U.S.C. 78k(b).

\10\ 17 CFR 240.11b-1.

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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.\11\ To

ensure that specialists fulfill these obligations, it is important that

the Exchange conduct effective

[[Page 12850]]

oversight of their performance. The BSE's SPEP is critical to this

oversight.

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

2155.01.

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The Commission believes that the Exchange's development of two new

objective criteria, Price Improvement and Added Depth, is a positive

step forward in establishing meaningful objective specialist

performance criteria. These new objective measures are designed to

measure market quality in two important areas of specialist

performance, price improvement and depth. By replacing Trading Between

the Quote with Price Improvement, the amount of time the specialist

executes orders at a price better than the NBBO \12\ will be measured

in three categories covering all market spreads, rather than just in

greater than \1/8\th markets. The Added Depth measure will allow BSE to

measure in percentage terms, how often a specialist executes an order

at a size greater than the NBBO size, at the NBBO price, relative to

all the other specialists. In addition, the Commission believes it is

reasonable to measure Price Improvement and Depth and Added Depth in

terms of shares executed, rather than trades, because it should give a

better picture of a specialist's execution quality by giving

specialists credit for the number of shares in a trade actually

executed above the NBBO size at the NBBO price, rather than for an

entire trade where the specialist may have only executed part of the

trade at or better than the NBBO price.\13\

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\12\ In Trading Between the Quote, the performance was measured

against BSE's BBO rather than the NBBO.

\13\ See supra example note 5. In that example, under the

current regime, a specialist who executed 600 out of the 1200 shares

would receive the same credit as one who executes 800 out of 1200.

However, under the proposed rule change, the specialist who executed

800 shares would receive a higher score than the one who executes

600 shares.

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The Commission believes it is reasonable under the Act to amend the

point system for all of the objective measures of specialist

performance. The Commission believes that the revised test, where

specialists who fall below the adequate threshold levels will not

receive any points, as compared to the current scale where points are

still awarded for performance below the adequate threshold level,

should provide an added incentive to specialists to receive partial

credit for unacceptable performance. Regarding BSE's proposed reliance

on share statistics (versus trade statistics), the Commission believes

that the threshold levels set for each objective measure are

reasonable. The Commission nevertheless reiterates its previous request

that BSE continually monitor the adequate threshold levels and propose

adjustments as necessary. The Commission also believes that the change

in the weighting of each objective measure is reasonable, in that the

Price Improvement and depth measures, which measure market quality and

liquidity, are more highly weighted than Turnaround Time and Holding

Orders Without Action, which have been reduced to 10% combined weight.

The Commission believes it is reasonable for BSE to eliminate the

current SPEQ, a subjective measure of specialist performance,

particularly given the breadth of the proposed performance measures,

which rely on objective criteria. The Commission also believes it is

consistent with the Act to allow the Exchange to review the specialist

performance quarterly, rather than tri-annually. By allowing for more

frequent review of specialist performance, BSE should be able to

respond more rapidly and efficiently in order to identify deficient

performance by specialists.

Extending the pilot program until December 31, 1998 will allow the

Exchange to gain experience in administering the new specialist

performance program and provide sufficient time for BSE to respond to

the Commission's continuing concerns about the SPEP. In particular, the

Commission expects the BSE to incorporate additional objective criteria

into the SPEP, most importantly, a measure of quote performance \14\

The Commission recently observed, in its study on the practice of

preferencing, that BSE specialists' quotes are only equal to the NBBO a

very low percentage of the time.\15\ In response to a request from the

Division of Market Regulation to address the issue of measuring

specialist quote performance, BSE has stated that it is currently

developing the technological means to evaluate quote performance and

will submit a rule amendment in September 1998 modifying its SPEP to

include an objective measure of quote performance.\16\

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\14\ 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 NBBO

(excluding quotes for 100 shares). Another possible objective

criteria could measure quote performance; how often the BSE

specialist's quote, in price, is alone at or the same as the NBBO.

See January 1996 Approval Order.

\15\ See Report on the Practice of Preferencing Pursuant to

Section 510(c) of the National Securities Markets Improvement Act of

1996, Commission, April 11, 1997 at Table V-5 (BSE specialists'

quotes are equal to the NBBO approximately only 5% of the time).

\16\ See letter from Karen A. Aluise, Vice President, BSE, to

Howard Kramer, Associate Director, Market Regulation, Commission,

dated February 13, 1998.

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During the next year of the pilot's operation, BSE should continue

to assess whether each SPEP measure is assigned an appropriate

weight.\17\ 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.\18\ The Commission notes its continued belief

that relative performance rankings that subject the bottom 10% of all

specialist units to review by an Exchange committee are 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.\19\ 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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\17\ 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 these existing measures, which together

accounted for 30% of the current SPEP, given the substantial overlap

between those two measures. In response to this recommendation, the

BSE first reduced the weights of two measures to 25% of the overall

program, and decreased the weight of the SPEQ to 5% and increasing

the weight of each of the other objective criteria from 25% to 35%.

See August 1996 Release. In addition, the current proposed rule

change further reduces the weights of the two measures to 5% each.

\18\ In August 1996, in response to this same recommendation the

BSE some of the minimum adequate performance levels to provide a

higher benchmark for acceptable specialist performance on the

Exchange. See August 1996 Release.

In the current proposed rule change, BSE has further amended the

performance level of price improvement (which replaces Trading

Between the Quote) and the two depth measures by slightly lowering

them, to reflect the change from measuring performance in terms of

trades to shares.

\19\ In response to these comments, the BSE previously 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 crieteria 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

[[Page 12851]]

Commission, by September 17, 1998, describing its experience with the

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

review period of 1997 and the first two review periods of 1998, on (1)

the number of specialists who fell below acceptable levels of

performances for each objective measure, \20\ the questionnaire (for

the last review period of 1997) 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 (for the last review

period of 1997) 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, 1998, as a proposed rule

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

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\20\ For objective measure, the Commission also requests that

the BSE provide the mean and median scores.

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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.\21\ Accordingly, the Commission

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

the proposed rule change.

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\21\ See February 1993 Approval Order, supra note 4.

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It is therefore ordered, pursuant to Section 19(b)(2) \22\ that the

proposed rule change is hereby approved on an accelerated basis,

through December 31, 1998.

\22\ 15 U.S.C. 78s(b)(2).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\23\

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\23\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-6662 Filed 3-13-98; 8:45 am]

BILLING CODE 8010-01-M