[Federal Register Volume 62, Number 175 (Wednesday, September 10, 1997)]
[Notices]
[Pages 47715-47718]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-23955]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39009; File No. SR-NYSE-96-16]
Self-Regulatory Organizations; New York Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change Relating to Amendments
to Percentage Order Rules 13 and 123A.30
September 3, 1997.
I. Introduction
On June 28, 1996, the New York Stock Exchange, Inc. (``NYSE'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend its rules relating to
percentage orders.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in Securities
Exchange Act Release No. 37495 (July 30, 1996), 61 FR 40699 (August 5,
1996). No comments were received on the proposal. This order approves
the proposed rule change.
II. Description
NYSE Rule 13 defines a percentage order as ``a limited price order
to buy (or sell) fifty percent of the volume of a specified stock after
its entry.'' A percentage order is essentially a memorandum entry left
with a specialist, specifying the total number of shares to be bought
or sold and the limit price, which becomes a ``live'' order capable of
execution in one of two ways: (i) all or part of the order can be
``elected'' as a limit order on the specialist's book based on trades
in the market; or (ii) all or part of the order can be ``converted''
into a limit order to make a bid or offer or to participate directly in
a trade.
A. The Election Process
1. Current Practice
Under the election process, as trades occur at the percentage
order's limit price or better, an equal number of shares of the
percentage order are ``elected'' and become a limit order on the
specialist's book. This limit order takes its place behind other limit
orders on the specialist's book at the same price. The percentage order
then is reduced by the number of elected shares until the entire order
has been satisfied.
[[Page 47716]]
Currently, there are three types of percentage orders: last sale
percentage orders, straight limit percentage orders,\3\ and buy minus-
sell plus percentage orders.\4\ The Exchange has indicated that most
percentage orders are entered as last sale percentage orders, meaning
that they are elected to the book at the price of the elecing sale and
may be executed at such price, or at a better price.\5\ These orders
may not, however, be executed at an inferior price to the electing sale
even if that inferior price is still within the limit price on the
order.
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\3\ A straight limit percentage order carries a limit price
equal to the percentage order limit price.
\4\ A buy minus-sell plus percentage order operates in the same
fashion as a straight limit percentage order, except that it places
the additional requirement that elected portions of buy (sell)
percentage orders be elected at a price on minus or zero-minus ticks
(plus or zero plus ticks) from the previous sale.
\5\ The various types of percentage orders differ only in terms
of execution, and not the process by which they are elected. See
supra notes 3 and 4.
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For example, assume that the specialist receives a last sale
percentage order to purchase 5,000 shares with a limit price of 30. If
a trade of 500 shares takes place at 29\1/2\, 500 shares of the
percentage order would be placed on the specialist's book as a limit
order at 29\1/2\. This order could be executed at a price of 29\1/2\ or
lower, but could not be executed at a higher price, even though the
limit price on the percentage order was 30.
2. Proposed Amendment to the Election Process
The Exchange is proposing to amend the definition of last sale
percentage order in Rule 13 to provide that if the order is marked with
the instruction ``last sale-cumulative volume,'' such orders may be re-
entered on the specialist's book after their initial election at the
price of subsequent transactions, as long as the price is within the
limit price on the percentage order. Thus, in the example noted above,
if there was a subsequent trade of 500 shares at 29\5/8\, 500 shares of
a percentage order marked last sale-cumulative volume would be elected
on to the specialist's book at 29\5/8\, and the 500 shares previously
entered on to the book at 29\1/2\ would be cancelled and reentered at
29\5/8\, for a total of 1,000 shares of the percentage order on the
book at 29\5/8\.\6\ If the order were simply marked ``last sale,'' it
would be handled as today under the current rule.
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\6\ In the event that a portion of a percentage order is elected
at the same price as a previously elected, but still unexecuted,
portion of the same percentage order, the previously-elected portion
will neither be cancelled nor lose its priority on the limit order
book. In such situations, however, the subsequently-elected portion
will not gain priority over previously-entered orders on the book at
that price. Telephone conversation between Donald Siemer, Director
of Market Suveillance, NYSE, Mel Hanton, Senior Counsel, NYSE, and
Jon Kroeper, Attorney, SEC, on August 30, 1996.
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B. The Conversion Process
1. Current Practice
The second way that a percentage order can be activated into a
limit order is through the conversion process. Most percentage orders
contain the additional instruction ``CAP-D.'' ``CAP'' is an acronym
meaning ``convert and parity,'' which instructs the specialist that he
or she may convert all or a portion of the order into a limit order,
and allows the specialist to be on parity with the converted percentage
order, either to participate directly in a trade or to make a bid or
offer (``bettering the market''). The ``D'' notation instructs the
specialist that the order may be converted to participate in
destabilizing transactions as well as stabilizing transactions.
The Exchange has stated that, as a practical matter, it views CAP-D
orders as a necessary adjunct to the standard election procedures
because they allow the specialist greater flexibility to match the
order with other buying and selling interest in the market. CAP-D
orders are subject to a number of restrictions intended to minimize the
specialist's discretion in handling such orders.\7\
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\7\ See NYSE Rule 123A.30; Securities Exchange Act Release No.
24505 (May 22, 1987), 52 FR 20484 (June 1, 1987) (order approving
amendment to Rule 123A.30 permitting conversion of percentage orders
on destabilizing ticks under certain restrictions).
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One such restriction codified in Rule 123A.30 provides that a
percentage order may be converted into a limit order to make a bid
(offer), but if a higher bid (lower offer) is subsequently made, the
converted percentage order bid (offer) is treated as cancelled, and
reverts to a memorandum entry with the specialist, which is subject to
further conversion. This means that the bid or offer loses whatever
priority it has with respect to other limit orders on the specialist's
book.
For example, assume that the market is quoted 20-20\1/4\, 10,000
shares bid and offered, with the bid at 20 representing 10,000 shares
of a converted percentage order. Under the current rule, if the
specialist then receives an order to buy 5,000 shares at 20, and an
order to buy 200 shares at 20\1/8\, when the specialist changes the
quotation to 20\1/8\-20\1/4\, 200 shares bid and 10,000 offered, the
converted percentage order bid of 20 for 10,000 is cancelled, and the
5,000 share order now has priority on the specialist's book at 20. If a
transaction took place at 20\1/8\, and the quotation reverted to 20-
20\1/4\, the percentage order, although it can be re-converted to add
to a bid at 20, would have lost its priority on the book.
2. Proposed Amendments to the Conversion Process
The Exchange is proposing to amend Rule 123A.30 to allow the
converted percentage order to retain its priority on the book when a
higher bid (lower offer) is made. However, if a transaction is effected
at that higher bid (lower offer), and a bid or offer is made that is
higher (lower) than the price of such transaction, the converted
percentage order would be cancelled, subject to re-conversion. The
order would not be cancelled, however, regardless of subsequent trades
in the market, if it was converted at its maximum limit price.
In addition, the Exchange is proposing to amend Rule 123A.30 to
include a provision that a specialist must document the status of a
converted percentage order on the specialist's book as a limit order at
the price it was converted.
III. Discussion
The Commission has considered carefully whether the NYSE's proposal
is consistent with the Act. Specifically, the Commission has considered
whether the proposal is consistent with the requirements set forth in
Sections 6(b) and 11(b) of the Act.\8\ In reviewing previous proposals
involving percentage orders, the Commission has been concerned whether
such orders provide the specialist with ``discretion'' in violation of
Section 11(b) of the Act. Section 11(b) was designed, in part, to
address potential conflicts of interest that may arise as a result of a
specialist's dual role as agent and principal in executing stock
transactions. In particular, Congress intended to prevent specialists
from unduly influencing market trends through their knowledge of market
interest from the specialist book and their handling of discretionary
agency orders.\9\ The Commission has interpreted this section to mean
that all orders other than market or limit orders are discretionary and
therefore cannot be accepted by a specialist.\10\
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\8\ 15 U.S.C. 78f(b) and 78k(b).
\9\ See H. Rep. No. 1383, 73d Cong., 2d Sess. 22; S. Rep. 792,
73d Cong., 2d Sess. 18 (1934).
\10\ See e.g., SEC, Special Study of the Securities Markets,
H.R. Doc. No. 95, 88th Cong., 1st Sess., Part 2, 72 (1963)
(``Special Study'') (nothing that ``Section 11(b)* * * prohibits,
without exception, a specialist's effecting any transaction except
upon a market or limit order'').
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The Commission previously has determined that it is appropriate to
treat
[[Page 47717]]
percentage orders as equivalent to limit orders.\11\ With regard to the
conversion process in particular, while acknowledging that it permits
specialists to employ their judgment to a certain extent, the
Commission believed that the requirements imposed on the specialist
when converting a percentage order for execution or quotation purposes
provided sufficiently stringent guidelines to ensure that the
specialist only will implement the conversion provisions in a manner
consistent with his or her market making duties and Section 11(b).
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\11\ See Securities Exchange Act Release No. 24505 (May 22,
1987), 52 FR 20484 (June 1, 1987) (File No. SR-NYSE-85-1).
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Furthermore, the Commission previously has determined that the
NYSE's percentage order rules are consistent with the standards set
forth under Section 6(b)(5) of the Act. This section requires that the
rules of an exchange be designed to prevent fraudulent and manipulative
acts and practices. The Commission determined that the NYSE's
percentage order rules contain various limiting and protective
provisions, to ensure that such rules will not increase the possibility
of specialist abuse of the market.
As discussed in greater detail below, the Commission finds that the
proposed rule change, in adding a last sale-cumulative volume
instruction to the election process and making a minor modification to
the conversion process, does not adversely impact the protective scheme
that has been incorporated into the percentage order rules.
Accordingly, the Commission finds that the proposed rule change is
consistent with Sections 6(b)(5) and 11(b) of the Act in that it
neither increases specialists' ability to engage in fraudulent and
manipulative practices nor allots discretion to specialists in their
handling of percentage orders.
A. Adoption of the Last Sale-Cumulative Volume Instruction
Currently, portions of last sale percentage orders only may be
elected to the specialist's book as limit orders at the price of the
electing transaction. If the market subsequently moves away from this
place, such orders will remain on the book without receiving an
execution.\12\ To address this situation, the Exchange has proposed to
add a last sale-cumulative volume percentage order instruction option
to the definition of last sale percentage order in NYSE Rule 13. If a
percentage order entered with the specialist is marked ``last sale-
cumulative volume,'' a previously-elected portion of a percentage order
will be cancelled and re-entered at the price of subsequent
transactions that are within the limit price of the percentage order.
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\12\ The Commission notes that the floor broker who entered the
percentage order may instruct the specialist to cancel the elected
order from the book at any time.
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The Commission believes that the adoption of the last sale-
cumulative volume instruction is appropriate in that it comports with
the underlying rationale for the percentage order rule; namely, to
allow larger-sized orders to trade along with the trend of the market
without requiring a floor broker to remain in the trading crowd to work
the order. By cancelling and re-entering previously-elected portions of
a last sale percentage order at the current market price, the proposed
instruction will increase the likelihood that such orders will be
executed in accordance with the trend of the market, instead of
remaining on the specialist's book at an elected price from which the
market has moved away. In the same regard, the Commission notes that
the proposed instruction should facilitate the use of last sale
percentage orders by floor brokers, as a floor broker will no longer
have to take the active step of cancelling such orders from the
specialist's book when the market moves away from the price of the
electing transaction.\13\ Further, the Commission believes that the
proposed instruction is appropriate in that it should have the
beneficial effect of increasing the possibility of interaction between
last sale percentage orders and contrasided market interest.
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\13\ The Commission notes, however, that a floor broker
maintains his or her best execution obligations with regard to any
percentage order that he or she may leave with a specialist.
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In addition, the Commission finds that the proposed instruction is
consistent with the Act in that it does not provide discretion to
specialists in the handling of last sale percentage orders or increase
the ability of specialists to engage in fraudulent or manipulative
activity on the Exchange. In this regard, the process whereby last
sale-cumulative volume percentage orders are elected and may be
cancelled from the book and re-entered at the price of subsequent
transactions is a purely mechanical one, determined solely by the
application of the proposed instruction to the price of subsequent
trades on the Exchange. The specialist is not provided with any
discretion over the process of cancelling or re-entering elected
orders.
Finally, the Commission believes that the proposed instruction
adequately addresses the issue of the priority of pre-existing orders
on the specialist's book to subsequently-elected portions of percentage
orders. For example, assume that the market is quoted at 20-20\1/2\,
1000 shares bid and offered, the bid composed of (in order of priority)
a 500 share customer order and 500 shares of an elected portion of a
last sale-cumulative volume percentage order for 5000 shares with a
limit price of 20\1/2\. The specialist then receives a customer limit
order to buy 1000 shares at 20 and changes his or her quote to 20-20\1/
4\, 2000 shares bid and 1000 offered. If a market order to sell 500
shares then enters the market and is executed against the customer
order to buy 500 shares at 20, an additional 500 shares of the
percentage order will be elected to the specialist's book. However,
this subsequently-elected portion of the percentage order will not be
combined with the previously-elected portion (as would be the case if
the transaction had occurred at a higher price than 20) and thereby
gain priority over the customer limit order for 1000 shares at 20.
Instead, the subsequently-elected portion will be placed at the bottom
of the book, behind both the previously-elected portion and the
customer order for 1000 shares in priority. As a result, pre-existing
customer interest will maintain its priority over subsequently-elected
percentage orders at the same price.
B. Amendments to the Conversion Process
Presently, a percentage order to buy (sell) that has been converted
for purposes of bettering the existing quote must be cancelled and
revert to a percentage order if a higher bid (lower offer) subsequently
is made. As the Exchange has noted, while the converted percentage
order would be subject to re-conversion at the same price, it would
lose its priority on the specialist's book to other orders at that
price. The proposed rule change would address this situation by
requiring that such converted percentage orders remain in the
specialist's book at their converted price unless a higher bid (lower
offer) is made, a transaction is effected at that price, and a bid
(offer) is made at a price higher (lower) than the price of the
transaction. In such an instance, the converted percentage order would
be cancelled, subject to reconversion.
The Commission believes that the proposed change to the conversion
process is appropriate in that it adequately balances the interest of
permitting converted percentage orders to retain their priority on the
specialist's book over subsequently-arriving orders at the same price
with that of removing
[[Page 47718]]
such converted percentage orders from the book when conditions strongly
indicate that the market has moved away from the conversion price.\14\
Moreover, the Commission finds that the proposal may have the
additional beneficial effect of increasing the transparency of the
market. Specifically, the proposal will allow percentage orders to buy
(sell) to remain on the book in the event of the entry of what may be a
short-lived higher bid (lower offer) instead of reverting directly to a
memorandum entry that the specialist may or may not decide to re-
convert for quotation purposes.
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\14\ At the same time, it should be noted that the Commission
has previously stated that a specialist can utilize the conversion
process to enable the percentage order and the specialist trading
for his or her own account to receive an execution while bypassing
pre-existing trading crowd and limit order book interest. See SEC,
Report on the Practice of Preferencing (April 11, 1997) at Part
II.B.6.
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Moreover, in approving the adoption of the CAP-D instruction, the
Commission stated that it ``views as important the cancellation
provision of the proposed bettering the market rule.'' \15\ The
significance of such a provision is to provide a cancellation mechanism
that does not grant any discretion to the specialist when superior-
priced same-sided interest enters the market. Accordingly, the
Commission believes that the proposed procedure is an appropriate
replacement for the existing cancellation provision in that it serves
this same purpose.
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\15\ See Securities Exchange Act Release No. 24505, supra note
11.
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Finally, the Exchange proposes to add to Rule 123A.30 a provision
that a specialist must document the status of a converted percentage
order on his or her book as a limit order at the price it was
converted. The Commission finds that this provision is appropriate in
that it provides specialists with a clearer statement of their existing
responsibility to book converted percentage orders.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\16\ that the proposed rule change (SR-NYSE-96-16) is approved.
\16\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\17\
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\17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Secretary.
[FR Doc. 97-23955 Filed 9-9-97; 8:45 am]
BILLING CODE 8010-01-M