Self-Regulatory Organizations; Order Approving Proposed Rule Change by the New York Stock Exchange, Inc. to Amend Exchange Rule 104 (“Dealings by Specialists”)

I. Introduction

On November 16, 1999, the New York Stock Exchange, Inc. (“NYSE” or “Exchange”) submitted to the Securities and Exchange Commission (“Commission”), pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, a proposed rule change. In its proposal, the NYSE seeks to increase capital requirements for specialist entities exceeding certain concentration-based criteria, and prescribe additional capital requirements for specialist entities resulting from merger, acquisition, consolidation, or other combinations of specialist assets. The proposed rule change was published for comment in the Federal Register on February 18, 2000. The Commission received no comments on the proposed rule change, and this order approves the proposal.

II. Description of the Proposal

During the last decade, there has been a significant decline in the number of specialist units operating on the floor of the Exchange. Currently, there are 27 specialist units, with 491 specialists registered in 2,871 common stocks. The trend in specialist consolidations has raised concerns at the NYSE over the number of stocks assigned to any one specialist entity and the impact that market volatility can have on specialist entities and the overall operation of the market. The NYSE believes that adequate capitalization of the significantly larger specialist units is critical in dealing with volatile markets and in meeting specialist market maintenance obligations. Accordingly, the NYSE proposed Rule 104.21 to increase the minimum capital requirements of any specialist or specialist unit that exceeds certain concentration criteria.

The new provision would apply to any specialist or specialist unit whose market share is greater than 5% of any of the following concentration measures:

(1) All listed common stock (current);

(2) The 250 most active listed common stocks (over the previous 12 months);

(3) The total share volume of stock trading on the Exchange (over the previous 12 months);

(4) The total dollar value of stock trading on the Exchange (over the previous 12 months).

If the 5% threshold is exceeded, the new provision requires that the specialist entity maintain, at a minimum, net liquid assets equivalent to the following applicable requirements:

(1) $4 million for each specialist security contained in the Dow Jones Industrial Average;

(2) $2 million for each specialist security contained in the Standard & Poor's 100, not contained in 1;

(3) $1 million for each specialist security contained in the Standard & Poor's 500, not contained in 1 or 2;

(4) $500,000 for each specialist common stock, excluding bond funds, not contained in 1, 2, or 3;

(5) $100,000 for each specialist security not included in 1 through 4, excluding warrants.

In addition, proposed Rule 104.22 would require any new specialist entities resulting from merger, acquisition, consolidation, or other combination of specialist assets, to maintain net liquid assets equivalent to the greater of either:

(1) The aggregate net liquid assets of the specialist entities prior to their combination, or

(2) The capital requirements otherwise prescribed by Rule 104. According to the Exchange, the purpose of this requirement is to prevent specialist units from withdrawing capital, prior to or upon combination of their assets, resulting in the combined entity having less capital than its component parts.

Because the proposal may subject specialist entities to sudden and substantially increased capital requirements, the proposal would grant the Exchange the discretion to allow a specialist entity to operate, for a period not to exceed 5 business days, despite the specialist entity's non-compliance with the provisions mentioned above. The Exchange believes that this limited discretionary authority would, under appropriate circumstances, permit the Exchange to determine a reasonable time period for the infusion of additional specialist capital without disruption the maintenance of a fair and orderly market, particularly in volatile market situations. The Exchange also believes that the time period would allow for the orderly reallocation of specialist securities in the event a specialist entity is unable to comply with the prescribed requirements. The NYSE notes that this authority extends only to compliance with the heightened concentration/combination standards proposed in this filing; it does not apply to the Commission's net capital requirements or the net capital requirements prescribed by NYSE Rule 104.20.

Further, the Exchange proposed that the capital requirements of specialist securities not specifically addressed in the Rule (i.e., certain derivatives and structured products) be determined by the Exchange according to a comparison of the products' structure and characteristics relative to the existing standardized securities whose capital requirements are currently prescribed in the Rule. The NYSE believes that this provision is necessary given the potentially limitless variety of derivative and structured products, which are not easily categorized. In addition, the NYSE proposes to clarify the definition of “net liquid assets” and distinguish its application to specialist units subject to the Commission's net capital rule from specialist units which are not.

The Exchange proposed that the effective date of the rule amendments will be no later than ninety (90) days from the date of Commission approval, but it may be earlier, i.e., thirty (30) days following written notice to the membership if the NYSE determines that specialist entities are ready to comply with the new requirements.

III. Discussion

After careful review, the Commission finds that the proposed rule change is consistent with the requirements of the Act. In particular, the Commission finds the proposal is consistent with Section 6(b)(5) of the Act in that it addresses concerns about capitalization, operational efficiency, and risk management. Section 6(b)(5) requires, among other things, that the rules of an exchange be designed to promote just and equitable principles of trade and to protect investors and the public interest.

The Commission believes that these new requirements are appropriate because they help ensure that specialist units have sufficient, separately dedicated capital with which to meet their market making responsibilities. Specialists occupy a unique position at the NYSE, and under NYSE rules, specialists are charged with the responsibility of maintaining fair and orderly markets. The proposal increases capital requirements for specialist entities exceeding certain concentration-based criteria. In times of market volatility, specialist entities that meet these concentration criteria could potentially be subject to financial risk. This proposal helps ensure that these specialists are adequately capitalized and can meet their obligation of maintaining fair and orderly markets.

The Commission also believes that it is appropriate to place additional capital requirements on specialists units that are combining. The combined entity will be larger than either of the two (or more) original entities, responsible for more securities, and financially exposed to a larger degree. The potential impact of the financial failure of a large-sized specialist unit upon the NYSE would be proportionately greater in comparison to the failure of either original unit. Thus, imposing more stringent capitalization requirements upon the new unit should decrease the probability of any such failure, and minimize any subsequent detrimental impact upon the market place.

IV. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-NYSE-99-46) is approved.