Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing of Proposed Rule Change Amending NYSE Rule 98 and Related Rules To Redefine Specialist Operations at the NYSE, 38274-38284 [E8-15165]

Download as PDF 38274 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action The proposed rule change has become effective pursuant to Section 19(b)(3)(A) of the Act 11 and Rule 19b–4(f)(6) thereunder 12 because the foregoing proposed rule change: (1) Does not significantly affect the protection of investors or the public interest; (2) does not impose any significant burden on competition; and (3) by its terms, does not become operative for 30 days after the date of filing, or such shorter time as the Commission may designate if consistent with the protection of investors and the public interest. A proposed rule change filed under Rule 19b–4(f)(6) normally may not become operative prior to 30 days after the date of filing.13 However, Rule 19b– 4(f)(6)(iii) permits the Commission to designate a shorter time if such action is consistent with the protection of investors and the public interest. The Exchange has asked the Commission to waive the 30-day operative delay, as specified in Rule 19b–4(f)(6)(iii),14 which would make the rule change effective and operative upon filing. The Commission believes that waiving the 30-day operative delay is consistent with the protection of investors and the public interest because such waiver would allow the Conditional Transaction Pilot to continue without interruption through September 30, 2008 and provide the Exchange and the Commission additional time to evaluate the pilot.15 Accordingly, the Commission designates the proposed rule change effective and operative upon filing with the Commission. At any time within 60 days of the filing of the proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. 11 15 U.S.C. 78s(b)(3)(A). CFR 240.19b–4(f)(6). 13 17 CFR 240.19b–4(f)(6)(iii). In addition, Rule 19b–4(f)(6)(iii) requires the self-regulatory organization to give the Commission notice of its intent to file the proposed rule change, along with a brief description and text of the proposed rule change, at least five business days prior to the date of filing of the proposed rule change, or such shorter time as designated by the Commission. NYSE has satisfied this requirement. 14 17 CFR 240.19b–4(f)(6)(iii). 15 For purposes only of waiving the operative delay for this proposal, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). mstockstill on PROD1PC66 with NOTICES 12 17 VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 IV. 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. Comments may be submitted by any of the following methods: For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.16 Florence E. Harmon, Acting Secretary. [FR Doc. E8–15100 Filed 7–2–08; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–NYSE–2008–50 on the subject line. Paper Comments [Release No. 34–58052; File No. SR–NYSE– 2008–45] Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing of Proposed Rule Change Amending NYSE Rule 98 and Related Rules To Redefine Specialist Operations at the NYSE • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, Station Place, 100 F Street, NE., Washington, DC 20549–1090. June 27, 2008. 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 in the Commission’s Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make publicly available. All submissions should refer to File Number SR–NYSE–2008–50 and should be submitted on or before July 24, 2008. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change 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 June 11, All submissions should refer to File 2008, New York Stock Exchange LLC (‘‘NYSE’’ or ‘‘Exchange’’) filed with the Number SR–NYSE–2008–50. This file Securities and Exchange Commission number should be included on the subject line if e-mail is used. To help the (‘‘Commission’’) the proposed rule change as described in Items I, II, and Commission process and review your III below, which Items have been comments more efficiently, please use only one method. The Commission will substantially prepared by the Exchange. post all comments on the Commission’s The Commission is publishing this notice to solicit comments on the Internet Web site (https://www.sec.gov/ proposed rule change from interested rules/sro.shtml). Copies of the persons. submission, all subsequent PO 00000 The Exchange proposes to amend Rule 98 and related rules to redefine specialist operations at the NYSE. The text of the proposed rule change is available at NYSE’s principal office, the Commission’s Public Reference Room, and https://www.nyse.com. 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 Exchange 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 those statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. 16 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 1 15 Frm 00103 Fmt 4703 Sfmt 4703 E:\FR\FM\03JYN1.SGM 03JYN1 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices A. Self-Regulatory Organization’s Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change mstockstill on PROD1PC66 with NOTICES 1. Purpose The NYSE is proposing to amend Rule 98 to reduce the regulatory burdens imposed by the rule and to provide flexibility to member organizations as to how they can structure their specialist operations and manage their risks. In particular, because of changes to the marketplace, including changes to the specialist’s role as a result of the increased use of electronic trading, the Hybrid Market, and Regulation NMS, as well as technological advances in surveillance and internal controls, the NYSE believes that current Rule 98 imposes unnecessary restrictions on member organizations seeking to engage in specialist operations at the Exchange. Accordingly, the NYSE proposes revising Rule 98 in its entirety to provide a framework for specialist operations that meet both the regulatory concerns of the current rule and the reality of today’s marketplace. In addition to changes to Rule 98, the NYSE proposes making conforming changes to other NYSE rules that rely on Rule 98 exemptions for approved persons. As discussed in further detail below, the revisions to Rule 98 would include: (1) Redefining the persons to whom Rule 98 would apply; (2) allowing specialist operations to be integrated into better capitalized member organizations; (3) permitting a specialist unit to share non-trading related services with its parent member organization or approved persons; and (4) providing flexibility to member organizations and their approved persons in how to conduct risk management of specialist operations. To achieve these changes, the NYSE proposes shifting the paradigm of Rule 98 from one that assumes that the approved persons of a specialist member organization are subject to certain NYSE rules unless an exemption is provided to one where NYSE Regulation, Inc. (‘‘NYSE Regulation’’) reviews whether a trading unit that proposes to engage in specialist operations is sufficiently walled off from either its approved persons or parent member organization. Under the new paradigm, rules governing specialist operations, such as Rule 104, will apply only to the unit approved to engage in specialist operations at the NYSE. As the NYSE market model continues to evolve, the NYSE believes that the proposed amendments to Rule 98 will VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 provide a platform from which to further modernize specialist operations. A. Background The NYSE adopted Rule 98 in 1987 in response to consolidation in the securities industry, when NYSE specialist firms that had been independent member-owned entities increasingly became subsidiaries of larger, better capitalized broker-dealers. Because of the specialists’ unique position within the markets, and the restrictions on dealers under section 11(a) of the Act,3 the Exchange crafted a rule that governed how larger member organizations could be connected to specialist firms. The rule establishes a functional separation between the specialist organization and the rest of the brokerdealer. The purpose of that separation was to eliminate or control conflicts of interest between the specialist’s actions as market maker in an issuer’s securities and other interactions among the specialist’s parent or sibling entities and the issuer. In its current form, Rule 98 applies to specialist units and so-called ‘‘approved persons’’ of a specialist organization— that is, entities that are in a control relationship with a specialist organization, or share a common corporate parent with the specialist organization and are engaged in a kindred business.4 Such entities are, by virtue of their association with the specialist organization, subject to the rules and restrictions applicable to specialists. These include, among other things, restrictions on the approved persons’ ability to trade in specialty stock options, restrictions on certain of their business transactions with issuers for whom the specialist organization is the registered specialist, and limits on the amount of securities of such issuers that the specialist and approved persons may own in the aggregate. So as not to unreasonably hamstring a broker-dealer organization overall, Rule 98(b) provides that an approved person may seek Exchange approval to be exempted from most of those restrictions. To obtain a Rule 98(b) exemption, the approved person must establish policies and procedures that are consistent with the Guidelines for Approved Persons Associated with a Specialist’s Member Organization (‘‘Rule 98 Guidelines’’). These guidelines set out in detail how approved persons and associated specialist organizations should structure and conduct their respective businesses PO 00000 3 See 4 See 15 U.S.C. 78k(a). NYSE Rules 2(d) and 304(e). Frm 00104 Fmt 4703 Sfmt 4703 38275 in order to ensure complete separation between the specialist organization and the rest of the member organization. Among other things, the Rule 98 Guidelines provide that the specialist member organization be housed in a separate corporate entity and brokerdealer from its approved persons. Further, to ensure that information does not flow improperly from the specialist organization to approved persons and that approved persons do not have undue influence over particular trading decisions by the specialist, the guidelines establish ‘‘functional regulations’’ that enforce the required separateness. These include requirements that the organizations maintain separate books and records, separate financial accounting, and separate required capital, and that each organization have in place procedures to safeguard confidential information derived from business interactions with the issuer or contained in draft research reports prepared by the approved person. The assumption that all entities affiliated with a specialist are subject to specialist rules unless they have obtained a Rule 98(b) exemption creates a substantial administrative burden on specialist organizations and their approved persons: Each approved person of a specialist organization must establish and continually update a separate exemption under Rule 98 if it wishes to engage in activity that would otherwise be restricted under applicable specialist rules. This burden creates a real and substantial barrier to entry for new broker-dealers who may want to establish specialist units. In the face of significant structural changes to the NYSE and the equity markets, and in recognition of the vastly different competitive landscape compared to 1987, the Exchange believes that Rule 98 must be updated in order to provide both existing and prospective specialist firms with the necessary tools to remain competitive while at the same time meeting their obligations as specialists at the NYSE. The proposed changes to Rule 98 also address the Exchange’s desire to ease the burdens of a new member organization seeking entry to supplement the six specialist firms currently trading on the Exchange, or the very real possibility of such a firm replacing one or more of the existing specialist firms if they withdraw from the market. Concerning the latter possibility, the NYSE notes that this is not just a theoretical concern: Within the past six months, two specialist firms have already withdrawn. E:\FR\FM\03JYN1.SGM 03JYN1 38276 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices To address these very real concerns, the Exchange proposes to fundamentally amend Rule 98. The proposed rule is described in detail below, but at root, the amendment reverses the assumption that all affiliated entities of a specialist firm are automatically governed by the rules applicable to specialists, and shifts the focus of the rule onto the specialist unit rather than the approved person. As part of this restructuring, the NYSE proposes to eliminate the prescriptive approach of the current rule and move towards a more principlebased approach. The NYSE believes that a principle-based rule closely overseen by NYSE Regulation can achieve the same goals as a rule that attempts to enumerate every possible situation that must be avoided. For that, the proposed rule still requires NYSE Regulation to review whether a specialist unit’s policies and procedures are reasonably designed to protect confidential information. However, the rule provides sufficient flexibility so that as the type of information that needs to be protected and the manner in which such information can be protected evolves with changes to the trading environment, so too can the manner in which NYSE Regulation conducts its review. The NYSE believes that the proposed changes to Rule 98 will minimize regulatory burdens and barriers to entry while at the same time provide the necessary level of regulatory scrutiny to ensure that confidential information continues to be protected. In addition, the proposed changes will reduce the regulatory burdens on existing specialist member organizations to enable them to continue such operations at lower cost. mstockstill on PROD1PC66 with NOTICES B. Proposed Amendments to Rule 98 1. Applicability of Rule 98 Under the proposed rule, a member organization seeking to operate a specialist unit, either as its entire business or as one of its trading units, would need to apply for and be approved by NYSE Regulation before it can begin, or if applicable, continue operations as a specialist unit. As described in more detail below, NYSE Regulation will review whether a proposed specialist unit has: (1) Adopted written policies and procedures governing the conduct and supervision of the business handled by the specialist unit; (2) established a process for regular review of such written policies and procedures; and (3) implemented controls and surveillances reasonably designed to prevent and detect violations of those policies and procedures. Among other things, these VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 policies and procedures must be reasonably designed to protect specialist confidential information and non-public order information, as defined below. Once approved, the NYSE specialist rules, as defined below, including Rule 104, would generally only be applicable to the approved specialist unit and not to its approved persons or, if applicable, parent member organization. As discussed in more detail below, on a case-by-case basis, NYSE Regulation will assess whether an integrated proprietary aggregation unit that manages the risk for a specialist unit could be subject to the specialist rules if the integrated proprietary aggregation unit causes the specialist unit to violate its obligations. The NYSE recognizes that despite the proposed rule changes, an existing specialist member organization may determine to either keep its current operational structure or wait before it implements changes to its operational structure, as permitted by the proposed amended rule. Because current Rule 98 would still be applicable to those specialist units that would not have yet sought the relief available under proposed Rule 98, the Exchange proposes keeping current Rule 98 in its rulebook as ‘‘Rule 98 (Former)’’ until such time as all specialist units are approved pursuant to proposed Rule 98(c). Any new entrant to become a specialist unit would be required to comply with proposed Rule 98; current Rule 98 procedures would not be available to new entrants to the specialist business. As proposed, current Rule 98(b) exemptive relief would be available only so long as the member organization and its approved persons have not materially changed their operational structure, internal controls, or compliance and audit procedures. In such case, the current Rule 98, i.e. , Rule 98 (Former), would govern the specialist member organization and its approved persons.5 Any significant changes to the status quo after the effective date of the proposed new rule would require the member organization to apply for 5 As discussed in more detail below, in addition to amending Rule 98, the Exchange proposes to amend related rules that reference the current Rule 98 exemptions for approved persons. To ensure that member organizations operating pursuant to Rule 98 (Former) are subject to the appropriate rules, the Exchange proposes to maintain two forms of the related rules: the amended version and an otherwise unchanged version, except for the title ‘‘(Former)’’ added to the unamended version of the rule or, if applicable, the section affected by the proposed rule change. Once all member organizations are subject to the proposed Rule 98, the Exchange will file to delete any ‘‘Former’’ versions of Rule 98 and the related rules or sections. PO 00000 Frm 00105 Fmt 4703 Sfmt 4703 approval pursuant to the procedures described below. The Exchange recognizes that an existing specialist member organization that does not implement structural changes to its operations that would require it to apply for approval under the proposed rule may still need certain relief available under the proposed version of the Rule. Accordingly, the Exchange proposes that a member organization operating pursuant to Rule 98 (Former) may apply for relief pursuant to proposed Rule 98(e), which concerns sharing non-trading related services, without first obtaining approval under other provisions of proposed Rule 98. In such situation, the specialist member organization would need to apply for approval from NYSE Regulation to share non-trading related services, as specified in proposed Rule 98(e). If approved, except for the sharing of non-trading related services, such member organization and its approved persons would continue to be subject to Rule 98 (Former) as well as the ‘‘(Former)’’ versions of NYSE rules that reference exemptions from Rule 98 for approved persons, as discussed in more detail below. Once approved pursuant to proposed Rule 98 to operate a specialist unit, share non-trading related services, or engage in risk management, any material changes in how a specialist unit operates its business would require the specialist unit to resubmit its revised written policies and procedures to NYSE Regulation for review. For example, if a specialist unit is approved to operate as a stand-alone aggregation unit and would like to change its business operations to include the specialist unit as part of a larger integrated proprietary aggregation unit, as permitted by proposed Rule 98(d), such change would require preapproval. 2. Proposed Definitions To ensure clarity, the proposed amendments include a number of defined terms that are applicable throughout the rule. These definitions are designed to provide a level of scalability to the rule so that as the NYSE market model evolves, the definitions used throughout the rule will have common meaning. Among the proposed definitions are: • ‘‘Specialist unit’’—this definition is intended to apply to any trading unit that is seeking approval to operate as a specialist at the Exchange. As proposed, a specialist unit could be a stand-alone member organization, an aggregation unit within a member organization, or a trading unit (or ‘‘desk’’) within a larger E:\FR\FM\03JYN1.SGM 03JYN1 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices mstockstill on PROD1PC66 with NOTICES aggregation unit. Regardless of which corporate structure a member organization chooses, the term ‘‘specialist unit’’ would refer to the unit that is responsible for specialist activities at the Exchange. If approved pursuant to proposed Rule 98(c), a specialist unit would be eligible for allocations under NYSE Rule 103B and be subject to specialist rules. For purposes of Exchange rules, the term ‘‘specialist unit’’ is synonymous with the term ‘‘specialist organization’’ or ‘‘specialist member organization.’’ • ‘‘Specialist’s account’’—this definition refers to any account through which a specialist unit trades at the Exchange. Sometimes referred to as a dealer account, this revised definition would encompass any of the variouslydefined accounts that a specialist unit may use to trade at the Exchange. • ‘‘Specialist rules’’—this definition refers to those rules that govern specialist conduct or trading at the Exchange. Currently, the specialist rules include, among others, Rules 104, 105, and 113, but as the rules at the Exchange change, these rule designations may change. Accordingly, so that proposed Rule 98 evolves along with changes to other rules, this proposed definition does not identify specific rules. • ‘‘Specialist confidential information’’—this definition concerns the principal or proprietary trading activity of a specialist unit at the Exchange in the securities allocated to it pursuant to Rule 103B, including the unit’s positions in those securities, decisions relating to trading or quoting in those securities, and any algorithm or computer system that is responsible for such trading activity and that interface with Exchange systems, such as the specialist application protocol interface (‘‘specialist API’’).6 The definition does not include information about nonpublic order information, as described below. • ‘‘Non-public order’’—this definition refers to any information relating to order flow at the Exchange, including verbal indications of interest made with an expectation of privacy, electronic order interest, e-quotes, reserve interest, or information about imbalances at the Exchange, that is not publicly-available on a real-time basis via an Exchangeprovided datafeed, such as NYSE 6 The specialist API is the electronic link between specialist trading algorithms and the NYSE Display Book. Via this interface, specialist organization trading algorithms send quoting and trading messages to the Exchange for implementation in the NYSE Display Book, and the Exchange transmits information necessary to acting as a specialist to specialist organizations. VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 OpenBook, or otherwise publiclyavailable. The definition also encompasses information regarding a reasonably imminent non-public transaction or series of transactions. For example, if in requesting information about the state of the Book, a Floor broker informs the specialist about an order that he or she has, such information would fall under the definition of ‘‘non-public order.’’ As defined, non-public orders include order information at the open, any reopenings, the close, when the security is trading in a slow mode (e.g., in a Gap quote or LRP situation), and any other information in the NYSE Display Book 7 that is not available via NYSE OpenBook.8 As proposed, the linchpin to the definition of ‘‘non-public order’’ is that it is information not publicly available on a real-time basis. Currently, specialists have unique access to certain non-public order information. However, in its proposed new market model, the Exchange will be proposing to change the specialist’s access to such nonpublic order information. The proposed definition is intended to take into consideration such future changes so that as the specialist’s or specialist API’s access to non-public order information changes, so will the specialist unit’s responsibilities to protect that information change, but without having to revise Rule 98. • ‘‘Investment banking department’’ and ‘‘Research department’’—these definitions refer to the same departments that are defined as such in NYSE Rule 472 and NASD Rule 2711. • ‘‘Customer-facing department’’— this definition is intended to encompass any department, division, marketmaking desk, aggregation unit, or trading desk that receives, routes, or executes orders for customer execution or clearing accounts, regardless of whether such unit also engages in principal or proprietary trading. A hallmark of this definition is that a customer has an expectation of confidentiality and best execution on its behalf, which could include a customer that is another broker-dealer. Examples 7 The Display Book system is an order management and execution facility. The Display Book system receives and displays orders to the specialists, contains the Book, and provides a mechanism to execute and report transactions and publish results to the Consolidated Tape. The Display Book system is connected to a number of other Exchange systems for the purposes of comparison, surveillance, and reporting information to customers and other market data and national market systems. 8 NYSE OpenBook provides aggregate limitorder volume that has been entered on the Exchange at price points for all NYSE-traded securities. PO 00000 Frm 00106 Fmt 4703 Sfmt 4703 38277 of trading desks that would meet this definition include a Nasdaq marketmaking desk and most block-trading desks. However, this definition is not intended to include an aggregation unit that solely conducts proprietary trading or proprietary market making (sometimes referred to as electronic market making). • ‘‘Aggregation unit’’—this definition adopts the standard of Rule 200(f) of Regulation SHO.9 The proposed rule uses this term throughout to refer to any department, division, unit, or trading desk that has been segregated pursuant to the requirements of Regulation SHO. The NYSE believes that the Regulation SHO requirements for establishing an aggregation unit, including any requirements for information barriers, would be sufficient for segregating a specialist unit’s operations from the remainder of a member organization or its approved persons. • ‘‘Non-trading related services’’— this definition refers to the type of support services that a specialist unit may share with its parent member organization or approved person. The core of the proposed definition is that the type of services are not related to making decisions about the day-to-day trading of the specialist unit or provide trading support to such activity, such as by a trading assistant or specialist clerk. Examples of non-trading related services include stock loan (so long as consistent with Regulation SHO), clearing and settlement, controllers (for financial accounting purposes), technology support, and personnel who develop applications and algorithmic models. • ‘‘Integrated proprietary aggregation unit’’—this definition is intended to encompass any aggregation unit that has a trading objective to engage in proprietary trading, including proprietary market-making activities. As defined, an integrated proprietary aggregation unit must not include any activities that would be performed by an investment banking, research, or customer-facing department. Subject to proposed Rule 98(d), a specialist unit could be part of a member organization’s integrated proprietary aggregation unit. Alternatively, an approved person or member organization could maintain an integrated proprietary aggregation unit separate from the specialist unit. In such case, the definition of an integrated proprietary aggregation unit becomes relevant in connection with proposed Rule 98(f)(3) and the ability of an approved person to engage in risk management activities on behalf of the 9 See E:\FR\FM\03JYN1.SGM 17 CFR 242.200(f). 03JYN1 38278 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices mstockstill on PROD1PC66 with NOTICES specialist unit of an associated member organization. • ‘‘Related products’’—this definition refers to any derivative instrument that is related to a security allocated to a specialist unit. It can include options, warrants, hybrid securities, single-stock futures, security-based swap agreements, a forward contract, or any other contract that is exercisable into or whose price is based upon or derived from a security listed at the Exchange. The list referenced in the definition is not intended to be exhaustive and the definition is intended to cover any existing or future products that could be related to a security listed at the Exchange. 3. Proposed Rule 98(c): Approval to Operate a Specialist Unit Pursuant to proposed Rule 98(c), a member organization must obtain prior written approval from NYSE Regulation before it can operate a specialist unit. For approval, a specialist unit must demonstrate that it has: (i) Adopted and implemented comprehensive written procedures and guidelines governing the conduct and supervision of business handled by the specialist unit; (ii) established a process for regular review of such written policies and procedures; and (iii) implemented controls and surveillances reasonably designed to prevent and detect violations of these procedures and guidelines. As proposed, these policies and procedures must be reasonably designed to provide that the specialist unit will maintain the confidentiality of both specialist confidential information and non-public orders. The proposed rule enumerates certain bright-line divisions that the specialist unit must maintain, including information barriers between the specialist unit and investment banking, research, and customer-facing departments and approved persons. Such information barriers should guarantee confidentiality two ways: the specialist unit cannot access material non-public information about securities allocated to that unit from either its approved persons or non-specialist operations of a parent member organization and vice versa. With respect to a specialist unit’s internal controls and surveillances, NYSE Regulation will be reviewing such surveillance plans to determine whether they are reasonably designed to protect information as required under the proposed rule. Where feasible, NYSE Regulation will expect specialist units to use automated surveillances to check for breaches of the information barriers required by the proposed rule. As with the current rule, NYSE Regulation will VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 also review whether a member organization has implemented internal audit procedures relating to compliance with the proposed Rule 98 policies and procedures. In addition to the specific information barriers enumerated in the proposed rule, if a member organization proposes to operate a specialist unit as a standalone unit, the Exchange proposes importing the requirements of a Regulation SHO independent trading unit for specialist units. Accordingly, as required by Rule 200(f) of Regulation SHO,10 NYSE proposes requiring a specialist unit to have a written plan of organization that specifies its trading objectives and meet all of the other requirements of an independent trading unit under Regulation SHO. If a specialist unit seeks to avail itself of the exemption from NYSE Rule 105 under proposed Rule 98(f)(1), that written plan of organization would need to include its trading objectives for trading in related products. As with the current rule, proposed Rule 98 would require the specialist unit to maintain net capital sufficient to meet the requirements of NYSE Rule 104.21. The NYSE believes that if a specialist unit is integrated within a larger member organization, the net capital requirement can be met by having the requisite capital amount allocated to the specialist unit by the member organization. Despite the segregations required by the rule, the NYSE believes that senior managers who are not dedicated to the specialist unit and are associated with either an approved person or a member organization that runs a specialist unit should still be able to provide management oversight to the specialist unit. As proposed, the revised rule is not intended to be more restrictive than the current rule, which permits an approved person to provide general oversight over its associated specialist member organization. The proposed rule instead shifts from a detailed list of specific types of oversight that is permissible to a principle-based approach that focuses on protecting specialist confidential information and non-public order information. As with the current rule, as proposed, senior management oversight of a specialist unit should not conflict with or compromise in any way with the specialist unit’s market-making obligations. Proposed Rule 98(c)(2)(E) provides guidance on how a member organization or approved person should handle situations where a senior manager is PO 00000 10 See 17 CFR part 242.200(f). Frm 00107 Fmt 4703 Sfmt 4703 called upon for risk management purposes and in connection with that role, gains access to specialist confidential information or non-public order information. The Exchange notes that non-public order information could become stale if the order is executed or cancelled without the specialist’s knowledge. To ensure that there is no misuse of such information, whether material or not, the senior manager must not make (directly or indirectly) specialist confidential information or non-public order information available to the persons or systems responsible for making trading decisions in aggregation units, departments, divisions, or trading desks that are not part of the specialist unit, including the customer-facing departments. The senior manager also must not use such information to directly or indirectly influence the dayto-day trading decisions of the other aggregation units of the member organization or approved person with respect to the securities allocated to the specialist unit. The NYSE believes that these restrictions on the use of specialist confidential information and non-public order information are similar to how broker-dealers currently handle situations where a senior manager has oversight over multiple aggregation units and in such capacity, becomes privy to confidential information of one aggregation unit. For such situations, broker-dealers have already developed procedures for protecting confidential information and the NYSE believes that such procedures should be reasonable for the oversight of a specialist unit as well. The Exchange notes that although the proposed amendments to Rule 98 eliminate the exemption process under current Rule 98(b), the review that NYSE Regulation would conduct when approving a specialist unit would be as rigorous as the current review for obtaining an exemption, just simply a different focus of what is reviewed. As with the current Rule 98 exemption process, staff from both the Market Surveillance Division of NYSE Regulation as well as relevant staff from the Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’), who are responsible for the routine examinations of specialist units, would be involved in reviewing a specialist unit’s written policies and procedures and proposed automated surveillances and controls.11 11 In connection with the July 2007 transfer of certain member firm regulation functions from NYSE Regulation to FINRA, NYSE Regulation and FINRA entered into a regulatory services agreement (‘‘RSA’’) whereby FINRA agreed to provide NYSE Regulation with certain services relating to NYSE’s E:\FR\FM\03JYN1.SGM 03JYN1 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices For existing specialist firms, the initial approval process associated with any changes to how they operate may require upfront work to ensure that the specialist unit’s policies and procedures are reasonably designed to meet the requirements of the proposed rule. However, unlike the current rule, as proposed, specialist units would be relieved of the requirement to update any written statements to the Exchange for changes in approved persons or dually-affiliated employees. Once approved, NYSE Regulation and FINRA would examine whether a specialist unit’s policies and procedures continue to meet the rule requirements and whether the implemented controls and automated surveillances are functioning as designed. As part of such examination review, NYSE Regulation and FINRA will conduct on-site reviews of a specialist unit to review for breaches of the controls or surveillances. And, as noted above, if the specialist unit proposes making any material changes to its operations, it would need to seek additional approval before it can change its operations. mstockstill on PROD1PC66 with NOTICES 4. Proposed Rule 98(d): Operating a Specialist Unit Within an Integrated Proprietary Unit One of the goals of proposed Rule 98 is to provide a member organization with greater flexibility in how it manages the risk of a specialist unit. As discussed below, in proposed Rule 98(f), the NYSE proposes providing member organizations with an array of options of how to conduct risk management. The NYSE believes that the flexibility afforded by these options will meet the varying business models of the member organizations currently operating or seeking to operate a specialist unit at the Exchange. As discussed in more detail below, one proposed risk management model would be to permit a member organization to integrate a specialist unit within a larger aggregation unit that meets the requirements of an integrated proprietary aggregation unit. Proposed Rule 98(d) sets forth the minimum requirements for how to structure such an integrated unit. While such a unit would be considered a single aggregation unit for Regulation SHO purposes, as proposed, the member retained responsibilities to examine for compliance with NYSE rules that govern trading on or through the systems and facilities of the Exchange. In particular, pursuant to the RSA, FINRA participates in the current Rule 98(b) exemption process and examines specialist firms for compliances with that rule. As proposed, FINRA would continue to participate in the approval process under the proposed Rule 98 and examine specialist units for compliance with the rule. VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 organization would need to establish information barriers within the integrated proprietary aggregation unit to restrict access to non-public order information to the specialist unit only. And depending on the risk management model proposed by a specialist unit, a member organization or approved person may need to further segregate the flow of information within a specialist unit. As proposed, the specialist unit that would operate within the integrated proprietary aggregation unit would need to meet the requirements of proposed Rule 98(c)(2)(A), (C), (D), and (E) of the rule, which concern the information barriers associated with the specialist unit and non-specialist unit operations, net capital requirements, and senior management oversight. Because an integrated proprietary aggregation unit that includes a specialist unit would likely already be subject to Rule 200(f) of Regulation SHO that it qualify as an independent trading unit, the specialist unit operating within the integrated proprietary aggregation unit would not need to separately meet the Rule 200(f) requirement for an independent trading unit. Accordingly, as proposed, a specialist unit that operates within an integrated proprietary aggregation unit would not need to meet the requirements of proposed Rule 98(c)(2)(B), which requires a specialist unit to separately comply with all of the Regulation SHO independent trading unit requirements.12 In addition to meeting certain requirements of proposed Rule 98(c), under proposed Rule 98(d)(2)(B), the specialist unit must restrict access to non-public order information or specialist confidential information from the rest of the integrated proprietary aggregation unit. Such information barriers must ensure that both individuals and systems that are not assigned to the specialist unit do not have access to non-public order information, or, unless otherwise provided for in proposed Rule 98(f), specialist confidential information. The NYSE believes that as proposed, Rule 98(d)(2)(B) provides sufficient flexibility for how a member organization structures its operations to evolve as the NYSE market model changes. For example, the specialist API 12 The Exchange recognizes that there may be some Regulation SHO issues in connection with how a member organization may choose to structure its specialist unit within an integrated proprietary aggregation unit or provide risk management to the specialist unit pursuant to proposed Rule 98(f). In such case, approval to operate under proposed Rule 98 would not be provided until all Regulation SHO issues that may arise have been resolved. PO 00000 Frm 00108 Fmt 4703 Sfmt 4703 38279 currently has access to limited nonpublic order information, but does not have access to information available in the NYSE Display Book. So long as the specialist API has access to that nonpublic order information, the Exchange believes that systems not dedicated to the specialist unit should not be integrated with the specialist API. Accordingly, the trading algorithms of the integrated proprietary aggregation unit that are not dedicated to the specialist unit would not have access to any non-public order information via the specialist API, or any other system. Proposed Rule 98(d)(2)(B)(iii) addresses the situation of communications from the Floor of the Exchange to the rest of the integrated proprietary aggregation unit. Currently, specialist unit employees on the Floor of the Exchange have access to nonpublic order information, whether via access to information in the Display Book or because of verbal representations of imminent orders. The NYSE believes that the best way to ensure that such information is not provided to individuals or systems not dedicated to the specialist unit is to restrict communications while the employee is still on the Floor of the Exchange. Proposed Rule 98(d)(2)(B)(iv) considers the possibility that an individual who works on the Floor of the Exchange 13 may also, on an intraday basis, move to an off-Floor location and engage in a non-specialist related role within the integrated proprietary aggregation unit pursuant to proposed Rule 98(d) or for an ‘‘upstairs’’ desk trading in related products within the specialist unit pursuant to proposed Rule 98(f)(1). In such case, the individual must not make any nonpublic order information or, unless specifically provided for, specialist confidential information, available to individuals or systems that are not dedicated to the specialist unit. Nor may that individual use such non-public information, or, except as provided for in the Rule, specialist confidential information, in any way in connection with responsibilities that are not related to Floor-based activities of the specialist unit. For purposes of proposed Rule 98(f)(1), once off the Floor, a specialist may not use non-public information to directly or indirectly trade in related products. However, nothing in the rule 13 Note that NYSE rules define being on the Floor to include the trading Floor of the Exchange, and the premises immediately adjacent thereto, such as the various entrances and lobbies of 11 Wall Street, 18 New Street, 12 Broad Street, and 18 Broad Street, as well as the telephone lobby in the first basement of 11 Wall Street. See Rule 112(b). E:\FR\FM\03JYN1.SGM 03JYN1 38280 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices mstockstill on PROD1PC66 with NOTICES bars a specialist unit from moving personnel among different positions intraday, so long as the restrictions on information flow and use are followed. The NYSE believes that this would provide member organizations with sufficient flexibility to transfer its employees among various roles, including on the Floor of the Exchange and in a specialist unit upstairs location during a given trading day. For intra-day transfers, the Exchange will expect specialist units to have written policies and procedures reasonably designed to ensure that non-public order information and specialist confidential information (unless otherwise permitted) would not be used from an off-Floor location. The Exchange notes that in addition to the information barriers required by proposed Rule 98, specialists must continue to abide by Exchange rules that govern their access to and use of non-public order information.14 As noted above, an integrated proprietary aggregation unit would need to qualify as an aggregation unit, which for Regulation SHO purposes, requires the unit to net its positions. While the proposed rule would no longer require separate books and records for a specialist unit, to ensure that NYSE Regulation can review the trading activity by the specialist unit at the Exchange without having to parse through commingled records, under proposed Rule 98(d)(2)(C), in addition to meeting Regulation SHO requirements, an integrated proprietary aggregation unit must maintain records of its specialist’s accounts in a manner that is separate from the accounts of the integrated proprietary aggregation unit.15 In addition to the above, the integrated proprietary aggregation unit must have written policies and procedures that address how it will ensure that the unit will not engage in any activities that could violate other Exchange rules or federal securities laws and regulations, including Regulation SHO. The policies and procedures must address, at a minimum, how the unit will ensure against front running, wash sales, and market manipulation. In connection with wash sales, a potential concern for an integrated proprietary aggregation unit is the possibility that the specialist unit could be selling (buying) one of the securities 14 See, e.g. , NYSE Rules 70.20(h)(ii), 104(b), 115, and 115A. 15 The Exchange is engaging in a separate discussion with Commission staff of the Regulation SHO implications of requiring a specialist unit to separately aggregate its trading positions for purposes of Exchange rules. VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 registered to it and an individual or trading system of the integrated proprietary aggregation unit could at the same time be buying (selling) that same security at the Exchange. With the proper use of mnemonics associated with those orders, Exchange systems are capable of rejecting one side of those orders. Because the presumption would be in favor of the specialist unit trading, i.e., to meet its affirmative obligations at the Exchange, the NYSE proposes rejecting the order from the integrated proprietary aggregation unit. The NYSE also proposes that to the extent an integrated proprietary aggregation unit directs its trading at the Exchange in any security that has been allocated to the specialist unit through the specialist unit, such trading would be subject to the specialist rules. In other words, while the specialist unit would be subject to certain marketmaking obligations while trading at the Exchange, the integrated proprietary aggregation unit’s independent ‘‘upstairs’’ operations would be able to trade freely. Finally, to ensure that NYSE Regulation can review the trading activities of the integrated proprietary aggregation unit, proposed Rule 98(d)(4) requires member organizations to maintain audit trail information for any trading by such unit, including trading at the Exchange and at other market centers. The NYSE proposes to amend NYSE Rule 132B to have the Order Tracking System (‘‘OTS’’) requirements apply to trading by a specialist unit, and if applicable, an integrated proprietary aggregation unit. Member organizations must maintain sufficient records to reconstruct in a time-sequenced manner its trading in securities allocated to the specialist unit and any trading by the integrated proprietary aggregation unit in those securities in other market centers or trading in related products. As with the approval process under proposed Rule 98(c), to obtain approval to operate a specialist unit within an integrated proprietary aggregation unit, a member organization would need to submit its written policies and procedures to NYSE Regulation for review of whether such policies and procedures are reasonably designed to meet the rule requirements. Once approved under proposed Rule 98(d), NYSE Regulation and FINRA would continue to examine whether a specialist unit’s policies and procedures continue to meet the rule requirements and whether the implemented controls and surveillances plans are functioning as designed. PO 00000 Frm 00109 Fmt 4703 Sfmt 4703 5. Proposed Rule 98(e): Sharing NonTrading Related Services One of the restrictions of current Rule 98 is the limit on a specialist member organization and its approved persons to share operational support personnel. In its current form, Rule 98(c) permits dual affiliation only if the specialist member organization and approved person provide the Exchange with a written statement of the duties of such person and why it is necessary for the individual to have a dual affiliation. Any changes to dual affiliations must be submitted to the Exchange for approval in advance of making such change. The NYSE believes that current Rule 98(c) unnecessarily restricts the ability of a specialist member organization and its approved person to share non-trading related services, i.e., operational support services. Accordingly, the NYSE proposes amending Rule 98 to permit the sharing of non-trading related services, subject to the approval of NYSE Regulation. As with the approval process to become a specialist unit, the approval process for a specialist unit to share non-trading related services with its parent member organization or approved person would require the specialist unit to: (1) Adopt written policies and procedures governing the sharing or non-trading related services; (2) establish a process for regular review of such written policies and procedures; and (3) implement controls and surveillances reasonably designed to prevent and detect violations of those policies and procedures. In accordance with the purpose of Rule 98, such policies and procedures must be reasonably designed to protect specialist confidential information and non-public order information. The NYSE understands that personnel or systems that provide non-trading related services may have access to specialist confidential information or non-public order information. For example, clearance and settlement services would have knowledge of specialist positions in securities, and technological support personnel may have knowledge of how a specialist algorithm conducts its trading. However, access to such information should not be the basis for restricting the sharing of such personnel or systems. Rather, such personnel or systems can be shared so long as the specialist unit has controls reasonably designed to ensure that the individuals or systems who have access to specialist confidential information or non-public information neither provide nor make available that information to any E:\FR\FM\03JYN1.SGM 03JYN1 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices mstockstill on PROD1PC66 with NOTICES individuals or systems not part of the specialist unit. In particular, under no circumstances should non-public order information or specialist confidential information be made available to the investment banking, research, or customer-facing departments. Before a specialist unit can share nontrading related services, NYSE Regulation will review whether the specialist unit has adopted policies and procedures and controls and surveillances reasonably designed to protect specialist confidential information and non-public order information. Once approved, a specialist unit would no longer need to provide NYSE Regulation with a written statement of why a certain individual has a dual affiliation and update such written statements if the individual involved changes. On an ongoing basis, NYSE Regulation and FINRA will examine whether the specialist unit’s policies and procedures and controls comply with the requirements of the rule. 6. Proposed Rule 98(f): Risk Management Specialist member organizations and their approved persons are currently limited in their ability to manage the specialist member organization’s trading risks: Rule 98 currently restricts an approved person from being involved in any trading decisions of an associated specialist member organization; Rule 105 currently restricts the specialist member organization’s ability to trade in options and single-stock futures related to the securities allocated to the specialist member organization. Together, these restrictions place specialist member organizations at a ` competitive disadvantage vis-a-vis other market-making or trading firms. The NYSE believes that the changes to the marketplace that have occurred since 1987, when Rule 98 was adopted, call for an overhaul of how specialist units are permitted to manage their risk. For example, when Rule 98 was adopted, the NYSE enjoyed an approximately 85% market share in trading of NYSE-listed securities and specialists participated in approximately 12% of the transactions at the Exchange. Now, the NYSE’s market share for listed securities hovers under 40%, and of that, specialist participation is in the range of two percent. These numbers are telling: Because of automatic executions at the Exchange, specialists no longer have a unique advantage over other market participants. To the contrary, specialists are now at a disadvantage to other market participants because they must VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 meet their affirmative and negative obligations to the Exchange, yet cannot participate in the type of hedging activities that other market participants may and can do. Accordingly, the Exchange proposes providing specialist units with the ability to manage their risks by broadening the ability to trade in related products and expanding the universe of who may be involved in managing the risk of the specialist unit. Because there is no single correct model for risk management, the NYSE proposes providing specialist units with options of how to manage their risk, which they can choose to use in combination or alone. Regardless of which model a specialist unit proposes to adopt for risk management, at all times, the specialist unit will be ultimately responsible for its quoting or trading decisions at the Exchange. a. Specialist Unit Risk Management In order to provide a specialist unit with greater risk management tools, the NYSE proposes permitting specialist units to apply for an exemption from the Rule 105(b)–(d) restrictions on trading options and single-stock futures. In connection with this change, the NYSE proposes amending Rule 105 so that it applies only to a specialist unit, and not to any other departments or units of a member organization or approved person. If approved for an exemption from Rule 105, a specialist unit would be permitted to trade in related products, subject to proposed Rule 98(f)(1).16 As proposed, to obtain an exemption from Rule 105, the specialist unit must: (i) Adopt and implement comprehensive written procedures and guidelines governing the conduct of trading in related products; (ii) establish a process for regular review of such written procedures and guidelines; and (iii) implement controls and surveillances reasonably designed to prevent and detect violations of these procedures and guidelines. These policies and procedures must be reasonably designed to ensure that the individuals or systems responsible for trading related products do not have access to non-public order information, 16 The Exchange also proposes amending section (m) of the Rule 105 Guidelines to provide that a specialist unit is not permitted to engage in marketmaking activities in single-stock futures or options. However, if eligible for an exemption under Rule 105(b)–(d), nothing restricts a specialist unit from having a trading desk that trades in options or single-stock futures. Because an integrated proprietary aggregation unit that includes a specialist unit may engage in options market making, the Exchange proposes eliminating sections (m)(ii) and (iii) of the Rule 105 Guidelines. PO 00000 Frm 00110 Fmt 4703 Sfmt 4703 38281 or, unless otherwise specifically provided for, specialist confidential information. In addition, individuals who work on the Floor of the Exchange would not be permitted to trade or direct trading in related products, nor would the specialist API be permitted to make any trading decisions in related products. Accordingly, any trading in related products by the specialist unit must be conducted by an off-Floor, i.e., ‘‘upstairs’’ office. All trading in related products must be conducted by individuals who are qualified and registered to trade in the marketplaces where such trading occurs. Moreover, the member organization that houses the specialist unit must be a member of FINRA or other self-regulatory organizations, as required by each marketplace where the specialist unit proposes to trade. The NYSE believes that a specialist unit should have the flexibility to transfer its employees among different functions within the unit. Accordingly, the proposed rule does not expressly prohibit specialists from trading in related products; it only bars directly entering or executing trades in related products while on the Floor of the Exchange.17 As proposed, a specialist unit could transfer a specialist back and forth from the Floor of the Exchange to a specialist unit upstairs desk that trades in related products, so long as that specialist is registered and qualified to trade in related products and nonpublic order information is not used when trading in related products. In such case, however, a specialist unit must have policies and procedures reasonably designed to ensure that a specialist who moves off the Floor of the Exchange does not make available or use any non-public information or, unless otherwise specified, specialist confidential information, to which the specialist may have had access while on the Floor of the Exchange. As noted above, while off the Floor of the Exchange, specialists continue to be subject to other NYSE rules that govern their access to and use of non-public order information. To ensure that the specialist unit upstairs desk that trades in related products can effectively hedge the specialist unit’s positions, the NYSE proposes that the specialist unit upstairs desk have electronic access to the trades by the specialist unit at the Exchange in securities allocated to the specialist unit 17 The Exchange notes that a specialist unit that has not been approved for an exemption from Rule 105 under proposed Rule 98(f)(1) would still be permitted to enter orders in options or single-stock futures from the Floor, subject to the requirements of Rule 105. E:\FR\FM\03JYN1.SGM 03JYN1 38282 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices mstockstill on PROD1PC66 with NOTICES that have been printed to the Consolidated Tape. Currently, senior managers of specialist member organizations can be privy to information about trading on the Floor of the Exchange as well as any hedging conducted by the specialist member organization, even though such hedging opportunities are limited. For example, currently, a specialist on the Floor can call his or her senior manager to discuss hedging strategies. Under the proposed exemption from Rule 105, the NYSE believes that specialist unit senior managers should be able to continue in that role and provide oversight of both Floor specialist operations and any specialist unit upstairs trading in related products. The NYSE believes that the oversight model that works for larger broker-dealers, whose senior managers have a role with respect to multiple aggregation units, should apply within a specialist unit as well. Accordingly, the NYSE proposes Rule 98(f)(1)(vi) to address how a senior manager of a specialist unit should handle situations where he or she has access to non-public order information in connection with his or her role as a senior manager. As with proposed Rule 98(c)(2)(E), when trading in related products, the specialist unit must have policies and procedures reasonably designed to ensure that the specialist unit senior manager who has access to non-public order information does not provide such information to the specialist unit upstairs trading desk responsible for trading related products or use such non-public information to directly or indirectly influence trading by that upstairs desk. b. Integrated Proprietary Aggregation Unit Risk Management Proposed Rule 98(f)(2) addresses how an integrated proprietary aggregation unit that has been approved pursuant to proposed Rule 98(d) to include a specialist unit could engage in risk management of the specialist unit’s positions. At a minimum, an integrated proprietary aggregation unit must have policies and procedures that are reasonably designed to meet the protections enumerated in the rule, including how it trades in related products on behalf of a specialist unit and how it electronically accesses the specialist unit’s trades at the Exchange in securities allocated to the specialist unit that have been printed to the Consolidated Tape. In addition, proposed Rule 98(f)(2)(A)(i) would permit an integrated proprietary aggregation unit to send appetites of trading or quoting direction to the specialist unit. In practice, this VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 would permit a non-specialist unit ‘‘upstairs’’ risk management desk that has real-time access both to the specialist unit’s positions in securities allocated to it and to the integrated proprietary aggregation unit’s positions in related products and other securities to provide electronic direction to the specialist unit of whether to trade or quote in a certain direction. The Exchange believes that permitting an integrated proprietary aggregation unit to send quoting messages that are based on real-time positions of the unit as a whole will enable a specialist unit to better meet any quoting requirements at the Exchange. In other words, the specialist unit will no longer need to operate in a vacuum when determining how or when to quote at the Exchange. As proposed, the specialist unit would be ultimately responsible for whether to accept the electronic trading direction submitted by the integrated proprietary aggregation unit upstairs desk; a specialist unit must comply at all times with its market-marking obligations, including the specialist rules, notwithstanding any electronic trading directions received from that upstairs desk. Stated otherwise, the specialist unit would operate independently and be free to accept or reject the electronic trading directions sent by the integrated proprietary aggregation unit. However, to the extent an integrated proprietary aggregation unit causes a specialist unit to violate one or more of the specialist rules, the Exchange proposes that in such case, the integrated proprietary aggregation unit should also be held to those standards. At this time, as noted above, because of access to non-public order information, the NYSE does not believe it would be feasible to permit communications, whether verbal or electronic, from the specialist or the specialist API to the individuals or systems responsible for trading in related products and other securities within the integrated proprietary aggregation unit, or, if applicable, to an upstairs desk within the specialist unit. However, as the NYSE market model evolves, the NYSE will continue to review how best to integrate a specialist unit within an integrated proprietary aggregation unit, including the possibility of fully integrating the trading systems that interact with the Exchange for the specialist unit and the trading systems that trade in related products and other securities. The NYSE believes that ultimately, a competitive trading model would permit full integration, including PO 00000 Frm 00111 Fmt 4703 Sfmt 4703 permitting two-way communications among trading desks. c. Approved Person Risk Management As proposed, another option available to firms to manage the risk of the specialist unit is to permit a separate integrated proprietary aggregation unit that is housed in either an approved person or a member organization that runs a specialist unit to provide the same level of risk management as proposed for an integrated proprietary aggregation unit that includes a specialist unit. This option would provide flexibility for broker-dealers that want to keep the specialist unit as a separate member organization or aggregation unit, yet still have an approved person or separate aggregation unit provide risk management services for the specialist unit. As with proposed Rule 98(f)(2), proposed Rule 98(f)(3) would require that the approved person not have access to either specialist confidential information and non-public order information, except as provided for in that section of the rule. Specifically, an integrated proprietary aggregation unit of an approved person could have access to the trades by a specialist unit at the Exchange in securities allocated to that unit, so long as such trades have been printed to the Consolidated Tape. And as with proposed Rule 98(f)(2), an approved person could send electronic appetites of how the specialist unit should trade or quote in its allocated securities. As discussed above, a specialist unit would be free to reject or accept such electronic directions as it sees fit to meet its market-making obligations at the Exchange. The Exchange notes that an approved person that provides risk management under this proposed section may not itself be an NYSE member organization. In such case, the individuals at the approved person responsible for making risk management decisions on behalf of the specialist unit should be dually employed by the specialist unit that is part of an NYSE member organization and the approved person so that they are subject to the jurisdiction of NYSE Regulation. 7. Proposed Rule 98(g): Failure To Maintain Confidentiality, Reporting Obligations, and Breaches The NYSE proposes to keep certain provisions of current Rule 98, but adjust them to reflect the changes to the rest of the rule. In particular, current Rule 98(i) has been amended and is included in proposed Rule 98(g); current Rule 98(j) has been amended and is included in E:\FR\FM\03JYN1.SGM 03JYN1 mstockstill on PROD1PC66 with NOTICES Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices proposed Rule 98(h); and, current Rule 98(k) has been amended and is included in proposed Rule 98(i). Under proposed Rule 98(g), as with the current rule, if a specialist becomes aware of non-public material information from its approved person or parent member organization, such specialist may have to cease acting as a specialist in the security involved, which was formerly referred to as ‘‘giving up the Book.’’ The proposed rule does not change how such determinations would be made. However, the proposed rule updates the language of the rule and separates the rule into easier-to-read subsections. Under proposed Rule 98(h), the NYSE proposes adding to the existing reporting obligations that a specialist unit must report any actual breaches or internal investigations of possible breaches of the information barriers required by the rule. The reporting obligation for internal investigations is intended to be similar in effect to the reporting obligation pursuant to NYSE Rules 351(e) and 342.21. In particular, under proposed Rule 98(h)(4), a specialist unit will be required to conduct an internal investigation into any trading activity that may be a result of a breach of the information barriers required by proposed Rules 98(c), (d), (e), and (f). On a quarterly basis, a specialist unit must report in writing to NYSE Regulation whether it has commenced such an internal investigation, the quarterly progress of any open investigations, what remedial measures, if any, were taken, and the completion of any internal investigation, including the methodology and results of such investigation, any internal disciplinary action taken, and any referral of the matter to the NYSE, another selfregulatory organization, or the Commission. Finally, as with the current rule, proposed Rule 98(i) provides that any breach of the proposed Rule could result in disciplinary action, including the withdrawal of one or more securities allocated to the specialist unit or withdrawal of approval to operate a specialist unit. The Exchange notes that as with the current rule, any trading by any person while in possession of material, non-public information received as a result of any breach of internal controls required by proposed Rule 98 may violate Rule 10b–5 of the Act,18 Rule 14e–3 of the Act,19 NYSE Rule 104, just and equitable principles of trade or one or more provisions of the 18 See 19 See 17 CFR Part 240.10b–5. 17 CFR Part 240.14e–3. VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 Act, or regulations thereunder or rules of the Exchange. The Exchange intends to review carefully any such trading of which it becomes aware with a view towards determining whether any such violation has occurred. C. Proposed Amendments to Related Rules As noted above, because of the shift in paradigm away from approved persons, the NYSE proposes amending those NYSE rules that refer to approved persons and the need for an exemption from Rule 98. 1. Proposed Amendments to Rule 98A NYSE Rule 98A requires approved persons to agree in writing not to cause a specialist or odd-lot dealer to violate rules applicable to the specialist or oddlot dealer. The rule further requires that approved persons report to the Exchange any off-Floor orders for securities in which an associated specialist member organization specializes for any account in which the approved person has a direct or indirect interest. Because of the proposed changes to Rule 98, and in particular, the recognition that an appropriately walled-off specialist unit ameliorates the need to scrutinize the trading by an approved person, the NYSE proposes eliminating those portions of Rule 98A that concern approved persons. However, the NYSE would keep the limitation on an issuer, or a partner or subsidiary thereof, from becoming an approved person of a specialist unit. 2. Proposed Amendments to Rules 99, 102, 103B, 104, and 113 In their current form, NYSE Rules 99, 103B, 104, and 113 specifically apply to approved persons, unless such approved person has obtained an exemption under Rule 98. To ensure consistency among NYSE rules, and in particular, to ensure that the revised paradigm of proposed Rule 98 is consistently applied, the NYSE proposes to amend Rules 99, 103B, 104, and 113 to eliminate the references to approved persons.20 In addition, the Exchange proposes to delete Rule 102, which concerns trading in options by odd-lot dealers. Because the Exchange no longer has separate 20 For the period of time that the current Rule 98 stays in the NYSE Rules as ‘‘NYSE Rule 98 (Former),’’ each of NYSE Rules 99, 103B, 104, and 113 will have two forms: one to meet the requirements of NYSE Rule 98 (Former) and one to meet the requirements of proposed Rule 98. The version of the rules that relate to Rule 98 (Former) will be similarly designated with the ‘‘(Former’’) title either for the entire rule, or for a section of a rule, as appropriate. PO 00000 Frm 00112 Fmt 4703 Sfmt 4703 38283 odd-lot dealers and all specialists are also responsible for odd-lot trading in securities in which they are registered, there is no need for a separate rule governing trading in related products by an odd-lot dealer. Accordingly, because Rule 102 is duplicative of the standards set forth in proposed Rules 98 and 105, the Exchange proposes deleting that rule. 3. Proposed Amendments to Rule 460 In addition to amending Rule 460 to ensure consistent application of proposed Rule 98 and making other non-substantive changes, the NYSE proposes eliminating Rule 460.20 that approved persons of specialist member organizations be held to any limits on beneficial ownership of any equity security in which an associated specialist unit is registered. Instead, as proposed, any limitations on beneficial ownership should apply only to the specialist unit that has been approved pursuant to proposed Rule 98, and not to any other aggregation unit or other department or division of the member organization. With respect to the specialist unit’s beneficial ownership of outstanding shares of securities allocated to such unit, the NYSE proposes to amend NYSE Rule 460.10 to require that a specialist unit report when its beneficial ownership of outstanding shares exceeds 5% and to update such report if the beneficial ownership either falls below 5% or exceeds 10%. The NYSE thus proposes to eliminate the requirement that a specialist unit seek NYSE Regulation approval before it may have more than 10% beneficial ownership of a listed security. The NYSE believes that because of the reduced market share of the NYSE and the limited impact of specialist trading on securities allocated to a specialist unit, the protections of the existing rule are no longer necessary. However, the NYSE proposes retaining the prohibition on a specialist unit having beneficial ownership of more than 25% of the outstanding shares in a security allocated to such unit. Because the changes to the marketplace are in effect now, the Exchange believes that the changes to Rule 460 should be implemented notwithstanding whether a specialist member organization continues to operate under Rule 98 (Former). Accordingly, the Exchange proposes having a single version of Rule 460 to reflect the proposed amendments. 2. Statutory Basis The Exchange believes the proposed rule change is consistent with and E:\FR\FM\03JYN1.SGM 03JYN1 38284 Federal Register / Vol. 73, No. 129 / Thursday, July 3, 2008 / Notices furthers the objectives of section 6(b)(5) of the Act,21 in that it is designed to prevent fraudulent and manipulative acts and practices, 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. 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 that is not necessary or appropriate in furtherance of the purposes of the Act. II. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others No written comments were solicited or received with respect to the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will: (A) By order approve the proposed rule change, or (B) Institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Commission, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NYSE–2008–45. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro.shtml). 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 in the Commission’s Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the NYSE. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–NYSE–2008–45 and should be submitted on or before July 24, 2008. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.22 Florence E. Harmon, Acting Secretary. [FR Doc. E8–15165 Filed 7–2–08; 8:45 am] BILLING CODE 8010–01–P Electronic Comments mstockstill on PROD1PC66 with NOTICES 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. Comments may be submitted by any of the following methods: Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Extend the Quarterly Options Series Pilot Program • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–NYSE–2008–45 on the subject line. Paper Comments • Send paper comments in triplicate to Secretary, Securities and Exchange SECURITIES AND EXCHANGE COMMISSION [Release No. 34–58039; File No. SR–Phlx– 2008–44] June 26, 2008. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 U.S.C. 78f(b)(5). VerDate Aug<31>2005 16:46 Jul 02, 2008 Jkt 214001 PO 00000 I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to amend its Rules 1012 (Series of Options Open for Trading) and 1101A (Terms of Option Contracts), in order to extend for a period of one year an Exchange pilot program (the ‘‘Pilot Program’’) to permit the listing and trading of options series that may be opened for trading on any business day and expire at the close of business on the last business day of a calendar quarter (‘‘Quarterly Options’’ or ‘‘Quarterly Options Series’’). The Pilot Program currently continues through July 10, 2008.5 The text of the proposed rule change is available on the Exchange’s Web site (https:// www.phlx.com/regulatory/ reg_rulefilings.aspx.), at the principal office of the Exchange, and at the Commission’s Public Reference Room. 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 Exchange included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. 3 15 U.S.C. 78s(b)(3)(A)(iii). CFR 240.19b–4(f)(6). 5 See Securities Exchange Act Release No. 56030 (July 9, 2007), 72 FR 38645 (July 13, 2007) (SR– Phlx–2007–42). 4 17 22 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 1 15 21 15 notice is hereby given that on June 19, 2008, the Philadelphia Stock Exchange, Inc. (‘‘Exchange’’ or ‘‘Phlx’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been substantially prepared by the Exchange. The Exchange has designated this proposal as non-controversial under Section 19(b)(3)(A)(iii) of the Act 3 and Rule 19b–4(f)(6) thereunder,4 which renders the proposed rule change effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. Frm 00113 Fmt 4703 Sfmt 4703 E:\FR\FM\03JYN1.SGM 03JYN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 73, Number 129 (Thursday, July 3, 2008)]
[Notices]
[Pages 38274-38284]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-15165]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58052; File No. SR-NYSE-2008-45]


Self-Regulatory Organizations; New York Stock Exchange LLC; 
Notice of Filing of Proposed Rule Change Amending NYSE Rule 98 and 
Related Rules To Redefine Specialist Operations at the NYSE

June 27, 2008.
    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 June 11, 2008, New York Stock Exchange LLC (``NYSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been substantially prepared by the 
Exchange. The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

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

    The Exchange proposes to amend Rule 98 and related rules to 
redefine specialist operations at the NYSE. The text of the proposed 
rule change is available at NYSE's principal office, the Commission's 
Public Reference Room, and https://www.nyse.com.

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 Exchange 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 those statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
sections A, B, and C below, of the most significant aspects of such 
statements.

[[Page 38275]]

A. Self-Regulatory Organization's Statement of the Purpose of, and the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The NYSE is proposing to amend Rule 98 to reduce the regulatory 
burdens imposed by the rule and to provide flexibility to member 
organizations as to how they can structure their specialist operations 
and manage their risks. In particular, because of changes to the 
marketplace, including changes to the specialist's role as a result of 
the increased use of electronic trading, the Hybrid Market[supreg], and 
Regulation NMS, as well as technological advances in surveillance and 
internal controls, the NYSE believes that current Rule 98 imposes 
unnecessary restrictions on member organizations seeking to engage in 
specialist operations at the Exchange.
    Accordingly, the NYSE proposes revising Rule 98 in its entirety to 
provide a framework for specialist operations that meet both the 
regulatory concerns of the current rule and the reality of today's 
marketplace. In addition to changes to Rule 98, the NYSE proposes 
making conforming changes to other NYSE rules that rely on Rule 98 
exemptions for approved persons. As discussed in further detail below, 
the revisions to Rule 98 would include: (1) Redefining the persons to 
whom Rule 98 would apply; (2) allowing specialist operations to be 
integrated into better capitalized member organizations; (3) permitting 
a specialist unit to share non-trading related services with its parent 
member organization or approved persons; and (4) providing flexibility 
to member organizations and their approved persons in how to conduct 
risk management of specialist operations.
    To achieve these changes, the NYSE proposes shifting the paradigm 
of Rule 98 from one that assumes that the approved persons of a 
specialist member organization are subject to certain NYSE rules unless 
an exemption is provided to one where NYSE Regulation, Inc. (``NYSE 
Regulation'') reviews whether a trading unit that proposes to engage in 
specialist operations is sufficiently walled off from either its 
approved persons or parent member organization. Under the new paradigm, 
rules governing specialist operations, such as Rule 104, will apply 
only to the unit approved to engage in specialist operations at the 
NYSE.
    As the NYSE market model continues to evolve, the NYSE believes 
that the proposed amendments to Rule 98 will provide a platform from 
which to further modernize specialist operations.

A. Background

    The NYSE adopted Rule 98 in 1987 in response to consolidation in 
the securities industry, when NYSE specialist firms that had been 
independent member-owned entities increasingly became subsidiaries of 
larger, better capitalized broker-dealers. Because of the specialists' 
unique position within the markets, and the restrictions on dealers 
under section 11(a) of the Act,\3\ the Exchange crafted a rule that 
governed how larger member organizations could be connected to 
specialist firms.
---------------------------------------------------------------------------

    \3\ See 15 U.S.C. 78k(a).
---------------------------------------------------------------------------

    The rule establishes a functional separation between the specialist 
organization and the rest of the broker-dealer. The purpose of that 
separation was to eliminate or control conflicts of interest between 
the specialist's actions as market maker in an issuer's securities and 
other interactions among the specialist's parent or sibling entities 
and the issuer.
    In its current form, Rule 98 applies to specialist units and so-
called ``approved persons'' of a specialist organization--that is, 
entities that are in a control relationship with a specialist 
organization, or share a common corporate parent with the specialist 
organization and are engaged in a kindred business.\4\ Such entities 
are, by virtue of their association with the specialist organization, 
subject to the rules and restrictions applicable to specialists. These 
include, among other things, restrictions on the approved persons' 
ability to trade in specialty stock options, restrictions on certain of 
their business transactions with issuers for whom the specialist 
organization is the registered specialist, and limits on the amount of 
securities of such issuers that the specialist and approved persons may 
own in the aggregate.
---------------------------------------------------------------------------

    \4\ See NYSE Rules 2(d) and 304(e).
---------------------------------------------------------------------------

    So as not to unreasonably hamstring a broker-dealer organization 
overall, Rule 98(b) provides that an approved person may seek Exchange 
approval to be exempted from most of those restrictions. To obtain a 
Rule 98(b) exemption, the approved person must establish policies and 
procedures that are consistent with the Guidelines for Approved Persons 
Associated with a Specialist's Member Organization (``Rule 98 
Guidelines''). These guidelines set out in detail how approved persons 
and associated specialist organizations should structure and conduct 
their respective businesses in order to ensure complete separation 
between the specialist organization and the rest of the member 
organization.
    Among other things, the Rule 98 Guidelines provide that the 
specialist member organization be housed in a separate corporate entity 
and broker-dealer from its approved persons. Further, to ensure that 
information does not flow improperly from the specialist organization 
to approved persons and that approved persons do not have undue 
influence over particular trading decisions by the specialist, the 
guidelines establish ``functional regulations'' that enforce the 
required separateness. These include requirements that the 
organizations maintain separate books and records, separate financial 
accounting, and separate required capital, and that each organization 
have in place procedures to safeguard confidential information derived 
from business interactions with the issuer or contained in draft 
research reports prepared by the approved person.
    The assumption that all entities affiliated with a specialist are 
subject to specialist rules unless they have obtained a Rule 98(b) 
exemption creates a substantial administrative burden on specialist 
organizations and their approved persons: Each approved person of a 
specialist organization must establish and continually update a 
separate exemption under Rule 98 if it wishes to engage in activity 
that would otherwise be restricted under applicable specialist rules. 
This burden creates a real and substantial barrier to entry for new 
broker-dealers who may want to establish specialist units.
    In the face of significant structural changes to the NYSE and the 
equity markets, and in recognition of the vastly different competitive 
landscape compared to 1987, the Exchange believes that Rule 98 must be 
updated in order to provide both existing and prospective specialist 
firms with the necessary tools to remain competitive while at the same 
time meeting their obligations as specialists at the NYSE. The proposed 
changes to Rule 98 also address the Exchange's desire to ease the 
burdens of a new member organization seeking entry to supplement the 
six specialist firms currently trading on the Exchange, or the very 
real possibility of such a firm replacing one or more of the existing 
specialist firms if they withdraw from the market. Concerning the 
latter possibility, the NYSE notes that this is not just a theoretical 
concern: Within the past six months, two specialist firms have already 
withdrawn.

[[Page 38276]]

    To address these very real concerns, the Exchange proposes to 
fundamentally amend Rule 98. The proposed rule is described in detail 
below, but at root, the amendment reverses the assumption that all 
affiliated entities of a specialist firm are automatically governed by 
the rules applicable to specialists, and shifts the focus of the rule 
onto the specialist unit rather than the approved person.
    As part of this restructuring, the NYSE proposes to eliminate the 
prescriptive approach of the current rule and move towards a more 
principle-based approach. The NYSE believes that a principle-based rule 
closely overseen by NYSE Regulation can achieve the same goals as a 
rule that attempts to enumerate every possible situation that must be 
avoided. For that, the proposed rule still requires NYSE Regulation to 
review whether a specialist unit's policies and procedures are 
reasonably designed to protect confidential information. However, the 
rule provides sufficient flexibility so that as the type of information 
that needs to be protected and the manner in which such information can 
be protected evolves with changes to the trading environment, so too 
can the manner in which NYSE Regulation conducts its review.
    The NYSE believes that the proposed changes to Rule 98 will 
minimize regulatory burdens and barriers to entry while at the same 
time provide the necessary level of regulatory scrutiny to ensure that 
confidential information continues to be protected. In addition, the 
proposed changes will reduce the regulatory burdens on existing 
specialist member organizations to enable them to continue such 
operations at lower cost.

B. Proposed Amendments to Rule 98

1. Applicability of Rule 98
    Under the proposed rule, a member organization seeking to operate a 
specialist unit, either as its entire business or as one of its trading 
units, would need to apply for and be approved by NYSE Regulation 
before it can begin, or if applicable, continue operations as a 
specialist unit. As described in more detail below, NYSE Regulation 
will review whether a proposed specialist unit has: (1) Adopted written 
policies and procedures governing the conduct and supervision of the 
business handled by the specialist unit; (2) established a process for 
regular review of such written policies and procedures; and (3) 
implemented controls and surveillances reasonably designed to prevent 
and detect violations of those policies and procedures. Among other 
things, these policies and procedures must be reasonably designed to 
protect specialist confidential information and non-public order 
information, as defined below.
    Once approved, the NYSE specialist rules, as defined below, 
including Rule 104, would generally only be applicable to the approved 
specialist unit and not to its approved persons or, if applicable, 
parent member organization. As discussed in more detail below, on a 
case-by-case basis, NYSE Regulation will assess whether an integrated 
proprietary aggregation unit that manages the risk for a specialist 
unit could be subject to the specialist rules if the integrated 
proprietary aggregation unit causes the specialist unit to violate its 
obligations.
    The NYSE recognizes that despite the proposed rule changes, an 
existing specialist member organization may determine to either keep 
its current operational structure or wait before it implements changes 
to its operational structure, as permitted by the proposed amended 
rule. Because current Rule 98 would still be applicable to those 
specialist units that would not have yet sought the relief available 
under proposed Rule 98, the Exchange proposes keeping current Rule 98 
in its rulebook as ``Rule 98 (Former)'' until such time as all 
specialist units are approved pursuant to proposed Rule 98(c). Any new 
entrant to become a specialist unit would be required to comply with 
proposed Rule 98; current Rule 98 procedures would not be available to 
new entrants to the specialist business. As proposed, current Rule 
98(b) exemptive relief would be available only so long as the member 
organization and its approved persons have not materially changed their 
operational structure, internal controls, or compliance and audit 
procedures. In such case, the current Rule 98, i.e. , Rule 98 (Former), 
would govern the specialist member organization and its approved 
persons.\5\ Any significant changes to the status quo after the 
effective date of the proposed new rule would require the member 
organization to apply for approval pursuant to the procedures described 
below.
---------------------------------------------------------------------------

    \5\ As discussed in more detail below, in addition to amending 
Rule 98, the Exchange proposes to amend related rules that reference 
the current Rule 98 exemptions for approved persons. To ensure that 
member organizations operating pursuant to Rule 98 (Former) are 
subject to the appropriate rules, the Exchange proposes to maintain 
two forms of the related rules: the amended version and an otherwise 
unchanged version, except for the title ``(Former)'' added to the 
unamended version of the rule or, if applicable, the section 
affected by the proposed rule change. Once all member organizations 
are subject to the proposed Rule 98, the Exchange will file to 
delete any ``Former'' versions of Rule 98 and the related rules or 
sections.
---------------------------------------------------------------------------

    The Exchange recognizes that an existing specialist member 
organization that does not implement structural changes to its 
operations that would require it to apply for approval under the 
proposed rule may still need certain relief available under the 
proposed version of the Rule. Accordingly, the Exchange proposes that a 
member organization operating pursuant to Rule 98 (Former) may apply 
for relief pursuant to proposed Rule 98(e), which concerns sharing non-
trading related services, without first obtaining approval under other 
provisions of proposed Rule 98. In such situation, the specialist 
member organization would need to apply for approval from NYSE 
Regulation to share non-trading related services, as specified in 
proposed Rule 98(e). If approved, except for the sharing of non-trading 
related services, such member organization and its approved persons 
would continue to be subject to Rule 98 (Former) as well as the 
``(Former)'' versions of NYSE rules that reference exemptions from Rule 
98 for approved persons, as discussed in more detail below.
    Once approved pursuant to proposed Rule 98 to operate a specialist 
unit, share non-trading related services, or engage in risk management, 
any material changes in how a specialist unit operates its business 
would require the specialist unit to resubmit its revised written 
policies and procedures to NYSE Regulation for review. For example, if 
a specialist unit is approved to operate as a stand-alone aggregation 
unit and would like to change its business operations to include the 
specialist unit as part of a larger integrated proprietary aggregation 
unit, as permitted by proposed Rule 98(d), such change would require 
pre-approval.
2. Proposed Definitions
    To ensure clarity, the proposed amendments include a number of 
defined terms that are applicable throughout the rule. These 
definitions are designed to provide a level of scalability to the rule 
so that as the NYSE market model evolves, the definitions used 
throughout the rule will have common meaning. Among the proposed 
definitions are:
     ``Specialist unit''--this definition is intended to apply 
to any trading unit that is seeking approval to operate as a specialist 
at the Exchange. As proposed, a specialist unit could be a stand-alone 
member organization, an aggregation unit within a member organization, 
or a trading unit (or ``desk'') within a larger

[[Page 38277]]

aggregation unit. Regardless of which corporate structure a member 
organization chooses, the term ``specialist unit'' would refer to the 
unit that is responsible for specialist activities at the Exchange. If 
approved pursuant to proposed Rule 98(c), a specialist unit would be 
eligible for allocations under NYSE Rule 103B and be subject to 
specialist rules. For purposes of Exchange rules, the term ``specialist 
unit'' is synonymous with the term ``specialist organization'' or 
``specialist member organization.''
     ``Specialist's account''--this definition refers to any 
account through which a specialist unit trades at the Exchange. 
Sometimes referred to as a dealer account, this revised definition 
would encompass any of the variously-defined accounts that a specialist 
unit may use to trade at the Exchange.
     ``Specialist rules''--this definition refers to those 
rules that govern specialist conduct or trading at the Exchange. 
Currently, the specialist rules include, among others, Rules 104, 105, 
and 113, but as the rules at the Exchange change, these rule 
designations may change. Accordingly, so that proposed Rule 98 evolves 
along with changes to other rules, this proposed definition does not 
identify specific rules.
     ``Specialist confidential information''--this definition 
concerns the principal or proprietary trading activity of a specialist 
unit at the Exchange in the securities allocated to it pursuant to Rule 
103B, including the unit's positions in those securities, decisions 
relating to trading or quoting in those securities, and any algorithm 
or computer system that is responsible for such trading activity and 
that interface with Exchange systems, such as the specialist 
application protocol interface (``specialist API'').\6\ The definition 
does not include information about non-public order information, as 
described below.
---------------------------------------------------------------------------

    \6\ The specialist API is the electronic link between specialist 
trading algorithms and the NYSE Display Book[supreg]. Via this 
interface, specialist organization trading algorithms send quoting 
and trading messages to the Exchange for implementation in the NYSE 
Display Book[supreg], and the Exchange transmits information 
necessary to acting as a specialist to specialist organizations.
---------------------------------------------------------------------------

     ``Non-public order''--this definition refers to any 
information relating to order flow at the Exchange, including verbal 
indications of interest made with an expectation of privacy, electronic 
order interest, e-quotes, reserve interest, or information about 
imbalances at the Exchange, that is not publicly-available on a real-
time basis via an Exchange-provided datafeed, such as NYSE 
OpenBook[supreg], or otherwise publicly-available. The definition also 
encompasses information regarding a reasonably imminent non-public 
transaction or series of transactions. For example, if in requesting 
information about the state of the Book, a Floor broker informs the 
specialist about an order that he or she has, such information would 
fall under the definition of ``non-public order.'' As defined, non-
public orders include order information at the open, any re-openings, 
the close, when the security is trading in a slow mode (e.g., in a Gap 
quote or LRP situation), and any other information in the NYSE Display 
Book[supreg] \7\ that is not available via NYSE OpenBook[supreg].\8\ As 
proposed, the linchpin to the definition of ``non-public order'' is 
that it is information not publicly available on a real-time basis. 
Currently, specialists have unique access to certain non-public order 
information. However, in its proposed new market model, the Exchange 
will be proposing to change the specialist's access to such non-public 
order information. The proposed definition is intended to take into 
consideration such future changes so that as the specialist's or 
specialist API's access to non-public order information changes, so 
will the specialist unit's responsibilities to protect that information 
change, but without having to revise Rule 98.
---------------------------------------------------------------------------

    \7\ The Display Book system is an order management and execution 
facility. The Display Book system receives and displays orders to 
the specialists, contains the Book, and provides a mechanism to 
execute and report transactions and publish results to the 
Consolidated Tape. The Display Book system is connected to a number 
of other Exchange systems for the purposes of comparison, 
surveillance, and reporting information to customers and other 
market data and national market systems.
    \8\ NYSE OpenBook[supreg] provides aggregate limit-order volume 
that has been entered on the Exchange at price points for all NYSE-
traded securities.
---------------------------------------------------------------------------

     ``Investment banking department'' and ``Research 
department''--these definitions refer to the same departments that are 
defined as such in NYSE Rule 472 and NASD Rule 2711.
     ``Customer-facing department''--this definition is 
intended to encompass any department, division, market-making desk, 
aggregation unit, or trading desk that receives, routes, or executes 
orders for customer execution or clearing accounts, regardless of 
whether such unit also engages in principal or proprietary trading. A 
hallmark of this definition is that a customer has an expectation of 
confidentiality and best execution on its behalf, which could include a 
customer that is another broker-dealer. Examples of trading desks that 
would meet this definition include a Nasdaq market-making desk and most 
block-trading desks. However, this definition is not intended to 
include an aggregation unit that solely conducts proprietary trading or 
proprietary market making (sometimes referred to as electronic market 
making).
     ``Aggregation unit''--this definition adopts the standard 
of Rule 200(f) of Regulation SHO.\9\ The proposed rule uses this term 
throughout to refer to any department, division, unit, or trading desk 
that has been segregated pursuant to the requirements of Regulation 
SHO. The NYSE believes that the Regulation SHO requirements for 
establishing an aggregation unit, including any requirements for 
information barriers, would be sufficient for segregating a specialist 
unit's operations from the remainder of a member organization or its 
approved persons.
---------------------------------------------------------------------------

    \9\ See 17 CFR 242.200(f).
---------------------------------------------------------------------------

     ``Non-trading related services''--this definition refers 
to the type of support services that a specialist unit may share with 
its parent member organization or approved person. The core of the 
proposed definition is that the type of services are not related to 
making decisions about the day-to-day trading of the specialist unit or 
provide trading support to such activity, such as by a trading 
assistant or specialist clerk. Examples of non-trading related services 
include stock loan (so long as consistent with Regulation SHO), 
clearing and settlement, controllers (for financial accounting 
purposes), technology support, and personnel who develop applications 
and algorithmic models.
     ``Integrated proprietary aggregation unit''--this 
definition is intended to encompass any aggregation unit that has a 
trading objective to engage in proprietary trading, including 
proprietary market-making activities. As defined, an integrated 
proprietary aggregation unit must not include any activities that would 
be performed by an investment banking, research, or customer-facing 
department. Subject to proposed Rule 98(d), a specialist unit could be 
part of a member organization's integrated proprietary aggregation 
unit. Alternatively, an approved person or member organization could 
maintain an integrated proprietary aggregation unit separate from the 
specialist unit. In such case, the definition of an integrated 
proprietary aggregation unit becomes relevant in connection with 
proposed Rule 98(f)(3) and the ability of an approved person to engage 
in risk management activities on behalf of the

[[Page 38278]]

specialist unit of an associated member organization.
     ``Related products''--this definition refers to any 
derivative instrument that is related to a security allocated to a 
specialist unit. It can include options, warrants, hybrid securities, 
single-stock futures, security-based swap agreements, a forward 
contract, or any other contract that is exercisable into or whose price 
is based upon or derived from a security listed at the Exchange. The 
list referenced in the definition is not intended to be exhaustive and 
the definition is intended to cover any existing or future products 
that could be related to a security listed at the Exchange.
3. Proposed Rule 98(c): Approval to Operate a Specialist Unit
    Pursuant to proposed Rule 98(c), a member organization must obtain 
prior written approval from NYSE Regulation before it can operate a 
specialist unit. For approval, a specialist unit must demonstrate that 
it has: (i) Adopted and implemented comprehensive written procedures 
and guidelines governing the conduct and supervision of business 
handled by the specialist unit; (ii) established a process for regular 
review of such written policies and procedures; and (iii) implemented 
controls and surveillances reasonably designed to prevent and detect 
violations of these procedures and guidelines.
    As proposed, these policies and procedures must be reasonably 
designed to provide that the specialist unit will maintain the 
confidentiality of both specialist confidential information and non-
public orders. The proposed rule enumerates certain bright-line 
divisions that the specialist unit must maintain, including information 
barriers between the specialist unit and investment banking, research, 
and customer-facing departments and approved persons. Such information 
barriers should guarantee confidentiality two ways: the specialist unit 
cannot access material non-public information about securities 
allocated to that unit from either its approved persons or non-
specialist operations of a parent member organization and vice versa.
    With respect to a specialist unit's internal controls and 
surveillances, NYSE Regulation will be reviewing such surveillance 
plans to determine whether they are reasonably designed to protect 
information as required under the proposed rule. Where feasible, NYSE 
Regulation will expect specialist units to use automated surveillances 
to check for breaches of the information barriers required by the 
proposed rule. As with the current rule, NYSE Regulation will also 
review whether a member organization has implemented internal audit 
procedures relating to compliance with the proposed Rule 98 policies 
and procedures.
    In addition to the specific information barriers enumerated in the 
proposed rule, if a member organization proposes to operate a 
specialist unit as a stand-alone unit, the Exchange proposes importing 
the requirements of a Regulation SHO independent trading unit for 
specialist units. Accordingly, as required by Rule 200(f) of Regulation 
SHO,\10\ NYSE proposes requiring a specialist unit to have a written 
plan of organization that specifies its trading objectives and meet all 
of the other requirements of an independent trading unit under 
Regulation SHO. If a specialist unit seeks to avail itself of the 
exemption from NYSE Rule 105 under proposed Rule 98(f)(1), that written 
plan of organization would need to include its trading objectives for 
trading in related products.
---------------------------------------------------------------------------

    \10\ See 17 CFR part 242.200(f).
---------------------------------------------------------------------------

    As with the current rule, proposed Rule 98 would require the 
specialist unit to maintain net capital sufficient to meet the 
requirements of NYSE Rule 104.21. The NYSE believes that if a 
specialist unit is integrated within a larger member organization, the 
net capital requirement can be met by having the requisite capital 
amount allocated to the specialist unit by the member organization.
    Despite the segregations required by the rule, the NYSE believes 
that senior managers who are not dedicated to the specialist unit and 
are associated with either an approved person or a member organization 
that runs a specialist unit should still be able to provide management 
oversight to the specialist unit. As proposed, the revised rule is not 
intended to be more restrictive than the current rule, which permits an 
approved person to provide general oversight over its associated 
specialist member organization. The proposed rule instead shifts from a 
detailed list of specific types of oversight that is permissible to a 
principle-based approach that focuses on protecting specialist 
confidential information and non-public order information. As with the 
current rule, as proposed, senior management oversight of a specialist 
unit should not conflict with or compromise in any way with the 
specialist unit's market-making obligations.
    Proposed Rule 98(c)(2)(E) provides guidance on how a member 
organization or approved person should handle situations where a senior 
manager is called upon for risk management purposes and in connection 
with that role, gains access to specialist confidential information or 
non-public order information. The Exchange notes that non-public order 
information could become stale if the order is executed or cancelled 
without the specialist's knowledge. To ensure that there is no misuse 
of such information, whether material or not, the senior manager must 
not make (directly or indirectly) specialist confidential information 
or non-public order information available to the persons or systems 
responsible for making trading decisions in aggregation units, 
departments, divisions, or trading desks that are not part of the 
specialist unit, including the customer-facing departments. The senior 
manager also must not use such information to directly or indirectly 
influence the day-to-day trading decisions of the other aggregation 
units of the member organization or approved person with respect to the 
securities allocated to the specialist unit.
    The NYSE believes that these restrictions on the use of specialist 
confidential information and non-public order information are similar 
to how broker-dealers currently handle situations where a senior 
manager has oversight over multiple aggregation units and in such 
capacity, becomes privy to confidential information of one aggregation 
unit. For such situations, broker-dealers have already developed 
procedures for protecting confidential information and the NYSE 
believes that such procedures should be reasonable for the oversight of 
a specialist unit as well.
    The Exchange notes that although the proposed amendments to Rule 98 
eliminate the exemption process under current Rule 98(b), the review 
that NYSE Regulation would conduct when approving a specialist unit 
would be as rigorous as the current review for obtaining an exemption, 
just simply a different focus of what is reviewed. As with the current 
Rule 98 exemption process, staff from both the Market Surveillance 
Division of NYSE Regulation as well as relevant staff from the 
Financial Industry Regulatory Authority, Inc. (``FINRA''), who are 
responsible for the routine examinations of specialist units, would be 
involved in reviewing a specialist unit's written policies and 
procedures and proposed automated surveillances and controls.\11\
---------------------------------------------------------------------------

    \11\ In connection with the July 2007 transfer of certain member 
firm regulation functions from NYSE Regulation to FINRA, NYSE 
Regulation and FINRA entered into a regulatory services agreement 
(``RSA'') whereby FINRA agreed to provide NYSE Regulation with 
certain services relating to NYSE's retained responsibilities to 
examine for compliance with NYSE rules that govern trading on or 
through the systems and facilities of the Exchange. In particular, 
pursuant to the RSA, FINRA participates in the current Rule 98(b) 
exemption process and examines specialist firms for compliances with 
that rule. As proposed, FINRA would continue to participate in the 
approval process under the proposed Rule 98 and examine specialist 
units for compliance with the rule.

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

[[Page 38279]]

    For existing specialist firms, the initial approval process 
associated with any changes to how they operate may require upfront 
work to ensure that the specialist unit's policies and procedures are 
reasonably designed to meet the requirements of the proposed rule. 
However, unlike the current rule, as proposed, specialist units would 
be relieved of the requirement to update any written statements to the 
Exchange for changes in approved persons or dually-affiliated 
employees. Once approved, NYSE Regulation and FINRA would examine 
whether a specialist unit's policies and procedures continue to meet 
the rule requirements and whether the implemented controls and 
automated surveillances are functioning as designed. As part of such 
examination review, NYSE Regulation and FINRA will conduct on-site 
reviews of a specialist unit to review for breaches of the controls or 
surveillances. And, as noted above, if the specialist unit proposes 
making any material changes to its operations, it would need to seek 
additional approval before it can change its operations.
4. Proposed Rule 98(d): Operating a Specialist Unit Within an 
Integrated Proprietary Unit
    One of the goals of proposed Rule 98 is to provide a member 
organization with greater flexibility in how it manages the risk of a 
specialist unit. As discussed below, in proposed Rule 98(f), the NYSE 
proposes providing member organizations with an array of options of how 
to conduct risk management. The NYSE believes that the flexibility 
afforded by these options will meet the varying business models of the 
member organizations currently operating or seeking to operate a 
specialist unit at the Exchange.
    As discussed in more detail below, one proposed risk management 
model would be to permit a member organization to integrate a 
specialist unit within a larger aggregation unit that meets the 
requirements of an integrated proprietary aggregation unit. Proposed 
Rule 98(d) sets forth the minimum requirements for how to structure 
such an integrated unit. While such a unit would be considered a single 
aggregation unit for Regulation SHO purposes, as proposed, the member 
organization would need to establish information barriers within the 
integrated proprietary aggregation unit to restrict access to non-
public order information to the specialist unit only. And depending on 
the risk management model proposed by a specialist unit, a member 
organization or approved person may need to further segregate the flow 
of information within a specialist unit.
    As proposed, the specialist unit that would operate within the 
integrated proprietary aggregation unit would need to meet the 
requirements of proposed Rule 98(c)(2)(A), (C), (D), and (E) of the 
rule, which concern the information barriers associated with the 
specialist unit and non-specialist unit operations, net capital 
requirements, and senior management oversight. Because an integrated 
proprietary aggregation unit that includes a specialist unit would 
likely already be subject to Rule 200(f) of Regulation SHO that it 
qualify as an independent trading unit, the specialist unit operating 
within the integrated proprietary aggregation unit would not need to 
separately meet the Rule 200(f) requirement for an independent trading 
unit. Accordingly, as proposed, a specialist unit that operates within 
an integrated proprietary aggregation unit would not need to meet the 
requirements of proposed Rule 98(c)(2)(B), which requires a specialist 
unit to separately comply with all of the Regulation SHO independent 
trading unit requirements.\12\
---------------------------------------------------------------------------

    \12\ The Exchange recognizes that there may be some Regulation 
SHO issues in connection with how a member organization may choose 
to structure its specialist unit within an integrated proprietary 
aggregation unit or provide risk management to the specialist unit 
pursuant to proposed Rule 98(f). In such case, approval to operate 
under proposed Rule 98 would not be provided until all Regulation 
SHO issues that may arise have been resolved.
---------------------------------------------------------------------------

    In addition to meeting certain requirements of proposed Rule 98(c), 
under proposed Rule 98(d)(2)(B), the specialist unit must restrict 
access to non-public order information or specialist confidential 
information from the rest of the integrated proprietary aggregation 
unit. Such information barriers must ensure that both individuals and 
systems that are not assigned to the specialist unit do not have access 
to non-public order information, or, unless otherwise provided for in 
proposed Rule 98(f), specialist confidential information.
    The NYSE believes that as proposed, Rule 98(d)(2)(B) provides 
sufficient flexibility for how a member organization structures its 
operations to evolve as the NYSE market model changes. For example, the 
specialist API currently has access to limited non-public order 
information, but does not have access to information available in the 
NYSE Display Book. So long as the specialist API has access to that 
non-public order information, the Exchange believes that systems not 
dedicated to the specialist unit should not be integrated with the 
specialist API. Accordingly, the trading algorithms of the integrated 
proprietary aggregation unit that are not dedicated to the specialist 
unit would not have access to any non-public order information via the 
specialist API, or any other system.
    Proposed Rule 98(d)(2)(B)(iii) addresses the situation of 
communications from the Floor of the Exchange to the rest of the 
integrated proprietary aggregation unit. Currently, specialist unit 
employees on the Floor of the Exchange have access to non-public order 
information, whether via access to information in the Display 
Book[supreg] or because of verbal representations of imminent orders. 
The NYSE believes that the best way to ensure that such information is 
not provided to individuals or systems not dedicated to the specialist 
unit is to restrict communications while the employee is still on the 
Floor of the Exchange.
    Proposed Rule 98(d)(2)(B)(iv) considers the possibility that an 
individual who works on the Floor of the Exchange \13\ may also, on an 
intra-day basis, move to an off-Floor location and engage in a non-
specialist related role within the integrated proprietary aggregation 
unit pursuant to proposed Rule 98(d) or for an ``upstairs'' desk 
trading in related products within the specialist unit pursuant to 
proposed Rule 98(f)(1). In such case, the individual must not make any 
non-public order information or, unless specifically provided for, 
specialist confidential information, available to individuals or 
systems that are not dedicated to the specialist unit. Nor may that 
individual use such non-public information, or, except as provided for 
in the Rule, specialist confidential information, in any way in 
connection with responsibilities that are not related to Floor-based 
activities of the specialist unit. For purposes of proposed Rule 
98(f)(1), once off the Floor, a specialist may not use non-public 
information to directly or indirectly trade in related products. 
However, nothing in the rule

[[Page 38280]]

bars a specialist unit from moving personnel among different positions 
intraday, so long as the restrictions on information flow and use are 
followed. The NYSE believes that this would provide member 
organizations with sufficient flexibility to transfer its employees 
among various roles, including on the Floor of the Exchange and in a 
specialist unit upstairs location during a given trading day. For 
intra-day transfers, the Exchange will expect specialist units to have 
written policies and procedures reasonably designed to ensure that non-
public order information and specialist confidential information 
(unless otherwise permitted) would not be used from an off-Floor 
location. The Exchange notes that in addition to the information 
barriers required by proposed Rule 98, specialists must continue to 
abide by Exchange rules that govern their access to and use of non-
public order information.\14\
---------------------------------------------------------------------------

    \13\ Note that NYSE rules define being on the Floor to include 
the trading Floor of the Exchange, and the premises immediately 
adjacent thereto, such as the various entrances and lobbies of 11 
Wall Street, 18 New Street, 12 Broad Street, and 18 Broad Street, as 
well as the telephone lobby in the first basement of 11 Wall Street. 
See Rule 112(b).
    \14\ See, e.g. , NYSE Rules 70.20(h)(ii), 104(b), 115, and 115A.
---------------------------------------------------------------------------

    As noted above, an integrated proprietary aggregation unit would 
need to qualify as an aggregation unit, which for Regulation SHO 
purposes, requires the unit to net its positions. While the proposed 
rule would no longer require separate books and records for a 
specialist unit, to ensure that NYSE Regulation can review the trading 
activity by the specialist unit at the Exchange without having to parse 
through commingled records, under proposed Rule 98(d)(2)(C), in 
addition to meeting Regulation SHO requirements, an integrated 
proprietary aggregation unit must maintain records of its specialist's 
accounts in a manner that is separate from the accounts of the 
integrated proprietary aggregation unit.\15\
---------------------------------------------------------------------------

    \15\ The Exchange is engaging in a separate discussion with 
Commission staff of the Regulation SHO implications of requiring a 
specialist unit to separately aggregate its trading positions for 
purposes of Exchange rules.
---------------------------------------------------------------------------

    In addition to the above, the integrated proprietary aggregation 
unit must have written policies and procedures that address how it will 
ensure that the unit will not engage in any activities that could 
violate other Exchange rules or federal securities laws and 
regulations, including Regulation SHO. The policies and procedures must 
address, at a minimum, how the unit will ensure against front running, 
wash sales, and market manipulation.
    In connection with wash sales, a potential concern for an 
integrated proprietary aggregation unit is the possibility that the 
specialist unit could be selling (buying) one of the securities 
registered to it and an individual or trading system of the integrated 
proprietary aggregation unit could at the same time be buying (selling) 
that same security at the Exchange. With the proper use of mnemonics 
associated with those orders, Exchange systems are capable of rejecting 
one side of those orders. Because the presumption would be in favor of 
the specialist unit trading, i.e., to meet its affirmative obligations 
at the Exchange, the NYSE proposes rejecting the order from the 
integrated proprietary aggregation unit.
    The NYSE also proposes that to the extent an integrated proprietary 
aggregation unit directs its trading at the Exchange in any security 
that has been allocated to the specialist unit through the specialist 
unit, such trading would be subject to the specialist rules. In other 
words, while the specialist unit would be subject to certain market-
making obligations while trading at the Exchange, the integrated 
proprietary aggregation unit's independent ``upstairs'' operations 
would be able to trade freely.
    Finally, to ensure that NYSE Regulation can review the trading 
activities of the integrated proprietary aggregation unit, proposed 
Rule 98(d)(4) requires member organizations to maintain audit trail 
information for any trading by such unit, including trading at the 
Exchange and at other market centers. The NYSE proposes to amend NYSE 
Rule 132B to have the Order Tracking System (``OTS'') requirements 
apply to trading by a specialist unit, and if applicable, an integrated 
proprietary aggregation unit. Member organizations must maintain 
sufficient records to reconstruct in a time-sequenced manner its 
trading in securities allocated to the specialist unit and any trading 
by the integrated proprietary aggregation unit in those securities in 
other market centers or trading in related products.
    As with the approval process under proposed Rule 98(c), to obtain 
approval to operate a specialist unit within an integrated proprietary 
aggregation unit, a member organization would need to submit its 
written policies and procedures to NYSE Regulation for review of 
whether such policies and procedures are reasonably designed to meet 
the rule requirements. Once approved under proposed Rule 98(d), NYSE 
Regulation and FINRA would continue to examine whether a specialist 
unit's policies and procedures continue to meet the rule requirements 
and whether the implemented controls and surveillances plans are 
functioning as designed.
5. Proposed Rule 98(e): Sharing Non-Trading Related Services
    One of the restrictions of current Rule 98 is the limit on a 
specialist member organization and its approved persons to share 
operational support personnel. In its current form, Rule 98(c) permits 
dual affiliation only if the specialist member organization and 
approved person provide the Exchange with a written statement of the 
duties of such person and why it is necessary for the individual to 
have a dual affiliation. Any changes to dual affiliations must be 
submitted to the Exchange for approval in advance of making such 
change.
    The NYSE believes that current Rule 98(c) unnecessarily restricts 
the ability of a specialist member organization and its approved person 
to share non-trading related services, i.e., operational support 
services. Accordingly, the NYSE proposes amending Rule 98 to permit the 
sharing of non-trading related services, subject to the approval of 
NYSE Regulation.
    As with the approval process to become a specialist unit, the 
approval process for a specialist unit to share non-trading related 
services with its parent member organization or approved person would 
require the specialist unit to: (1) Adopt written policies and 
procedures governing the sharing or non-trading related services; (2) 
establish a process for regular review of such written policies and 
procedures; and (3) implement controls and surveillances reasonably 
designed to prevent and detect violations of those policies and 
procedures. In accordance with the purpose of Rule 98, such policies 
and procedures must be reasonably designed to protect specialist 
confidential information and non-public order information.
    The NYSE understands that personnel or systems that provide non-
trading related services may have access to specialist confidential 
information or non-public order information. For example, clearance and 
settlement services would have knowledge of specialist positions in 
securities, and technological support personnel may have knowledge of 
how a specialist algorithm conducts its trading. However, access to 
such information should not be the basis for restricting the sharing of 
such personnel or systems. Rather, such personnel or systems can be 
shared so long as the specialist unit has controls reasonably designed 
to ensure that the individuals or systems who have access to specialist 
confidential information or non-public information neither provide nor 
make available that information to any

[[Page 38281]]

individuals or systems not part of the specialist unit. In particular, 
under no circumstances should non-public order information or 
specialist confidential information be made available to the investment 
banking, research, or customer-facing departments.
    Before a specialist unit can share non-trading related services, 
NYSE Regulation will review whether the specialist unit has adopted 
policies and procedures and controls and surveillances reasonably 
designed to protect specialist confidential information and non-public 
order information. Once approved, a specialist unit would no longer 
need to provide NYSE Regulation with a written statement of why a 
certain individual has a dual affiliation and update such written 
statements if the individual involved changes. On an ongoing basis, 
NYSE Regulation and FINRA will examine whether the specialist unit's 
policies and procedures and controls comply with the requirements of 
the rule.
6. Proposed Rule 98(f): Risk Management
    Specialist member organizations and their approved persons are 
currently limited in their ability to manage the specialist member 
organization's trading risks: Rule 98 currently restricts an approved 
person from being involved in any trading decisions of an associated 
specialist member organization; Rule 105 currently restricts the 
specialist member organization's ability to trade in options and 
single-stock futures related to the securities allocated to the 
specialist member organization. Together, these restrictions place 
specialist member organizations at a competitive disadvantage vis-
[agrave]-vis other market-making or trading firms.
    The NYSE believes that the changes to the marketplace that have 
occurred since 1987, when Rule 98 was adopted, call for an overhaul of 
how specialist units are permitted to manage their risk. For example, 
when Rule 98 was adopted, the NYSE enjoyed an approximately 85% market 
share in trading of NYSE-listed securities and specialists participated 
in approximately 12% of the transactions at the Exchange. Now, the 
NYSE's market share for listed securities hovers under 40%, and of 
that, specialist participation is in the range of two percent. These 
numbers are telling: Because of automatic executions at the Exchange, 
specialists no longer have a unique advantage over other market 
participants. To the contrary, specialists are now at a disadvantage to 
other market participants because they must meet their affirmative and 
negative obligations to the Exchange, yet cannot participate in the 
type of hedging activities that other market participants may and can 
do.
    Accordingly, the Exchange proposes providing specialist units with 
the ability to manage their risks by broadening the ability to trade in 
related products and expanding the universe of who may be involved in 
managing the risk of the specialist unit. Because there is no single 
correct model for risk management, the NYSE proposes providing 
specialist units with options of how to manage their risk, which they 
can choose to use in combination or alone. Regardless of which model a 
specialist unit proposes to adopt for risk management, at all times, 
the specialist unit will be ultimately responsible for its quoting or 
trading decisions at the Exchange.
a. Specialist Unit Risk Management
    In order to provide a specialist unit with greater risk management 
tools, the NYSE proposes permitting specialist units to apply for an 
exemption from the Rule 105(b)-(d) restrictions on trading options and 
single-stock futures. In connection with this change, the NYSE proposes 
amending Rule 105 so that it applies only to a specialist unit, and not 
to any other departments or units of a member organization or approved 
person. If approved for an exemption from Rule 105, a specialist unit 
would be permitted to trade in related products, subject to proposed 
Rule 98(f)(1).\16\
---------------------------------------------------------------------------

    \16\ The Exchange also proposes amending section (m) of the Rule 
105 Guidelines to provide that a specialist unit is not permitted to 
engage in market-making activities in single-stock futures or 
options. However, if eligible for an exemption under Rule 105(b)-
(d), nothing restricts a specialist unit from having a trading desk 
that trades in options or single-stock futures. Because an 
integrated proprietary aggregation unit that includes a specialist 
unit may engage in options market making, the Exchange proposes 
eliminating sections (m)(ii) and (iii) of the Rule 105 Guidelines.
---------------------------------------------------------------------------

    As proposed, to obtain an exemption from Rule 105, the specialist 
unit must: (i) Adopt and implement comprehensive written procedures and 
guidelines governing the conduct of trading in related products; (ii) 
establish a process for regular review of such written procedures and 
guidelines; and (iii) implement controls and surveillances reasonably 
designed to prevent and detect violations of these procedures and 
guidelines.
    These policies and procedures must be reasonably designed to ensure 
that the individuals or systems responsible for trading related 
products do not have access to non-public order information, or, unless 
otherwise specifically provided for, specialist confidential 
information. In addition, individuals who work on the Floor of the 
Exchange would not be permitted to trade or direct trading in related 
products, nor would the specialist API be permitted to make any trading 
decisions in related products. Accordingly, any trading in related 
products by the specialist unit must be conducted by an off-Floor, 
i.e., ``upstairs'' office. All trading in related products must be 
conducted by individuals who are qualified and registered to trade in 
the marketplaces where such trading occurs. Moreover, the member 
organization that houses the specialist unit must be a member of FINRA 
or other self-regulatory organizations, as required by each marketplace 
where the specialist unit proposes to trade.
    The NYSE believes that a specialist unit should have the 
flexibility to transfer its employees among different functions within 
the unit. Accordingly, the proposed rule does not expressly prohibit 
specialists from trading in related products; it only bars directly 
entering or executing trades in related products while on the Floor of 
the Exchange.\17\ As proposed, a specialist unit could transfer a 
specialist back and forth from the Floor of the Exchange to a 
specialist unit upstairs desk that trades in related products, so long 
as that specialist is registered and qualified to trade in related 
products and non-public order information is not used when trading in 
related products. In such case, however, a specialist unit must have 
policies and procedures reasonably designed to ensure that a specialist 
who moves off the Floor of the Exchange does not make available or use 
any non-public information or, unless otherwise specified, specialist 
confidential information, to which the specialist may have had access 
while on the Floor of the Exchange. As noted above, while off the Floor 
of the Exchange, specialists continue to be subject to other NYSE rules 
that govern their access to and use of non-public order information.
---------------------------------------------------------------------------

    \17\ The Exchange notes that a specialist unit that has not been 
approved for an exemption from Rule 105 under proposed Rule 98(f)(1) 
would still be permitted to enter orders in options or single-stock 
futures from the Floor, subject to the requirements of Rule 105.
---------------------------------------------------------------------------

    To ensure that the specialist unit upstairs desk that trades in 
related products can effectively hedge the specialist unit's positions, 
the NYSE proposes that the specialist unit upstairs desk have 
electronic access to the trades by the specialist unit at the Exchange 
in securities allocated to the specialist unit

[[Page 38282]]

that have been printed to the Consolidated Tape.
    Currently, senior managers of specialist member organizations can 
be privy to information about trading on the Floor of the Exchange as 
well as any hedging conducted by the specialist member organization, 
even though such hedging opportunities are limited. For example, 
currently, a specialist on the Floor can call his or her senior manager 
to discuss hedging strategies. Under the proposed exemption from Rule 
105, the NYSE believes that specialist unit senior managers should be 
able to continue in that role and provide oversight of both Floor 
specialist operations and any specialist unit upstairs trading in 
related products. The NYSE believes that the oversight model that works 
for larger broker-dealers, whose senior managers have a role with 
respect to multiple aggregation units, should apply within a specialist 
unit as well.
    Accordingly, the NYSE proposes Rule 98(f)(1)(vi) to address how a 
senior manager of a specialist unit should handle situations where he 
or she has access to non-public order information in connection with 
his or her role as a senior manager. As with proposed Rule 98(c)(2)(E), 
when trading in related products, the specialist unit must have 
policies and procedures reasonably designed to ensure that the 
specialist unit senior manager who has access to non-public order 
information does not provide such information to the specialist unit 
upstairs trading desk responsible for trading related products or use 
such non-public information to directly or indirectly influence trading 
by that upstairs desk.
b. Integrated Proprietary Aggregation Unit Risk Management
    Proposed Rule 98(f)(2) addresses how an integrated proprietary 
aggregation unit that has been approved pursuant to proposed Rule 98(d) 
to include a specialist unit could engage in risk management of the 
specialist unit's positions. At a minimum, an integrated proprietary 
aggregation unit must have policies and procedures that are reasonably 
designed to meet the protections enumerated in the rule, including how 
it trades in related products on behalf of a specialist unit and how it 
electronically accesses the specialist unit's trades at the Exchange in 
securities allocated to the specialist unit that have been printed to 
the Consolidated Tape.
    In addition, proposed Rule 98(f)(2)(A)(i) would permit an 
integrated proprietary aggregation unit to send appetites of trading or 
quoting direction to the specialist unit. In practice, this would 
permit a non-specialist unit ``upstairs'' risk management desk that has 
real-time access both to the specialist unit's positions in securities 
allocated to it and to the integrated proprietary aggregation unit's 
positions in related products and other securities to provide 
electronic direction to the specialist unit of whether to trade or 
quote in a certain direction. The Exchange believes that permitting an 
integrated proprietary aggregation unit to send quoting messages that 
are based on real-time positions of the unit as a whole will enable a 
specialist unit to better meet any quoting requirements at the 
Exchange. In other words, the specialist unit will no longer need to 
operate in a vacuum when determining how or when to quote at the 
Exchange.
    As proposed, the specialist unit would be ultimately responsible 
for whether to accept the electronic trading direction submitted by the 
integrated proprietary aggregation unit upstairs desk; a specialist 
unit must comply at all times with its market-marking obligations, 
including the specialist rules, notwithstanding any electronic trading 
directions received from that upstairs desk. Stated otherwise, the 
specialist unit would operate independently and be free to accept or 
reject the electronic trading directions sent by the integrated 
proprietary aggregation unit. However, to the extent an integrated 
proprietary aggregation unit causes a specialist unit to violate one or 
more of the specialist rules, the Exchange proposes that in such case, 
the integrated proprietary aggregation unit should also be held to 
those standards.
    At this time, as noted above, because of access to non-public order 
information, the NYSE does not believe it would be feasible to permit 
communications, whether verbal or electronic, from the specialist or 
the specialist API to the individuals or systems responsible for 
trading in related products and other securities within the integrated 
proprietary aggregation unit, or, if applicable, to an upstairs desk 
within the specialist unit. However, as the NYSE market model evolves, 
the NYSE will continue to review how best to integrate a specialist 
unit within an integrated proprietary aggregation unit, including the 
possibility of fully integrating the trading systems that interact with 
the Exchange for the specialist unit and the trading systems that trade 
in related products and other securities. The NYSE believes that 
ultimately, a competitive trading model would permit full integration, 
including permitting two-way communications among trading desks.
c. Approved Person Risk Management
    As proposed, another option available to firms to manage the risk 
of the specialist unit is to permit a separate integrated proprietary 
aggregation unit that is housed in either an approved person or a 
member organization that runs a specialist unit to provide the same 
level of risk management as proposed for an integrated proprietary 
aggregation unit that includes a specialist unit. This option would 
provide flexibility for broker-dealers that want to keep the specialist 
unit as a separate member organization or aggregation unit, yet still 
have an approved person or separate aggregation unit provide risk 
management services for the specialist unit.
    As with proposed Rule 98(f)(2), proposed Rule 98(f)(3) would 
require that the approved person not have access to either specialist 
confidential information and non-public order information, except as 
provided for in that section of the rule. Specifically, an integrated 
proprietary aggregation unit of an approved person could have access to 
the trades by a specialist unit at the Exchange in securities allocated 
to that unit, so long as such trades have been printed to the 
Consolidated Tape.
    And as with proposed Rule 98(f)(2), an approved person could send 
electronic appetites of how the speci

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