[Federal Register Volume 59, Number 105 (Thursday, June 2, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-13344] [[Page Unknown]] [Federal Register: June 2, 1994] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-34109; File No. SR-Phlx-93-29] Self-Regulatory Organizations; Order Approving and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 1 to a Proposed Rule Change by the Philadelphia Stock Exchange, Inc., Relating to Enhanced Specialist Participation in Parity Options Trades. May 25, 1994. On August 9, 1993, the Philadelphia Stock Exchange, Inc. (``Phlx'' or ``Exchange'') filed with the Securities and Exchange Commission (``Commission''), pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change relating to enhanced specialist participation in parity options trades. Notice of the proposal appeared in the Federal Register on September 20, 1993.\3\ One comment letter was received opposing the proposed rule change,\4\ to which the Phlx responded.\5\ On April 19, 1994, the Exchange filed Amendment No. 1.\6\ This order approves the Exchange's proposal, as amended. --------------------------------------------------------------------------- \1\15 U.S.C. 78s(b)(1) (1988). \2\17 CFR 240.19b-4 (1992). \3\See Securities Exchange Act Release No. 32891 (September 14, 1993), 58 FR 48921. \4\See Letter from Jay Mizrahi, General Partner, P.J. Shoreline Securities (``Shoreline''), to Jonathan Katz, Secretary, Commission, dated December 16, 1993 (``Shoreline Securities Letter''). \5\See Letter from William Uchimoto, Vice President and General Counsel, Phlx, to Sharon Lawson, Assistant Director, Office of Derivatives and Equity Oversight (``ODEO''), Division of Market Regulation (``Division''), Commission, dated February 23, 1994 (``Phlx Response Letter''). \6\On April 19, 1994, the Exchange filed Amendment No. 1 to the proposed rule change to specify that: (1) The Exchange's Allocation, Evaluation and Securities Committee (``Committee'') may only extend the proposed six month Enhanced Parity Split (as defined herein) for one additional six month period; and (2) the Enhanced Parity Split cannot cause a customer order to receive a smaller participation as a result of this rule than any other crowd participant, including the specialist. Further, Amendment No. 1 clarifies that (1) a ``New Unit'' would be any new equity options specialist unit approved by the Exchange on or after June 16, 1993; (2) a `New Options Class'' is any class of options listed for trading by the Exchange on or after June 16, 1993; and (3) the Enhanced Parity Split may be granted for a New Options Class after the initial six month period has expired as long as the New Options Class is assigned to the New Unit while it is still entitled to receive the Enhanced Parity Split pursuant to the proposed rule change on the first New Options Class it commenced trading. See Letter from Michele Weisbaum, Associate General Counsel, Phlx, to Michael Walinskas, Branch Chief, ODEO, Division, Commission, dated April 19, 1994 (``Amendment No. 1''). --------------------------------------------------------------------------- Description of Proposal In order to encourage the registration with the Exchange of New Units,\7\ the Exchange proposes to add now Commentary .17 to Rule 1014. Specifically, the proposal would enable New Units trading New Options Classes,\8\ to execute 50% of the contracts in transactions where the New Unit is on parity with one registered options trader (``ROT''), and 40% of the contracts in a transaction where the New Unit is on parity with two or more ROTs (``Enhanced Parity Split''); provided, however, that no customer order which is on parity may receive a smaller participation than any other crowd participant, including the specialist.\9\ --------------------------------------------------------------------------- \7\See Amendment No. 1, supra note 6. \8\id. \9\In such cases, the specialist may waive the Enhanced Parity Split. Telephone conversation between Michele Weisbaum, Associate General Counsel, Phlx, and Brad Ritter, Attorney, ODEO, Division, Commission, on May 20, 1994. --------------------------------------------------------------------------- A New Unit can be formed by current ROTs and/or specialists as long as a new broker-dealer firm is established. Because the proposal will be limited to New Options Classes, options classes that are leased or otherwise transferred from an existing specialist to a New Unit, or that were listed on the Exchange prior to June 16, 1993, and which are assigned to a New Unit, and not covered by the proposed rule. The Enhanced Parity Split would be effective for a period of six months from the commencement of trading by the New Unite of its first New Options Class.\10\ Furthermore, the Committee may extend the Enhanced Parity Split for one additional six month period upon petition by the New Unit and a determination by the Committee that such extension is consistent with the promotion of just and equitable principles of trade and the public interest.\11\ The Enhanced Parity Split will also be applicable to any additional New Options Classes that are assigned to a New Unit, provided that at the time such classes are assigned, the New Unit is still entitled to receive the Enhanced Parity Split on the first New Options Class it commenced trading pursuant to this rule.\12\ The Committee may terminate any extension of the Enhanced Parity Split if the Committee determines that such action is consistent with the promotion of just and equitable principles of trade and the public interest.\13\ --------------------------------------------------------------------------- \10\On August 17, 1992, the Exchange filed a similar proposal pursuant to which all specialists would have received the enhanced parity split contained in this proposal. See File No. SR-Phlx-92-19. The Exchange has withdrawn that proposal. See Letter from Keith Kessel, Phlx, to Brad Ritter, Attorney, Office of Derivatives Regulation, Division of Market Regulation, Commission, dated December 2, 1993. On February 28, 1994, the Exchange filed another proposal which provides for a different form of enhanced parity participation for existing specialist units and for New Units that become ineligible for the Enhanced Parity Split pursuant to this proposal. See Securities Exchange Act Release No. 33935 (April 20, 1994), 59 FR 22038 (April 28, 1994) (notice of File No. SR-Phlx-94- 12). If approved, the enhanced parity participation for specialists proposed in File No. SR-Phlx-94-12 would not be available to New Units that are eligible for the Enhanced Parity Split pursuant to this proposal. Telephone conversation between Michele Weisbaum, Associate General Counsel, Phlx, and Brad Ritter, Attorney, ODEO, Division, Commission, on April 20, 1994. \11\See Amendment No. 1, supra note 6. \12\Once granted, the Enhanced Parity Split on additional New Options Classes assigned to a New Unit may remain in effect for up to one year as provided herein even though the Enhanced Parity Split on the first New Options Class assigned to the New Unit terminates during that time period. Id. \13\The Exchange represents that a New Unit will need the initial six month period in order to establish a trading record in the New Options Class. If, however, the New Unit's performance during the initial six month period is substandard, the Committee may reallocate the particular options class to another specialist pursuant to Phlx Rule 511. See Letter from William Uchimoto, General Counsel, Phlx, to Richard Zack, Branch Chief, ODEO, Division, Commission, dated January 5, 1994. --------------------------------------------------------------------------- Comment Letter The Comment letter received opposing the proposed rule change made several arguments as to why the proposed rule change is inappropriate.\14\ The commenter first argues that the Exchange has no evidence that granting an Enhanced Parity Split to New Units will in any way benefit Phlx public customers. In fact, the letter argues that the proposed rule is anti-competitive and will ultimately harm public customers by acting as a disincentive for ROTs to make competitive markets, thus removing liquidity from the market. Shoreline believes that price competition is restricted whenever the specialist is granted a benefit not available to the ROTs in the crowd. Shoreline also argues that there is no evidence that the Enhanced Parity Split will encourage New Units to make tight and liquid markets, as the Phlx claims. --------------------------------------------------------------------------- \14\See Shoreline Securities Letter, supra note 4. --------------------------------------------------------------------------- The commenter's next argument is that the proposed rule allows, but does not require, the New Unit to invoke the Enhanced Parity Split. Shoreline believes that this further harms ROTs because there may be instances where ROTs are forced to accept a greater percentage of an undesirable trade than they would if the New Unit is required to accept the Enhanced Parity Split. Shoreline also argues that by allowing existing specialists and ROTs to form New Units, the proposal does not serve its stated purpose, which is to encourage the formation and registration with the Exchange of new specialist units. Finally, the commenter argues that the Phlx has provided no specific criteria for maintaining or revoking the Enhanced Parity Split with respect to a particular New Options Class. Shoreline believes that if the Enhanced Parity Split is to be offered to New Units, the Committee should have objective standards to apply in making a determination of whether to extend the Enhanced Parity Split for the allowed additional six month period. Phlx Response The Phlx refutes the arguments raised by Shoreline.\15\ First, the Phlx believes that the proposal will in fact add liquidity to the market, thus directly benefiting public customers. The Phlx believes the proposal will attract new specialist units to the Exchange and will encourage these New Units to make tight markets in New Options Classes in order to attract order flow to the Exchange. The Phlx argues that because every newly listed options class is subject to multiple listings, disincentives are created which discourage specialist units from acting as specialists for those new classes of options. The Phlx believes that the Enhanced parity Split will counteract these disincentives by offering New Units a direct benefit if they are able to attract order flow to the Exchange. The Exchange believes the New Units will be able to attract this order flow, and thus capitalize on the Enhanced Parity Split, only if they maintain tight markets in the New Options Classes. As a result, the Phlx believes that public customers will directly benefit from the proposed rule change. --------------------------------------------------------------------------- \15\See Phlx Response Letter, supra note 5. --------------------------------------------------------------------------- The Phlx also disagrees with Shoreline's contention that any enhanced split is anti-competitive. First, the Enhanced Parity Split is available to any market making firm that is willing to establish a New Unit. Secondly, the proposal does not impact parity splits on existing options classes or New Options Classes traded by existing specialist units. Finally, a market maker can always establish priority in a trade by improving the market or by being the first in establishing a market that would otherwise be on parity. In response to the commenter's claims that market makers are unfairly disadvantaged by this proposal, the Phlx makes several arguments. First, the Phlx states that the claims that market makers will be hampered in hedging trades where they improve the market does not take into account the possibility that the market maker may be able to hedge by improving both sides of the market or by utilizing another options series for purposes of hedging. Additionally, the proposal does not impact in any manner the ability of a market maker to hedge an options position with underlying stock. Further, the Phlx argues that specialists have responsibilities and are subject to certain costs that market makers do not have, such as, updating and disseminating quotes, reflecting all market interest in the displayed quotes, and the fixed staffing cost committed to market making in a particular issue whether it is active or not. In order to attract specialist units to the Exchange who are willing to accept these responsibilities, the Phlx believes it is necessary to provide specialists with some benefits that are not available to ROTs. The Phlx believes that any negative impact to ROTs that may be caused by this proposal is more than offset by the benefit to the Exchange and its customers of attracting New Units to the Exchange. The Phlx also refutes the commenter's claim that ROTs are further harmed because the New Unit is not required to invoke the Enhanced Parity Split. The Phlx argues that because specialists and ROTs both desire to buy at the bid and sell at the ask, there should be few undesirable trades where the specialist would not find it desirable to invoke the Enhanced Parity Split. As a result, the Exchange believes that any negative impact on the ROTs as a result of the permissive nature of the rule will be de minimis. Finally, the Phlx argues that because the Enhanced Parity Split can apply to a New Options Class for at most one year, the Exchange does not believe that detailed evaluative criteria for use in awarding or removing the Enhanced Parity Split will be particularly effective or necessary. The Exchange believes that by the time that the New Unit establishes a trading history which can be reviewed and evaluated, the Enhanced Parity Split will probably have lapsed. Even without such criteria, however, the Phlx notes that the Committee has the ability to review the performance of a New Unit and to remove the Enhanced Parity Split at the end of the initial six month period, or in more egregious cases, to reallocate an options class for inadequate specialist performance. Discussion The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange, and, in particular, the requirements of section 6(b)(5)\16\ in that the proposal is designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market, and protect investors and the public interest. Specifically, the Commission finds that the proposal may serve to remove impediments to and perfect the mechanism of a free and open market by encouraging the creation of New Units and by encouraging those New Units to maintain tight markets for New Options Classes in order to attract order flow to the Exchange. The Commission believes the proposed rule change is a reasonable attempt by the PHlx to enhance the ability of New Units to compete for order flow in the environment of multiply- traded options classes. In addition, the protection of investors and the public interest is maintained because the Committee can refuse to extend the Enhanced Parity Split for an additional six months if the performance of the New Unit does not warrant an extension. Further, the proposed rule change provides the Enhanced Parity Split cannot disadvantage a public customer order that is on parity with a New Unit.\17\ --------------------------------------------------------------------------- \16\15 U.S.C. 78f(b)(5) (1988). \17\See Amendment No. 1, supra note 6. --------------------------------------------------------------------------- The Commission agrees with the Exchange that in order to attract order flow to the Exchange, the Phlx needs to be able to attract and retain well capitalized specialist units that are willing to trade New Options Classes, as well as existing options classes. Further, the Commission disagrees with the commenter that the proposed rule change will disadvantage public customers. On the contrary, the proposed rule change eliminates any direct injury to public customers by providing that customer orders on parity may not receive a smaller participation than any other crowd participant, including the specialist.\18\ Furthermore, because the proposal may serve to add liquidity to the market by encouraging New Units to maintain tight markets in order to attract order flow to the Exchange, the Commission believes that public customers could benefit from the proposed rule change.\19\ Accordingly, the Commission believes there is no evidence to support a conclusion that the proposed rule change will disadvantage public customers. --------------------------------------------------------------------------- \18\The specialist may waive the Enhanced Parity Split in these circumstances. See supra note 9. \19\The Commission notes that contrary to the commenter's contention, ROTs may in fact benefit from the Enhanced Parity Split if the New Units are successful in attracting order flow to the Exchange. --------------------------------------------------------------------------- The Commission also acknowledges that specialists have responsibilities that ROTs do not have and that these responsibilities have certain costs associated with them, such as the staff costs associated with continually updating and disseminating quotes. As a result, the Commission believes it is reasonable for the Exchange to grant certain advantages, such as the Enhanced Parity Split, to New Units in order to encourage New Units to register as specialists for New Options Classes. Accordingly, as long as these advantages do not unreasonably restrain competition and do not harm investors, the Commission believes that the granting of such benefits to specialists is within the business judgment of the Exchange. Therefore, even though the proposed rule change could arguably have some negative impact on ROTs, for the reasons stated above, the Commission believes the proposal is consistent with the Act.\20\ --------------------------------------------------------------------------- \20\Further, the Commission disagrees with the commenter that ROTs may be disadvantaged by the fact that New Units are not required to accept the Enhanced Parity Split in those instances where it applies. In those cases where a New Unit determines to waive the Enhanced Parity Split, the Exchange's normal parity rules will apply and the ROTs involved will be no worse off than they would on any other parity trade. --------------------------------------------------------------------------- Finally, the Commission agrees with the Phlx that the lack of quantifiable standards for the Committee to apply in determining whether to extend the Enhanced Parity Split for an additional six month period does not make the proposal unreasonable. Even if the Phlx proposed such standards, some time period would be necessary in order for the New Unit to establish a trading history in the New Option Class in order for such a review to have any validity. In addition, the Committee still will review the performance of the New Unit in determining whether to extend the Enhanced Parity Split for an additional six months for particular New Options Classes. Because the Enhanced Parity Split can be in effect for at most one year for each New Options Class, the Commission believes that the lack of such standards does not prevent a finding that the proposal is consistent with the Act. The Commission finds good cause for approving Amendment No. 1 to the proposed rule change prior to the thirtieth day after the date of publication of notice of filing thereof in the Federal Register. First, Amendment No. 1 limits to one year the maximum time period during which the Enhanced Parity Split can exist with respect to any New Options Class and provides that the proposed rule cannot disadvantage customer orders. The purpose of the Enhanced Parity Split is to encourage New Units to maintain tight spreads in New Options Classes, which is a benefit to investors. The Commission believes that providing such an incentive to specialists is appropriate for New Options Classes for the period during which the market for such options classes is being established as long as safeguards exist to ensure that customers are not harmed. As a result, the Commission believes these amendments accomplish these goals consistent with the Act. Secondly, Amendment No. 1 also clarifies certain aspects of the proposed rule change. The Commission believes that these amendments strengthen the proposed rule change by minimizing any confusion that may arise as to the applicability of the rule. As a result, the Commission believes it is consistent with section 6(b)(5) of the Act to approve Amendment No. 1 to the Phlx's proposal on an accelerated basis. Interested persons are invited to submit written data, views, and arguments concerning Amendment No. 1 to the proposed rule change. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Section, 450 Fifth Street, NW., Washington, DC. Copies of such filing will also be available for inspection and copying at the principal office of the Exchange. All submissions should refer to File No. SR-Phlx-93-29 and should be submitted by June 23, 1994. It is therefore ordered, pursuant to section 19(b)(2) of Act,\21\ that the proposed rule change (SR-Phlx-93-29) is hereby approved, as amended. \21\15 U.S.C. 78s(b)(2) (1988). --------------------------------------------------------------------------- For the Commission, by the Division of Market Regulation, pursuant to delegated authority.\22\ --------------------------------------------------------------------------- \22\17 CFR 200.30-3(a)(12) (1993). --------------------------------------------------------------------------- Margaret H. McFarland, Deputy Secretary. [FR Doc. 94-13344 Filed 6-1-94; 8:45 am] BILLING CODE 8010-01-M