[Federal Register Volume 59, Number 126 (Friday, July 1, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-16039]


[[Page Unknown]]

[Federal Register: July 1, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34259; File No. SR-Phlx-92-09]

 

Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc. Regarding Trading the 
Quote Spread on PACE

June 27, 1994.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on April 
10, 1992, the Philadelphia Stock Exchange, Inc. (``Phlx'' 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 prepared by the self-regulatory 
organization. On April 14, 1994, the Phlx submitted Amendment No. 1 to 
the proposal.\1\ On June 6, 1994, the Phlx submitted Amendment No. 2 to 
the proposal.\2\ The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\See letter from Gerald D. O'Connell, Vice President, Market 
Surveillance, Phlx, to Sharon Lawson, Assistant Director, Division 
of Market Regulation, Commission, dated April 14, 1994. The Phlx 
amended the language of the rule to clarify what level of activity 
will constitute a violation of the rule. Specifically, the Exchange 
proposes that three occurrences within one month will constitute 
such a violation.
    \2\In Amendment No. 2 the Exchange (a) clarified that the three 
occurrences referred to in the proposed commentary are meant to be 
in the same stock, and (b) changed the word ``may'' to ``will'' 
constitute a violation. See letter from Gerald D. O'Connell, Vice 
President, Phlx, to Sharon Lawson, Assistant Director, Commission, 
dated June 1, 1994.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx, pursuant to Rule 19b-4 of the Act, proposes to adopt 
Commentary .18 to Phlx Rule 229\3\ to prohibit the use of the 
Philadelphia Stock Exchange Automated Communication and Execution 
System (``PACE'') volume execution guarantees with offsetting orders in 
low-volatility, high volume stocks in order to ``trade the quote 
spread.'' Specifically, Commentary .18 would read as follows:

    \3\PACE is the Phlx's small order entry and execution system and 
Rule 229 details the execution guarantees due a PACE order. See 
Philadelphia Stock Exchange Rules, Rule 229.
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    Any established pattern of trading via PACE generating short-
term trading profits by unjustly exploiting PACE volume execution 
guarantees is prohibited. Specifically, it is deemed an unjust use 
of PACE to place an order to buy at the primary market's bid price 
and simultaneously or shortly thereafter place an order to sell for 
a related account at the primary market's offer price, or vice-
versa, with the intent to capitalize on the expectation that 
transactions on the primary market at the respective limit prices 
will elect the limit orders on the Phlx requiring their execution 
and thus generate a short-term trading profit without the need for a 
change in the quoted price of the issue on the primary market. Three 
such occurrences in the same security within a one-month period will 
constitute an established pattern in violation of this provision.

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

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

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

1. Purpose
    PACE is the Exchange's automated order routing, delivery and 
execution system for equity's securities. Pursuant to Phlx Rule 229, 
customer orders entered through PACE are entitled to certain execution 
guarantees.\4\ The Phlx proposes to adopt Commentary .18 to Phlx Rule 
229 to address the practice of customers using PACE volume execution 
guarantees with offsetting limit orders in low-volatility, high-volume 
stocks in order to ``trade the quote spread.''
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    \4\See Phlx Rule 229, Commentary .10.
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    Specifically, this practice is encountered when orders are placed 
through PACE to buy on the bid and sell on the offer, with the 
expectation that each of the orders will be executed when the required 
volume trades on the primary market. As a result, a profit may be 
realized on the quote spread without any quote change in the stock.
    There are currently many Exchange-traded stocks with low-
volatility, high-volume trading characteristics. The bid-ask spread for 
these stocks is often narrow and static. Because of PACE volume 
guarantees, limit orders to buy less than 600 shares of those stocks at 
a price equal to the primary market's bid as well as to sell at a price 
equal to the primary market's offer can often receive automatic 
executions on the Exchange.\5\
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    \5\See Phlx Rule 229, Commentary .10.
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    Specifically, these smaller-sized orders are executed when 1,000 
shares or more of that security trade on the primary market at the 
order's limit price. In this regard, proposed Commentary .18 is 
designed to address the practice of customers ``trading the quote 
spread'' by depending on the aforementioned PACE volume execution 
guarantees to generate short term trading profits by using offsetting 
limit orders in low-volatility, high-volume stocks.
    For example, an order may be placed through PACE to buy on the bid 
while another order in that stock for the same or related account is 
sent through PACE to sell the same number of shares on the offer. The 
expectation is that each of the orders will be executed at their 
respective limit prices when the required volume trades on the primary 
market. When both orders are filled due to volume guarantees, a profit 
is locked-in, equal to the amount of shares multiplied by the spread 
between the bid and offer less commissions. This profit can occur 
within minutes after the orders are placed and without any quote change 
in the stock. Utilizing PACE to trade the quote spread in this manner 
disadvantages other market participants, including other PACE orders on 
the Phlx book, and serves to create an erroneous impression as to the 
level of bona fide investment activity in the subject stocks.
    The Exchange notes that this practice is exploitative of the PACE 
volume execution guarantees and is unfair to both the specialist and to 
the other PACE orders on the specialist book.
2. Statutory Basis
    The proposed rule change is consistent with Section 6 of the Act, 
in general, and Section 6(b)(5) in particular, in that it is designed 
to prevent manipulative acts and practices and to prevent 
discrimination between customers, issuers, and brokers.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants or Others

    The Phlx has neither solicited nor received written comments on the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the 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

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying at the 
Commission's Public Reference Section, 450 Fifth Street, NW., 
Washington, DC 20549. Copies of such filing will also be available for 
inspection and copying at the principal office of the Phlx. All 
submissions should refer to File No. SR-Phlx-92-09 and should be 
submitted by July 22, 1994.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Jonathan G. Katz,
Secretary.
[FR Doc. 94-16039 Filed 6-30-94; 8:45 am]
BILLING CODE 8010-01-M