[Federal Register Volume 59, Number 134 (Thursday, July 14, 1994)]
[Unknown Section]
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From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17096]


[[Page Unknown]]

[Federal Register: July 14, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34338; File Nos. SR-PSE-93-19]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment Nos. 2 and 3 to Proposed Rule Change by the Pacific Stock 
Exchange, Inc. Relating to Extension of Market Maker Margin and Capital 
Treatment to Certain Market Maker Orders Entered From Off the Trading 
Floor

July 8, 1994.
    On August 13, 1993, as amended on March 28, 1994, April 21, 1994, 
and May 6, 1994, the Pacific Stock Exchange, Inc. (``PSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposal to extend market maker capital and margin 
treatment to orders entered by PSE market makers from off the Exchange 
floor, provided that at least 80% of their total transactions on the 
Exchange are executed in person and not through the use of orders. In 
addition, the proposal requires that all off-floor orders for which a 
market maker receives market maker treatment be consistent with a 
market maker's duty to maintain fair and orderly markets and, in 
general, be effected for the purpose of hedging, reducing the risk of, 
or rebalancing open positions of the market maker. The PSE originally 
proposed requiring that 75% of a market maker's total transactions on 
the PSE be executed on the PSE's floor. In addition, the original 
proposal did not contain any reference to market making obligations.
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    \1\15 U.S.C. 78s(b)(1) (1984).
    \2\17 CFR 240.19b-4 (1993).
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    The original proposal was published for comment in Securities 
Exchange Act Release No. 32958 (September 24, 1993), 58 FR 51661 
(October 4, 1993). No comments were received on the proposal. This 
order approves the PSE's proposal, as amended.\3\
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    \3\On March 28, 1994, the PSE amended its proposal to change 
references in PSE Rule 6.32, Commentary .02 from ``Commentary 
.07(A)'' to ``Commentary .07'' and to change the phrase ``set forth 
in'' to ``provided in'' (``Amendment No. 1''). Amendment No. 1 is 
technical in nature and makes no substantive changes. On April 21, 
1994, the PSE amended its proposal to provide that 80%, rather than 
75%, of a market maker's total transactions on the PSE be executed 
in person on the PSE's floor (``Amendment No. 2''). In addition, 
Amendment No. 2 states that the off-floor orders for which a market 
maker receives market-maker treatment shall be consistent with a 
market maker's duty to maintain fair and orderly markets and in 
general shall be effected for the purpose of hedging, reducing the 
risk of, or rebalancing open positions of the market maker. By a 
letter dated May 6, 1994, the PSE deleted a provision that provided 
that market makers who elected to enter orders from off the 
Exchange's floor but failed to meet the 80% requirement would be 
subject to the sanctions provided in PSE Rule 6.37, ``Obligations of 
Market Makers,'' Commentary .07. See Letter from Michael Pierson, 
Senior Attorney, Market Regulation, PSE, to Yvonne Fraticelli, Staff 
Attorney, Options Branch, Division of Market Regulation 
(``Division''), Commission, dated May 6, 1994 (``Amendment No. 3''). 
Instead, under Amendment No. 3, market makers who fail to comply 
with the proposal's requirements will be subject to disciplinary 
proceedings under PSE Rule 10. By a letter dated June 13, 1994, the 
Exchange indicated that it plans to issue a circular to its members 
describing the proposal and emphasizing the importance of monitoring 
off-floor trading activity. See Letter from Michael D. Pierson, 
Senior Attorney, Market Regulation, PSE, to Yvonne Fraticelli, Staff 
Attorney, Options Branch, Division, Commission, dated June 13, 1994 
(``June 13 Letter'').
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    Currently, under PSE Rule 6.32, ``Market Maker Defined,'' only 
transactions initiated on the PSE's floor count as market maker 
transactions. Thus, only on-floor market maker transactions qualify for 
favorable capital and margin treatment under the PSE's rules, even if 
such orders are entered to adjust or hedge the risk of positions of the 
market maker that result from his on-floor market making activity.\4\ 
The PSE states that because a market maker cannot effectively adjust 
his positions or engage in hedging or other risk limiting opening 
transactions from off the Exchange floor without incurring a 
significant economic penalty, PSE market makers must either be 
physically present on the floor at all times while the market is open, 
or face significant risks of adverse market movements during those 
times when they must necessarily be absent from the trading floor. The 
PSE argues that by imposing costs on certain hedging or risk-adjusting 
transactions of market makers, the PSE's current rules may prevent 
market makers from effectively discharging their market making 
obligations and expose them to unacceptable levels of risk.
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    \4\Questions of margin and capital treatment do not arise in 
connection with closing transactions initiated from off the floor, 
since they only reduce or eliminate existing positions.
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    The Exchange states that its proposal is designed to accommodate 
the occasional needs of PSE market makers to adjust or hedge options 
positions in their market maker accounts at times when they are not 
physically present on the trading floor, without diluting the 
requirement that the trading activity of market makers must fulfill 
their market making obligations and must contribute to the maintenance 
of a fair and orderly market on the Exchange.
    Currently, under PSE Rule 6.35, ``Appointment of Market Makers,'' 
Commentary .03, all PSE market makers are obligated to effect not less 
than 75% of their contract volume in their appointed classes of 
options. In addition, under PSE Rule 6.37, Commentary .07, PSE market 
makers are required to effect not less than 60% of their total 
transactions in person on the trading floor and not by entry of orders. 
The PSE proposes to amend Exchange Rule 6.32, ``Market Maker Defined,'' 
Commentary .02, to allow market makers who elect to meet a more 
stringent in-person requirement to receive market maker margin and 
capital treatment for opening transactions executed through off-floor 
orders. Specifically, the PSE proposes to amend PSE Rule 6.32 to allow 
market makers to elect to receive market maker treatment for off-floor 
opening transactions if the market maker, in addition to satisfying all 
of the other existing obligations imposed on market makers, executes at 
least 80% of his total transactions for any calendar quarter in person 
and not through the use of orders. In addition, the off-floor orders 
for which a market maker receives market maker treatment shall be 
consistent with a market maker's duty to maintain fair and orderly 
markets and in general shall be effected for the purpose of hedging, 
reducing risk of, rebalancing or liquidating open positions of the 
market maker.\5\
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    \5\See Amendment No. 2, supra note 3.
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    PSE market makers who elect market maker treatment for off-floor 
opening transactions but fail to satisfy the proposal's requirements, 
including the 80% in-person requirement, will be subject to full 
disciplinary proceedings under Chapter 10 of the PSE's rules.\6\ Under 
PSE Rule 10.1, ``Disciplinary Jurisdiction,'' the Exchange may impose 
appropriate discipline for violations of the Act and the Exchange's 
rules, including expulsion, suspension, limitation of activities, 
functions, and operations, suspension or bar from association with a 
member or member organization, fine, censure, or any other fitting 
sanction.
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    \6\See Amendment No. 3, supra note 3.
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    The PSE believes that the amended proposal presents a more 
appropriate and realistic treatment of market maker transactions 
initiated from off the trading floor than what is provided for under 
existing Exchange Rule 6.32. The PSE believes that extending favorable 
margin and capital treatment for off-floor transactions only to those 
market makers who submit to an 80% in-person requirement should have 
the effect of increasing the extent to which market maker transactions 
contribute to liquidity and to the maintenance of fair and orderly 
markets on the PSE by providing for a greater degree of in-person 
trading by market makers and by enabling market makers to better manage 
the risk of their market making activities.
    The PSE believes that the proposal is consistent with Section 6(b) 
of the Act, in general, and furthers the objectives of Section 6(b)(5), 
in particular, in that it will promote the maintenance of fair and 
orderly markets on the PSE and will contribute to the protection of 
investors and the public interest.
    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, with the requirements of Section 6(b)(5) in that the 
proposal is designed to promote just and equitable principles of trade 
and to protect investors and the public interest.\7\ In addition, the 
Commission finds that the proposal is consistent with the requirement 
under Section 11(a) of the Act that a member's transactions not be 
inconsistent with the maintenance of fair and orderly markets.\8\
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    \7\15 U.S.C. 78f(b)(5) (1982).
    \8\15 U.S.C. 78k (1982).
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    The Commission believes that the proposal is a reasonable effort by 
the PSE to accommodate the needs of PSE market makers to effect off-
floor opening transactions while maintaining the requirement under PSE 
Rule 6.37(a) that market makers' transactions constitute a course of 
dealings reasonably calculated to contribute to the maintenance of a 
fair and orderly market. Specifically, in order to qualify for market 
maker treatment for off-floor orders, the proposal requires a market 
maker to execute at least 80% of his total transactions for any 
calendar quarter in person and not through the use of orders. In 
addition, the proposal states that the off-floor orders for which a 
market maker receives market maker treatment shall be consistent with a 
market maker's duty to maintain fair and orderly markets and in general 
shall be effected for the purpose of hedging, reducing risk of, 
rebalancing or liquidating open positions of the market maker. The 
Commission believes that these requirements, taken together, will help 
to ensure that all market maker transactions continue to contribute to 
the maintenance of a fair and orderly market while, at the same time 
enabling market makers to better manage the risk of their market making 
activities.
    Under the current requirements, market makers who adjust existing 
positions for hedging purposes while not physically present on the 
floor cannot receive market maker margin treatment for such orders 
under any circumstances and must decide whether to close out their 
positions or place an order in a customer margin account requiring 50% 
margin. While the Commission believes that this may not be an 
unreasonable result in many cases, the Commission believes that the PSE 
has set forth a reasonable proposal that permits market maker treatment 
for certain off-floor orders under very limited circumstances that 
ensure that such orders must contribute to the maintenance of fair and 
orderly markets and require market makers to comply with a heightened 
80% in person trading requirement.
    By requiring both more stringent in person trading requirements and 
that off-floor opening transactions be effected only for the purpose of 
hedging, reducing the risk of, rebalancing or liquidating open 
positions, the proposal should help to ensure the stability and 
orderliness of the PSE's markets.
    The Commission expects the PSE to closely monitor those market 
makers electing to receive market maker treatment for certain off-floor 
orders as provided under the proposal to ensure that they are meeting 
the in person trading requirements in addition to the other market 
making obligations required under the proposal. The PSE has represented 
that market makers who choose to receive favorable margin and capital 
treatment under the proposal but fail to satisfy the proposal's 
requirements will be subject to full disciplinary proceedings under 
Chapter 10 of the PSE's rules. As noted above, the sanctions possible 
under Chapter 10 include expulsion, suspension, limitation of 
activities, functions, and operations, fine, censure, being suspended 
or barred from being associated with a member or any other fitting 
sanction. The Commission expects the Exchange to impose strict 
sanctions for violations of the rule, particularly in cases of 
egregious or repeated failures to comply with the rule's 
requirements.\9\
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    \9\The PSE plans to distribute a circular to its membership 
describing the rule change and emphasizing the importance of 
monitoring off-floor trading activity. See June 13 Letter, supra 
note 3.
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    Finally, the Commission notes that the staff of the Board of 
Governors of the Federal Reserve System (``Board'') has issued a letter 
raising no objection to the Commission's approval of an identical 
proposal by the Chicago Board Options Exchange, Inc. (``CBOE''),\10\ 
based on the Commission's belief that the off-floor transactions of 
CBOE market makers under the proposal are designed to contribute to the 
maintenance of a fair and orderly market and are consistent with the 
obligations of a specialist under section 11 of the Act.\11\
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    \10\See File No. SR-CBOE-93-19.
    \11\See Letter from Scott Holz, Senior Attorney, Board, to 
Howard Kramer, Associate Director, Division, Commission, dated March 
9, 1994.
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    The Commission finds good cause for approving Amendment Nos. 2 and 
3 prior to the thirtieth day after the date of publication of notice of 
filing thereof in the Federal Register. Amendment No. 2, which 
increases the in-person requirement from 75% to 80% and requires a 
market maker's off-floor transactions to be effected for the purpose of 
hedging, reducing risk of, rebalancing or liquidating open positions, 
limits the likelihood of abuse of the proposed rule change by limiting 
its availability to market makers who enter 80% of their orders in 
person on the PSE's floor and by requiring that the off-floor orders 
have a legitimate market making purpose. Moreover, the PSE's Amendment 
No. 2 is identical to Amendment No. 1 to the CBOE's proposal. The 
CBOE's Amendment No. 1 was published for comment in the Federal 
Register and the Commission received no comments on the CBOE's 
amendment.\12\ The PSE's Amendment No. 3, which provides for full 
disciplinary proceedings for failures to comply with the proposal's 
requirements, is consistent with the CBOE's proposal and should help to 
ensure compliance with the requirements of the proposed rule. As a 
result, the Commission believes that good cause exists for approving 
Amendment Nos. 2 and 3 on an accelerated basis.
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    \12\See Securities Exchange Act Release No. 33853 (April 1, 
1994), 59 FR 16869 (April 8, 1994) (File No. SR-CBOE-93-19).
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Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 2 and 3. 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. Copies of such filing will also be available for 
inspection and copying at the principal office of the above-mentioned 
self-regulatory organization. All submissions should refer to the file 
number in the caption above and should be submitted by August 4, 1994.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
\13\ that the proposed rule change (File No. SR-PSE-93-19), as amended, 
is hereby approved.
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    \13\15 U.S.C. 78s(b)(2) (1982).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-17096 Filed 7-13-94; 8:45 am]
BILLING CODE 8010-01-M