[Federal Register Volume 59, Number 149 (Thursday, August 4, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-18960]


[[Page Unknown]]

[Federal Register: August 4, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34463; File No. SR-Phlx-92-12]

 

Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc., Relating to 
Restrictions on Orders in Multiply Traded Options Entered by 
Specialists and Registered Options Traders for Execution on Other 
Exchanges

July 29, 1994.
    On December 14, 1992, 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 restrictions on 
entering orders in multiply traded options. Notice of the proposal 
appeared in the Federal Register on March 12, 1993.\3\ One comment 
letter was received opposing the proposed rule change,\4\ to which the 
Phlx responded.\5\ This order approves the Exchange's proposal.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1992).
    \3\See Securities Exchange Act Release No. 31961 (March 8, 
1993), 58 FR 13662 (March 12, 1993).
    \4\See Letter from Alger Chapman, Chairman and Chief Executive 
Officer, CBOE, to Jonathan Katz, Secretary, Commission, dated April 
13, 1993 (``CBOE Comment Letter'').
    \5\See Letter from Gerald O'Connell, Vice President, Market 
Regulation, Phlx, to Jonathan Katz, Secretary, Commission, dated 
June 25, 1993 (``Phlx Response Letter'').
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Description of Proposal

    The Phlx proposes to adopt Advice B-12, which would extend the 
prohibitions contained in Phlx Rule 1014 and Phlx Advice B-4, regarding 
off-floor opening orders for options traded on multiple exchanges. 
Currently, Commentary .14 to Phlx Rule 1014 and Phlx Advice B-4 
prohibit a Registered Options Trader (``ROT'') from placing an opening 
order for their market functions account from off-floor. The Phlx now 
seeks to restrict Phlx ROTs and specialists from sending orders which 
would establish or increase a position in registered options to other 
exchanges from off of the Phlx options trading floor. Before an opening 
order initiated from the Phlx equity options floor may be sent to 
another market for execution, it must first clear the crowd at the Phlx 
when the bid or offer of the order is on or between the Phlx 
disseminated market.\6\ Pursuant to the proposal, ROTs and specialists 
would be required to place their off-floor opening positions in their 
customer accounts, regardless of whether the execution of such orders 
occurs on the Phlx or on another exchange.\7\ The fine schedule for 
proposed Advice B-12 would run on a three year cycle, such that repeat 
violations within a three-year period would result in escalating 
fines.\8\
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    \6\Clearing the crowd on the Phlx would require that the order 
be loudly and audibly voiced in the crowd and, if not then executed, 
the order may be sent away.
    \7\Proposed Advice B-12 would only be applicable to transactions 
in equity option.
    \8\The fine schedule for Advice B-12 provides that a fine of 
$500 will be imposed for the first violation and a fine of $1,000 
will be imposed for the second violation. The sanction for the third 
violation is discretionary with the Phlx Business Conduct Committee. 
In addition, under a rolling three-year cycle, if three years elapse 
between the first and second violation, the second violation would 
be treated as a first violation. If there is a violation within the 
three years after the most recent violation, the next highest fine 
will be issued. Thus, a third violation less than three years after 
a fine was issued for a second violation would be treated as a 
``third violation,'' even though more than three years may have 
elapsed after the first violation.
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Comment Letter

    The CBOE believes that the Phlx proposal raises implications 
regarding the multiple listing of options which should be dealt with on 
a uniform basis by the options exchanges.\9\ Specifically, the CBOE 
believes that the proposal would allow Phlx specialists and ROTs, who 
enter transactions from the Phlx options floor, to obtain ``good 
faith'' margin treatment for options transactions executed on other 
exchanges even if there is little or no activity in those options on 
the Phlx and the transactions have no relationship to the specialists' 
and ROTs' performance at the Phlx. As a result, the CBOE believes that 
multiple listing could be used as a means of giving the floor members 
of options exchanges preferred access to options traded on other 
exchanges without regard to whether there is any meaningful competition 
in those options between the exchanges.\10\ The CBOE suggests that 
specialists and ROTs should be required to effect a certain percentage 
(e.g., 75%) of their contract volume in a class of options on the 
exchange on which they act as a specialist or ROT before being entitled 
to effect transactions on other exchanges in that options class through 
their market functions accounts.\11\
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    \9\The CBOE acknowledges, however, that the proposal is a 
logical extension of the Phlx's existing rules because it accords 
the same treatment to all transactions initiated from off the Phlx 
floor without regard to whether the transactions are executed on the 
Phlx or another exchange. See CBOE Comment Letter, supra note 4.
    \10\Id.
    \11\Id.
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Phlx Response

    The Phlx refutes the arguments raised by the CBOE.\12\ The Phlx 
states that by seeking to ensure that Phlx floor traders conduct their 
market making functions from the Phlx equity options floor where they 
can best meet their affirmative and negative market making obligations, 
the proposal merely brings the Phlx's rules into line with the existing 
rules of the other options exchanges, including the CBOE's. As a 
result, the Phlx contends that the proposal does not raise the 
implications contemplated by the CBOE of ``disparate, competitive 
treatment by the different options exchanges.''\13\
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    \12\See Phlx Response Letter, supra note 5.
    \13\Id.
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    Additionally, the Phlx argues that it has rules in place addressing 
the competitive concerns raised by the CBOE. Pursuant to Phlx Advice B-
3, ROTs are required to trade in person, and not through the use of 
orders, the greater of 1,000 contracts or 50% of their contract volume 
on the Exchange in each quarter.\14\ Additionally, at least 50% of a 
ROT's trading activity in each quarter must be in assigned options 
classes. Proposed Advice B-12 does not alter the application of Advice 
B-3. As a result, the Phlx argues that specialists and ROTs would not 
be able to obtain good faith margin treatment for a significant number 
of transactions executed on other markets relative to the number of 
trades that they must execute on the Phlx equity options floor, 
regardless of the level of trading activity in their assigned options 
classes at the Phlx.\15\
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    \14\These trades must actually be executed on the Exchange. 
Trades that are announced on the Exchange floor, clear the crowd, 
and are subsequently executed on another market, are not counted as 
Exchange trades for purposes of this requirement. Telephone 
conversation between Gerald O'Connell, Vice President, Market 
Regulation, Phlx, and Sharon Lawson, Assistant Director, Office of 
Market Supervision, Division of Market Regulation, Commission, on 
July 18, 1994.
    \15\Id.
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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 prevent fraudulent and manipulative acts and 
practices, promote just and equitable principles of trade, and to 
protect investors and the public interest. Specifically, the Commission 
finds that the proposal is a reasonable extension of the Phlx's 
existing rules by according the same treatment to all transactions 
initiated from off the Phlx floor, without regard to whether the 
transactions are executed on the Phlx or another exchange. The 
Commission agrees with the Exchange that this restriction should serve 
to ensure that Phlx floor traders are conducting their market making 
activities from on the floor where they can best meet their affirmative 
and negative market making obligations.
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    \16\15 U.S.C. 78f(b)(5) (1988).
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    The Commission appreciates the concerns raised by the CBOE; 
however, the Commission believes that the Phlx has adequate rules and 
procedures to ensure that Exchange ROTs and specialists can obtain 
market-maker treatment for options trades executed on other exchanges 
only where they perform a real market-making function for such options 
on the Phlx floor. First, under Section 11(b) of the Act,\17\ Rule 11b-
1 thereunder\18\ and Phlx Rule 1014, specialists and ROTs are required 
to engage in a course of dealings in a manner reasonably calculated to 
contribute to the maintenance of a fair and orderly market. This 
ensures that trades by such persons are for the purposes of fulfilling 
market-making obligations under the Act. Secondly, Exchange Advice B-3 
minimizes the opportunity for ROTs to obtain good faith margin for a 
significant number of trades executed on other exchanges. By requiring 
that the greater of 1,000 contracts or 50% of their contract volume be 
executed on the Exchange in each quarter\19\ and that at least 50% of 
their contract volume be in assigned classes in each quarter. Advice B-
3 effectively ensures that market-makers will not be able to use the 
Phlx floor simply to send orders to other markets but instead will have 
substantive obligations that ensure they are acting as a bona fide 
market-maker.\20\
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    \17\15 U.S.C. 78k(b) (1988).
    \18\17 CFR 240.11b-1 (1981).
    \19\See supra note 14.
    \20\CBOE Rule 8.7, Interpretation and Policy .03, is quite 
similar to Phlx Advice B-3. This CBOE rule requires that (1) ``at 
least 75 percent of a Market-Maker's total contract volume must be 
in option classes to which he has been appointed pursuant to [CBOE] 
Rule 8.3;'' and (2) ``a Market-Maker must execute in person, and not 
through the use of orders, at least 25 percent of his total 
transactions.''
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    In summary, the Commission notes that only market makers who are 
conducting bona fide market making activity on the Phlx floor are 
entitled to good faith margin treatment for their options transactions. 
As a result of the above, the Commission does not believe that the 
current proposal would result in disparate, competitive treatment by 
the options exchange, as envisioned by the CBOE.\21\
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    \21\Indeed, the Commission believes that approval of the 
proposed rule change makes the situation envisioned by the CBOE less 
likely by removing the ambiguity that currently exists in the Phlx's 
rules and clarifying that off-floor orders, whether executed on the 
Phlx floor or at another exchange, are not entitled to good faith 
margin treatment.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\22\ that the proposed rule change (SR-PHlx-92-12) is hereby 
approved.

    \22\15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\23\
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    \23\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-18960 Filed 8-3-94; 8:45 am]
BILLING CODE 8010-01-M