[Federal Register Volume 59, Number 220 (Wednesday, November 16, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-28216]


[[Page Unknown]]

[Federal Register: November 16, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34946; File No. SR-PSE-94-18]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Pacific Stock Exchange, Inc., Relating to the Expansion 
of the Exchange's Auto-Ex System Capacity to 20 Contracts

November 7, 1994.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ on June 20, 1994, the 
Pacific Stock Exchange, Inc. (``PSE'' or ``exchange'') submitted to the 
Securities and Exchange Commission (``SEC'' or ``Commission'') a 
proposed rule change to amend PSE Rule 6.87, ``Automatic Execution 
System,'' to allow the Options Floor Trading Committee (``OFTC'') to be 
authorized to increase, on an issue-by-issue basis, the size of the 
equity option orders that may be eligible to be executed through the 
Exchange's Automatic Execution System (``Auto-Ex'') up to a maximum of 
20 contracts.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1993).
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    The proposal was published for comment in Securities Exchange Act 
Release No. 34702 (September 22, 1994), 59 FR 49729 (September 29, 
1994). The Commission received one comment letter on the proposal,\3\ 
in addition to the PSE's response to the letter.\4\
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    \3\See Letter from Jeffery C. Hauke, JMD Trading Co., to the 
Commission, dated September 12, 1994 (``September 12 Letter''). In a 
subsequent letter, the commenter clarified that his comments are 
applicable to File No. SR-PSE-94-18 rather than to File No. SR-PSE-
94-19. See Letter from Jeffery C. Hauke, JMD Trading Co., to the 
Commission, dated October 10, 1994.
    \4\See Letter from David P. Semak, Vice President, Regulation, 
PSE, to Jonathan G. Katz, Secretary, Commission, dated October 31, 
1994 (``October 31 Letter'').
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    The Auto-Ex system, a feature of the PSE's Pacific Options Exchange 
Trading System (``POETS''), permits eligible market or marketable limit 
orders sent from member firms to be executed automatically at the 
displayed bid or offering price. Participating market makers are 
designated as the contra side to each Auto-Ex order.\5\ Participating 
market makers are assigned by Auto-Ex on a rotating basis, with the 
first market maker selected at random from the list of signed-on market 
makers. Auto-Ex preserves public Limit Order Book (``Book'') priority 
in all options. If Auto-Ex determines that the Book price is at or 
better than the market quote, the Auto-Ex order is executed against the 
Book. Automatic executions through Auto-Ex are currently available for 
public customer orders of 10 contracts or less in all series of options 
traded on the PSE's options floor.
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    \5\The Commission recently approved an Exchange proposal setting 
forth certain standards for market makers participating on Auto-Ex. 
The standards include restrictions on the number of Auto-Ex trading 
posts at which market makers may participate and mandatory log-on 
requirements to assure that market makers do not withdraw from the 
system during volatile market conditions. See Securities Exchange 
Act Release No. 32908 (September 15, 1993), 58 FR 49076 (September 
21, 1993).
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    The Exchanges proposes to amend PSE Rule 6.87 to increase the 
maximum size of equity option orders eligible for Auto-Ex and to 
provide the OFTC with the authority to designate such changes on an 
issue-by-issue basis. Under the proposal, the OFTC is authorized to 
increase the size of orders eligible for an execution on Auto-Ex to a 
size of up to 20 contracts without separate approval from the 
Commission.\6\ The PSE states that the proposed rule change is designed 
to enhance the Exchange's ability to compete for options order flow.
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    \6\The Commission recently approved an Exchange proposal to 
allow the OFTC to increase the size of Auto-Ex-eligible orders in 
one or more classes of multiple traded equity options to the extent 
that other options exchanges permit such larger-size orders to be 
entered into their own automated execution systems. The rule 
provides that if the OFTC intends to increase the Auto-Ex size 
eligibility pursuant to the rule, the Exchange will submit a 
proposed rule change to the Commission pursuant to Section 
19(b)(3)(A) under the Act. See securities Exchange Act Release No. 
34131 (May 27, 1994), 59 FR 29316 (June 6, 1994).
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    The PSE believes that any implementation of the proposal by the 
OFTC will not impose any significant additional burdens on the 
operation and capacity of the POETS system in general or on the Auto-Ex 
system in particular. In that regard, the Exchange has submitted a 
separate capacity statement to the Commission setting forth the basis 
for this contention.\7\ The exchange also represents that the OFTC will 
determine that adequate market making capacity exists prior to 
increasing Auto-Ex order size eligibility. The OFTC will make such a 
determination notwithstanding the fact that floor officials may require 
market makers who are members of a trading crowd to which a particular 
option class is assigned to log onto Auto-Ex in the event that there is 
inadequate participation in that options class.
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    \7\See Letter from Michael D. Pierson, Senior Attorney, PSE, to 
Richard L. Zack, Branch Chief, Options Regulation, Commission, dated 
December 20, 1993 (File No. SR-PSE-93-26).
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    The PSE believes that the proposal is consistent with Section 6(b) 
of the Act, in general, and with Section 6(b)(5), in particular, in 
that it is designed to facilitate transactions in securities and to 
promote just and equitable principles of trade.
    As noted above, the Commission received one comment letter 
concerning the proposal.\8\ In his September 12 Letter, the commenter 
argues that the proposal violates certain provisions of the Exchange's 
Certificate of Incorporation. Specifically, the commenter states that 
floor brokers in the trading crowd have no opportunity to participate 
in trades that are eligible for automatic execution through Auto-Ex 
unless they ``book'' their orders. Notwithstanding this, because 
certain types of orders, such as contingent orders and spreads, cannot 
be placed on the book, book orders represented in the crowd are not 
eligible for execution against orders entered through Auto-Ex. 
Therefore, the commenter believes that as a member of the Exchange, he 
should have an equal opportunity to participate in trades that occur on 
the Exchange floor. Finally, the commenter questions why the semi-Auto-
Ex function, which would solve his concerns, has not been utilized on 
the PSE.
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    \8\See September 12 Letter, supra note 3.
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    On October 31, 1994, the PSE submitted a letter responding to the 
comment letter.\9\ In its October 31 Letter, the PSE states that the 
Commission has approved automatic execution systems on other options 
exchanges and, in approving POETS, has concluded that POETS provides 
substantial benefits to public customers. In addition, the Exchange 
argues that providing floor brokers with the opportunity to participate 
in all trades on the Exchange floor would require the elimination of 
Auto-Ex, which would be inconsistent with the Commission's 
determination to give priority to small public customer orders and 
would place the PSE at a competitive disadvantage with the other 
options exchanges. In response to the commenter's statement about semi-
Auto-Ex, the PSE notes that the semi-Auto-Ex feature of POETS has never 
been implemented and that the Exchange continues to study the software 
and precise mechanism necessary to implement semi-Auto-Ex. Finally, the 
PSE argues that POETS and Auto-Ex has been approved previously by the 
Commission, and therefore that the arguments raised by the commenter 
are untimely.
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    \9\See October 31 Letter, supra note 4.
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    The Commission has considered carefully the opinions of the 
commenter and the PSE and finds, for the following reasons, 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. Specifically, the Commission finds that the 
proposal is consistent with Section 6 and Section 11A of the Act.\10\ 
The Commission continues to believe that the development and 
implementation of Auto-Ex provides for more efficient handling and 
reporting of orders in PSE equity options through the use of new data 
processing and communications techniques, thereby improving order 
processing and turnaround time. The Commission believes that Auto-Ex 
has benefitted public customers by ensuring that a POETS order will be 
executed at the current disseminated quotation, and by allowing small 
public customer orders to receive immediate executions and nearly 
instantaneous confirmations of orders.\11\ Accordingly, the Commission 
believes that expanding the eligibility of Auto-Ex to public customer 
orders of up to 20 contracts for all PSE-traded equity options is 
consistent with Section 6(b)(5) in that it will extend the benefits of 
automatic execution in equity options to a greater number of public 
customer orders while continuing to ensure adequate limit order 
protection.
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    \10\15 U.S.C. 78f and 78k-1 (1988).
    \11\See Securities Exchange Act Release No. 32703 (July 30, 
1993), 58 FR 42117 (August 6, 1993) (order approving File No. SR-
PSE-92-37) (``POETS Approval Order''). The Commission believes that 
the rationale in the POETS Approval Order supporting approval of 
Auto-Ex applies equally to the current proposal, and incorporates 
that rationale into the current discussion.
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    In regard to the commenter's specific concern, the Commission 
previously has approved small order execution systems for option 
exchanges. For all of these systems, the Commission has found that 
interaction with the limit order book was sufficient to provide limit 
order protection. Merely increasing the size of Auto-Ex eligible orders 
to 20 contracts does not change the character of Auto-Ex orders 
sufficiently to warrant a reexamination of whether Auto-Ex orders 
should interact with trading crowd orders. Orders of 20 contracts or 
less are still small sized orders, and truly large orders will continue 
to interact with the trading crowd.
    In addition, the Commission believes that the proposal will 
facilitate transactions in securities and promote competition among 
options markets by placing the PSE in an equal competitive posture with 
the other options exchanges when competing for order flow in equity 
options. In this regard, the Commission notes that the American Stock 
Exchange's and the Chicago Board Options Exchange's automatic execution 
systems both have Commission approval to accommodate public customer 
equity option orders of up to 20 contracts, and that the Philadelphia 
Stock Exchange's automatic execution system has Commission approval to 
accommodate public customer equity option orders of up to 25 
contracts.\12\ Accordingly, the Commission believes that the PSE's 
proposal is consistent with the Act because it eliminates constraints 
in the PSE's rules that restrict the Exchange's ability to compete for 
order flow in equity options. The Commission believes that enhanced 
competition among the exchanges for options order flow, in turn, should 
benefit public investors and the public interest.
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    \12\See Securities Exchange Act Release Nos. 32906 (September 
15, 1993) 58 FR 49345 (September 22, 1993) (order approving File No. 
SR-PHLX-92-38); 28411 (September 6, 1990), 55 FR 49345 (September 
13, 1990) (order approving File Nos. SR-CBOE-89-27 and 89-29); and 
24899 (September 10, 1987), 52 FR 35012 (September 16, 1987) (order 
approving File No. SR-Amex-87-21).
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    Finally, the Commission believes, based on representations by the 
Exchange, that expanding the order eligibility size of Auto-Ex to 20 
contracts for all equity options will not expose the PSE's options 
markets or equity markets to risk of failure or operational break-down. 
The Exchange also states that the OFTC will determine that adequate 
market making capacity exists prior to increasing the order size 
eligibility for any issue pursuant to the proposal.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-PSE-94-18) is approved.

    \13\15 U.S.C. 78s(b)(2). (1982).
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    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. 94-28216 Filed 11-15-94; 8:45 am]
BILLING CODE 8010-01-M