[Federal Register Volume 61, Number 155 (Friday, August 9, 1996)]
[Notices]
[Pages 41675-41677]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-20308]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37521; File No. SR-PSE-96-01]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment Nos. 2 and 3 Thereto by the Pacific Stock Exchange, Inc. 
Relating to its Options Firm Quote Rule

August 2, 1996.
    On January 16, 1996, the Pacific Stock Exchange, Inc. (``PSE'' or 
``Exchange'') submitted to 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 proposed rule change to amend its Options Firm Quote 
Rule (Rule 6.86, the ``Rule'') in order to codify some related floor 
policies and also to clarify certain provisions of the Rule. Notice of 
the proposed rule change was published for comment and appeared in the 
Federal Register on March 4, 1996.\3\ No comment letters were received 
on the proposal. On May 17, 1996, the Exchange filed Amendment No. 1 to 
the proposal.\4\ On June 27, 1996, the PSE filed Amendment No. 2 to the 
proposed rule change,\5\ and on July 25, 1996, the Exchange filed 
Amendment No. 3 to the proposal.\6\ This order approves the PSE 
proposal as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4
    \3\ See Securities Exchange Act Release No. 36883 (February 23, 
1996), 61 FR 8321 (March 4, 1996).
    \4\ See letter from Michael D. Pierson, Senior Attorney, Market 
Regulation, PSE, to James T. McHale, Attorney, Office of Market 
Supervision (``OMS''), Division of Market Regulation (``Division''), 
Commission, dated May 16, 1996 (``Amendment No. 1''). Amendment No. 
3 supersedes and replaces Amendment No. 1.
    \5\ In Amendment No. 2 the Exchange revised proposed Commentary 
.05(a) to make clear that with respect to combination orders 
involving option contracts on one side of the market, market makers 
in a trading crowd would only be responsible for providing an 
aggregate of 20 contracts; however, if a combination order is for 
option contracts on both sides of the market, market makers must 
provide a depth of 20 contracts on both sides of the market. 
Additionally, the Exchange revised proposed Commentary .07 to 
clarify that a floor broker, who has the opportunity to execute a 
limit order at the disseminated market price, but instead quotes a 
better price than the limit price stipulated on the order ticket and 
the market then changes so that the order can no longer be executed 
at the original disseminated price, will be held liable for the 
execution of a minimum of 20 contracts at the original disseminated 
price. See letter from Michael D. Pierson, Senior Attorney, 
Regulatory Policy, PSE, to James T. McHale, Attorney, Office of 
Market Supervision (``OMS''), Division of Market Regulation 
(``Division''), Commission, dated June 26, 1996 (``Amendment No. 
2'').
    \6\ In Amendment No. 3 the Exchange clarified a potential 
ambiguity in proposed Commentary .05(c) to Rule 6.86 by deleting a 
sentence which specified certain types of contingency orders to 
which Rule 6.86 did not apply. In addition, Amendment No. 3 deletes 
a sentence in proposed Commentary .05(c) which stated that the list 
of types of contingency orders to which the Rule applies would not 
be considered exhaustive. Finally, in Amendment No. 3 the PSE 
further clarifies proposed Commentary .07 to provide that the 
executing floor broker will be held liable to his customer for a 
minimum of 20 contracts at the original disseminated price, if the 
floor broker had the opportunity to execute the customer's limit 
order, but instead made a failed attempt to improve the execution. 
See letter from Michael D. Pierson, Senior Attorney, Market 
Regulation, PSE, to James T. McHale, Attorney, OMS, Division, 
Commission, dated May 16, 1996 (``Amendment No. 3'').
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I. Description of the Proposal

    The Exchange is proposing to modify its Options Firm Quote Rule as 
follows:

Order Identification

    Subsection (a) of the Rule currently provides that members and 
member organizations who enter orders for execution on the options 
floor must ascertain the account origin of such orders and provide a 
notation of the account origin on the order ticket. The Exchange is 
proposing to modify this provision to provide that such members and 
member organizations would be required to communicate such account 
information to the executing member organization. Accordingly, the 
member or member organization entering the order must indicate to the 
executing member organization whether the order is for the account of a 
customer, firm or market maker.
    The proposal would also set forth the duty of executing floor 
brokers to inquire personally as to the account origin of each eligible 
order upon receipt thereof or prior to its execution and to note such 
information on the order ticket.
    Finally, under the proposal, the executing member organization and 
the clearing member organization would bear greater responsibility with 
respect to the proper identification of orders that are executed on 
behalf of non-members of the Exchange.

Commentary .05

    Proposed Commentary .05 sets forth certain types of orders that are 
subject to the Rule and the extent to which the Rule applies to such 
orders. The Rule specifically addresses the treatment of combination 
orders, spread orders, straddle orders and contingency orders. With 
respect to combination orders involving option contracts on one side of 
the market, market makers in a trading crowd would only be responsible 
for providing an aggregate of 20 contracts; however, if a combination 
order is for option contracts on both sides of the market, market 
makers must provide a depth of 20 contracts on both sides of the 
market.\7\ Moreover, market makers would be required to provide a depth 
of 20 contracts on both sides of the market for spread and straddle 
orders. The proposed Commentary also enumerates the types of 
contingency orders that are subject to the Rule, i.e. ``minimum'' 
orders of 20 contracts or less, market not-held, limit not-held and 
delta orders that can be executed immediately, and all-or-none orders 
of twenty contracts or less.
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    \7\ See Amendment No. 2, supra note 5.
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    The proposed Commentary also provides that in executing contingency 
orders pursuant to the Rule, the order ticket must be time stamped upon 
being taken into the trading crowd. Finally, the proposed Commentary 
states that such orders are entitled to 20 contracts on the market 
disseminated at that time.

Commentary .06

    Proposed Commentary .06 provides that market makers must be 
afforded a reasonable opportunity to update their disseminated markets 
for the execution of consecutive eligible customer orders in options on 
the same underlying security. The Commentary further provides that such 
orders shall be executed on a time priority basis so that the order 
with the earliest time stamp will receive a guaranteed fill of 20 
contracts.

Commentary .07

    Proposed Commentary .07 provides that if a floor broker can 
immediately execute a limit order at the disseminated market price, but 
instead, the floor broker quotes a better price than the limit price 
stipulated on the order ticket, and the market then changes so that the 
order can no longer be executed at the disseminated market price, the 
floor broker shall be held liable to the customer for the execution of 
a minimum of 20 contracts at the original disseminated price.\8\
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    \8\ See Amendment Nos. 2 and 3, supra, notes 5 and 6, 
respectively.
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Commentary .08

    Proposed Commentary .08 designates those market makers to whom the 
order book official may, pursuant to current

[[Page 41676]]

Subsection (d), allocate the balance of contracts necessary to provide 
an execution of 20 contracts when the response of the members present 
at the trading post is insufficient to provide a depth of 20 contracts. 
Specifically, such allocations may be made to market makers who: (1) 
are present at the trading post at the time of a call for a market; and 
either (2) hold an appointment in the option classes at the trading 
post or (3) regularly effect transactions in person for their trading 
accounts at that trading post.
    In addition, this proposed Commentary provides that market markers 
who have logged on to the Exchange's Automatic Execution system 
(``Auto-Ex''),\9\ but who are not present in the trading crowd will not 
be eligible for an allocation by the order book official pursuant to 
current Subsection (d).
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    \9\ The Auto-Ex system 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 and 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. See Securities 
Exchange Act Release No. 34946 (November 7, 1994), 59 FR 59265 
(November 16, 1996).
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II. Discussion

    The Commission finds that the proposed rule change relating to the 
PSE's Options Firm Quote Rule 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) \10\ in that it is designed to facilitate transactions 
in securities, promote just and equitable principles of trade, and 
protect investors and the public interest. Specifically, with respect 
to ``order identification,'' the Commission believes that the rule 
change further clarifies the account origin responsibilities of the 
parties involved in a trade which is subject to the Rule. The rule 
change requires, among other things, that the executing floor broker 
verify whether the order is being executed for the account of a 
customer, firm or market maker. This clarification provides objective 
criteria against which the executing floor broker's actions can be 
measured and, thus, should make enforcement of the Rule more effective 
for the Exchange.
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    \10\ 15 U.S.C. 78f(b)(5).
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    Moreover, the Commission believes that interpreting the Options 
Firm Quote Rule as set forth in new Commentary .05 is consistent with 
the Act and the intent of the Rule.\11\ The Rule currently provides 
that all non-broker/dealer customer orders are entitled to execution at 
the bid or offer which is displayed as the disseminated market quote up 
to a depth of 20 contracts. With regard to combination orders, the 
Exchange has proposed clarifying that market makers are responsible for 
providing an aggregate of 20 contracts for combination orders on one 
side of the market, but 20 contracts on both sides of the market for 
combination orders on two sides of the market. The Commission believes 
this is reasonable since interpreting the Rule to require market makers 
to provide 20 contracts for combination orders involving options on the 
same side of the market would essentially create a ``40-up'' 
requirement, and potentially place undue burdens and capital risks on 
the PSE's options market makers.
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    \11\ See Securities Exchange Act Release No. 28021 (May 16, 
1990) 55 FR 21131 (May 22, 1990) (order approving PSE's original 
proposal requiring ten-up markets on a one-year pilot basis). The 
Exchange subsequently increased its minimum size guarantee for non-
broker/dealer customer orders from 10 to 20 contracts, See 
Securities Exchange Act Release No. 34891 (October 25, 1994) 59 FR 
54653 (November 1, 1994).
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    With respect to new Commentary .06, the Commission believes that it 
is appropriate and consistent with the Act \12\ for market makers to 
have a reasonable opportunity to update their market quotes for the 
execution of consecutive eligible customer orders in options on the 
same underlying security. Moreover, to provide that such orders shall 
be executed on a time priority basis so that the order with the 
earliest time stamp will receive a guaranteed fill of 20 contracts, is 
a fair interpretation of the Rule.
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    \12\ Cf. 17 CFR 11Ac1-1(c). This firm quote rule, applicable to 
certain equity securities, generally allows market makers a 
reasonable period of time to update their quotations following an 
execution. See Securities Exchange Act Release No. 37502 (July 30, 
1996).
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    Commentary .07 provides that if a floor broker can immediately 
execute a limit order at the disseminated market price, but instead the 
floor broker quotes a better price than the limit price stipulated on 
the order ticket, and the market then changes so that the order can no 
longer be executed at the disseminated market price, the floor broker 
shall be held liable to the customer for the execution of a minimum of 
20 contracts at the original disseminated price. The Commission 
believes that this should be an effective measure to protect investors 
by ensuring that a customer's executable limit order is filled at the 
limit price even if the floor broker makes a failed attempt at 
improving the execution. Finally, Commentary .08 provides an 
appropriate method to designate which market makers in the trading 
crowd are eligible to be allocated option contracts.
    The Commission finds good cause for approving Amendment Nos. 2 and 
3 to the proposal prior to the thirtieth day after the date of 
publication of the notice of filing thereof in the Federal Register. 
Specifically, in filing Amendment No. 2, the Exchange recognizes that 
some combination orders involve both sides of the market (e.g. 
``strangles''\13\). Amendment No. 2 changes Commentary .05(a) to 
clarify that while a market maker's responsibility with respect to 
combination orders on one side of the market is to provide an aggregate 
of 20 contracts, the market maker must provide a depth of 20 contracts 
on both sides of the market for combination orders that involve an 
order for option contracts on both sides of the market. Amendment No. 2 
also strengthens Commentary .07 by clarifying that a floor broker, who 
has the opportunity to execute a limit order at the disseminated market 
price, but instead quotes a better price than the limit price 
stipulated on the order ticket and the market then changes so that the 
order can no longer be executed at the original disseminated price, 
will be held liable for the execution of a minimum of 20 contracts at 
the original disseminated price.
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    \13\ A strangle is a combination order involving the same 
underlying stock in which the put and the call have the same 
expiration date but different exercise prices.
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    Amendment No. 3 eliminates language in Commentary .05(c) that would 
have prohibited application of the Rule to certain types of contingency 
orders. The Exchange has determined that it is more appropriate to 
define those types of orders to which the Rule applies, rather than 
defining those orders to which the Rule does not apply. Additionally, 
in Amendment No. 3 the PSE has eliminated a sentence in Commentary 
.05(c) which stated that the list of types of contingency orders to 
which the Rule applies would not be considered exhaustive. The 
Commission believes that these changes strengthen the proposal by 
setting forth a clear and finite set of contingency order types to 
which the Rule applies. Finally, Amendment No. 3 further amends 
proposed Commentary .07 to provide that the executing floor broker will 
be held liable to his customer for a minimum of 20 contracts at the 
original disseminated price, if the floor broker had the opportunity to 
execute the customer's limit order, but instead made a failed attempt 
to improve the execution. The Commission believes

[[Page 41677]]

that this portion of Amendment No. 3 clarifies a potential ambiguity in 
the interpretation of new Commentary .07, and, therefore, is not a 
substantive change to the proposal.
    Based on the above, the Commission finds good cause for approving 
Amendment Nos. 2 and 3 to the proposed rule change on an accelerated 
basis and believes that the proposal, as amended, is consistent with 
Sections 6(b)(5) and 19(b)(2) of the Act.

III. 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, N.W., Washington, 
D.C. 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, 
N.W., Washington, D.C. 20549. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
PSE. All submissions should refer to the File No. SR-PSE-96-01 and 
should be submitted by August 30, 1996.
    It therefore is ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-PSE-96-01) is approved.

    \14\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-20308 Filed 8-8-96; 8:45 am]
BILLING CODE 8010-01-M