[Federal Register Volume 61, Number 159 (Thursday, August 15, 1996)]
[Notices]
[Pages 42458-42460]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-20787]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37543; File No. SR-PSE-96-12]


Self-Regulatory Organizations; Pacific Stock Exchange, Inc.; 
Order Approving and Notice of Filing and Order Granting Accelerated 
Approval of Amendments to Proposed Rule Change Relating to Financial 
Arrangements of Market Makers

August 8, 1996.

I. Introduction

    On April 5, 1996, the Pacific Stock Exchange, Inc. (``PSE'' or 
``Exchange'') submitted to 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 
proposal to amend its rules on the trading restrictions that apply to 
options floor members with ``financial arrangements'' as defined in PSE 
Rule 6.40. The proposed rule change was published for comment in the 
Federal Register on May 15, 1996.\3\ The Exchange filed Amendment Nos. 
1 \4\ and 2 \5\ to its proposal on June 27, 1996, and July 25, 1996, 
respectively. No comments were received on the proposed rule change. 
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.
    \3\ See Securities Exchange Act Release No. 37186 (May 9, 1996), 
61 FR 24521.
    \4\ Amendment No. 1 effects three changes to the Exchange's 
proposal. First, the proposed amendment to PSE Rule 6.40(b)(2) is 
modified so that a reference to ``options series'' is replaced by 
one to ``trading crowd.'' Second, a new Rule 6.40, Commentary .01 is 
introduced to retain what is essentially current Commentary .04. 
Third, the numbering of the Minor Rule Plan addition is changed from 
``28'' to ``29'' because Item 28 already was used in another filing. 
Letter from Michael D. Pierson, Senior Attorney, Regulatory Policy, 
PSE, to Francois Mazur, Attorney, Office of Market Supervision, 
Division of Market Regulation, Commission, dated June 26, 1996 
(``Amendment No. 1'').
    \5\ Amendment No. 2 effects several changes to the Exchange's 
proposal. First, the Exchange is adding the phrase ``so represented 
or executed'' to the third line of subsection (b)(2) to Rule 6.40, 
and also is making some other technical changes to the text of that 
subsection. Second, the first line of subsection (b)(4), relating to 
exemptions, which introduces subsections (A) and (B), has been 
modified to address exemptions generally. Third, proposed 
6.40(b)(4)(A) has been modified to reflect that long-term exemptions 
will be reviewed at least annually. Fourth, the title of Rule 6.40 
has been changed to ``Financial Arrangements of Options Floor 
Members.'' Fifth, the Exchange notes that decisions to grant or 
revoke an exemption will be reflected in the Options Floor Trading 
Committee's (``OFTC'' or ``Committee'') minutes, and members whose 
exemptions are granted or revoked will be so notified in writing. 
Finally, the reference to ``specialists'' in 6.40(c) has been 
deleted. Amendment No. 2 also describes the manner in which 
previously-granted long-term exemptions will be reviewed. Letter 
from Michael D. Pierson, Senior Attorney, Regulatory Policy, PSE, to 
Francois Mazur, Attorney, Division of Market Regulation, Commission, 
dated July 24, 1996 (``Amendment No. 2'').
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II. Description of the Proposal

    PSE Rule 6.40(a) currently provides that two members have a 
``financial arrangement'' with each other for purposes of Rule 6.40 if: 
(1) One member directly finances the other member's dealings on the 
Exchange and has a beneficial interest in the other member's trading 
account such that the first member is entitled to at least 10% of the 
second member's trading profits; or (2) both members are trading for 
the same joint account. Rule 6.40(b) provides that two members with a 
financial arrangement may not bid, offer and/or trade in the same 
trading crowd without a written exemption from two floor officials.\6\ 
Current Commentary .06 sets forth the circumstances under which the 
OFTC ordinarily may grant an exemption to those trading restrictions, 
i.e., to provide liquidity in the trading crowd.
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    \6\ Under PSE Rule 6.40, Commentary .05, two or more Lead Market 
Makers (``LMMs'') who are trading on behalf of the same member 
organization may not trade in the same option series at the same 
time, but may trade in the same trading crowd at the same time.
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    The Exchange proposes to redefine the term ``financial 
arrangement'' for purposes of Rule 6.40, so that two members have a 
financial arrangement with each other if: (1) One member directly 
finances the other member's dealings on the Exchange, the amount 
financed is $5,000 or more, and the member providing the financing is 
entitled to a share of the other member's trading profits; or (2) both 
members are registered with the Exchange as nominees of the same member 
Organization; or (3) both members are registered with the Exchange to 
trade on behalf of the same joint account; or (4) both member's 
dealings on the Exchange are financed by the same source, the amount 
financed is $5,000 or more, and the member providing the financing is 
entitled to a share of each of the other member's trading profits. The 
proposal states that members with ``financial arrangements,'' as 
defined, may not bid, offer and/or trade in the same trading crowd at 
the same time in the absence of an exemption from the OFTC.
    The proposal further provides for both long-term and short-term 
exemptions that can be provided by the OFTC or two Floor Officials, 
respectively. Proposed Rule 6.40(b)(4) states, more specifically, that 
the OFTC may grant long-term exemptions to members on a case-by-case 
basis if it determines that a fair and orderly market would not be 
impaired by allowing such members with financial arrangements to trade 
in the same trading crowd at the same time. In making such 
determinations, the OFTC shall consider the following factors: (1) The 
nature of the financial arrangement; (2) the degree of independence to 
be maintained by the applicants in making trading decisions; (3) the 
impact on competition in the trading crowd if an exemption were 
granted; (4) the applicant's prior patterns of trading if they have 
traded previously in the same trading crowd at the same time; and (5) 
any other information relevant to whether the applicants would tend 
collectively to dominate the market in a particular trading crowd or a 
particular option series. The proposal further states that the 
Committee may revoke any long-term exemption granted pursuant to this 
subsection if it determines that a fair

[[Page 42459]]

and orderly market otherwise would be impaired by a continuation of the 
exemption. A decision to grant a long-term exemption will be reflected 
in the OFTC's minutes. Under the proposal, the Committee will review 
all long-term exemptions at least annually.\7\ In addition, with 
respect to previously-granted long-term exemptions, the OFTC will 
reserve its right to revoke a long-term exemption if it finds that the 
circumstances on which an exemption was based have changed.\8\ The 
OFTC's decision would be reflected in the OFTC minutes and the members 
whose exemption has been revoked will be so notified in writing.
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    \7\ Amendment No. 2, supra note 5.
    \8\ Amendment No. 2, supra note 5. For example, if the Committee 
grants a long-term exemption to two market makers, and the Exchange 
later is notified pursuant to Rule 4.18 that the nature of those 
market makers' financial arrangement with respect to each other has 
changed, the Exchange staff will request that the OFTC determine 
whether to revoke the exemption. Another situation would be one 
where two market makers with a financial arrangement and a long-term 
exemption change their patterns of trading in the same crowd, so 
that they would be jointly dominating the market in a particular 
option issue or series. The Exchange could detect this either by 
complaints from members of the trading crowd or by routine 
surveillance. Again, in this instance, Exchange staff would submit 
this to the OFTC for review. Id.
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    With respect to short-term exemptions, the proposal states that two 
Floor Officials may grant short-term exemptions to members on a case-
by-case basis if such Floor Officials determine that a fair and orderly 
market would not be impaired and that the need for liquidity in the 
trading crowd warrants such action.
    The proposed definition of ``financial arrangement'' would expand 
the types of arrangements to which that term applies. Specifically, the 
current rule allows two or more members who are backed financially by 
the same source (i.e., members with ``indirect'' financial 
arrangements), to trade in the same crowd or same series as long as 
they are not receiving trading profits from each other and are not 
trading for the same joint account. This may allow situations that 
violate the spirit, but not the letter, of Rule 6.40. Although current 
Commentary .04 to Rule 6.40 seeks to address such arrangements by 
expressly prohibiting unfair domination of markets, the Exchange 
proposes to remove this provision in light of the expanded definition 
of ``financial arrangement'' it proposes.
    The Exchange also proposes to remove a provision in the current 
rule that states that the primary appointment of a market maker may not 
include trading posts that constitute the primary appointment of any 
market maker with whom the first market maker has an existing financial 
arrangement.\9\
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    \9\ See PSE Rule 6.35, Commentary .05.
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    The exchange proposes to revise one of the trading restrictions 
imposed by Rule 6.40 by replacing a reference to ``option series'' with 
one to ``trading crowd.'' The effect of this change is to prevent a 
market maker from bidding, offering, or trading in the same trading 
crowd in which a floor broker holds an order on behalf of a market 
maker with whom he has an existing financial arrangement. In addition, 
orders of market makers having existing financial arrangements may not 
be represented concurrently, by one or more floor brokers, in a 
particular trading crowd.\10\
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    \10\ Amendment No. 1, supra note 4.
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    Finally, the PSE proposes to add violations of Rule 6.40(b) to the 
Exchange's Minor Rule Plan \11\ with recommended fines of $500, $1,000 
and $1,500 for first-, second- and third-time violations, respectively.
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    \11\ PSE Rule 10.13.
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III. 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, with Section 6(b)(5) of the Act, in that the proposal is 
designed to protect investors and the public interest. Specifically, 
the Commission finds, as it did in originally approving Rule 6.40,\12\ 
that full disclosure of financial arrangements among PSE market makers, 
members, and member organizations pursuant to Rule 4.18 (``Disclosure 
of Financial Arrangements of Market Makers'') helps the Exchange better 
to identify and deter potential trading abuses among affiliated PSE 
members and member organizations. In addition, with such disclosure, 
the Exchange's ability to monitor the financial condition of its 
members and member organizations is enhanced. The Commission believes 
that the proposed amendments to Rule 6.40 do not detract from these 
benefits in any material manner, and thus are consistent with the Act.
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    \12\ Securities Exchange Act Release No. 32775 (August 20, 
1993), 58 FR 45368.
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    The Commission believes that it is appropriate for the Exchange to 
amend the definition of ``financial arrangement'' to focus on the 
nature of the financial interest that a member may have in a market 
maker's trading account. The Commission believes that the amended 
definition will help the Exchange achieve a balance whereby it can 
still restrict the types of activity for which the rule was intended, 
without unnecessarily removing liquidity from its trading crowds. The 
Commission notes that the Exchange will continue to grant short-term 
exemptions to members on a case-by-case basis if two floor officials 
determine that the need for liquidity in the trading crowd warrants 
such action. In addition, the Exchange's proposal provides for long-
term exemptions if the OFTC determines that a fair and orderly market 
would not be impaired by allowing such members with financial 
arrangements to trade in the same trading crowd at the same time. The 
Commission believes that the availability of long-term exemptions, 
together with the factors to be considered by the OFTC in determining 
that a fair and orderly market would not be impaired by such an 
exemption, should address situations where it would be unnecessary to 
restrict members with a financial arrangement.
    The Commission believes that the Exchange's proposal to remove the 
provision prohibiting the primary appointments of market makers with 
financial arrangements with each other from overlapping (current 
Commentary .02 to Rule 6.40) is consistent with the Act. The Commission 
agrees with the Exchange that that provision is superfluous in light of 
the trading restrictions set forth in Rule 6.40. In addition, as noted 
by the Exchange, permitting members trading for joint accounts to 
establish overlapping primary appointment zones should allow for 
coverage on the floor when members who trade for those accounts are 
temporarily absent from the floor.\13\
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    \13\ In this regard, the Exchange notes that the Commission 
recently approved a PSE rule change to increase from two to six the 
maximum number of trading posts that may be included within a market 
maker's primary appointment zone. See Exchange Act Release No. 36370 
(October 13, 1995), 60 FR 54273.
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    The Commission believes that the PSE's proposal to add violations 
of Rule 6.40(b) to the Exchange's Minor Rule Plan is consistent with 
the Act. The Commission agrees with the Exchange that violations of 
Rule 6.40(b) are easily ascertainable and easily verifiable, and, 
therefore, are appropriate for inclusion in the Minor Rule Plan.\14\
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    \14\ Rule 19D-1(c)(2) under the Act, 17 CFR 240.19d-1(c)(2), 
authorizes national securities exchanges to adopt minor rule 
violation plans for the summary discipline and abbreviated reporting 
of minor rule violations by exchange members and member 
organizations. The Exchange's Minor Rule Plan initially was approved 
by the Commission in 1985. Securities Exchange Act Release No. 22654 
(November 21, 1985), 50 FR 48853.
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    The Commission finds good cause for approving Amendment Nos. 1 and 
2 to the proposed rule change prior to the thirtieth day after the date 
of

[[Page 42460]]

publication of notice thereof in the Federal Register. Amendment Nos. 1 
and 2 consist of clarifying changes that serve to strengthen the 
Exchange's proposal, but do not materially alter the terms of the 
proposal as originally described when published for comment.\15\ 
Accordingly, the Commission believes there is good cause, consistent 
with Sections 6(b)(5) and 19(b)(2) of that Act, to approve Amendment 
Nos. 1 and 2 to the proposal on an accelerated basis.
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    \15\ Securities Exchange Act Release No. 37186, supra note 3.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1 and 2. 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 
CBOE. All submissions should refer to File No. SR-PSE-96-12 and should 
be submitted by September 5, 1996.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-PSE-96-12), as amended, is 
approved.

    \16\ 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.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-20787 Filed 8-14-96; 8:45 am]
BILLING CODE 8010-01-M