[Federal Register Volume 61, Number 178 (Thursday, September 12, 1996)]
[Notices]
[Pages 48198-48200]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-23313]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37635; File No. SR-Phlx-96-19]


Self-Regulatory Organizations; Order Granting Approval to 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval to Amendment No. 1 to Proposed Rule Change by the 
Philadelphia Stock Exchange, Inc., To Establish a Firm Facilitation 
Exemption

September 4, 1996.

I. Introduction

    On June 3, 1996, the Philadelphia Stock Exchange, Inc. (``Phlx'' 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 
proposed rule change to establish a firm facilitation exemption \3\ for 
all non-multiply-listed Exchange options by adding new Commentary .08 
to Exchange Rule 1001 and new Commentary .02 to Exchange Rule 1001A. 
The exemption would be available to equity and index options, including 
customized options.\4\
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    \1\ 15 U.S.C. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4.
    \3\ The Commission notes that a facilitation trade is defined as 
a transaction that involves crossing an order of a member firm's 
public customer with an order for the member firm's proprietary 
account.
    \4\ See Securities Exchange Act Release No. 37048 (March 29, 
1996), 61 FR 15549 (April 8, 1996) (File No. SR-Phlx-96-08).
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    The proposed rule change appeared in the Federal Register on July 
10, 1996.\5\ No comments were received on the proposed rule change. The 
Phlx subsequently filed Amendment No. 1 to the proposed rule change on 
July 26, 1996.\6\ This order approves the Phlx's proposal.
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    \5\ See Securities Exchange Act Release No. 37398 (July 2, 
1996), 61 FR 36410 (July 10, 1996).
    \6\ In Amendment No.1, the Phlx amended its proposed rule filing 
to: (1) require that a member organization submit to the Exchange's 
Market Surveillance Department appropriate forms substantiating the 
basis for the exemption within two business days or the time 
specified by the Exchange when approval is granted on the basis of 
verbal representations; (2) clarify that the proposal does not apply 
to multiply-listed options; (3) add language prohibiting the use of 
the exemption with respect to ``all or none'' or ``fill or kill'' 
orders; and (4) state that violations of the exemptive requirements, 
absent reasonable justification or excuse, shall result, in addition 
to any disciplinary action, in the withdrawal of the exemption, and 
may form the basis for subsequent denial of an application for an 
exemption under this rule. See letter from Gerald D. O'Connell, 
Senior Vice President, Market Regulation and Trading Operations, 
Phlx, to Matthew Morris, Office of Market Supervision, Division of 
Market Regulation, Commission, dated July 26, 1996 (``Amendment No. 
1'').
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II. Background and Description

    The Phlx is proposing to establish a firm facilitation exemption 
for all non-multiply-listed Exchange options. Under the proposal, the 
procedures in Exchange Rule 1064(b) for crossing a customer order with 
a firm facilitation order must be followed. Moreover, only after all 
market participants in the trading crowd have been given a reasonable 
opportunity to accept the terms, may the representing Floor Broker 
cross all or any remaining part of such order in accordance with the 
rule. According to the Phlx, the purpose of this procedure is to ensure 
that the trading crowd cannot first facilitate the order before 
resorting to a position limit exemption for the facilitating firm. 
Thus, only after it is determined that the trading crowd will not fill 
the order may the firm's customer order be crossed with the firm's 
facilitation order pursuant to the exemption.
    The Phlx notes that the firm facilitation provision will be in 
addition to and separate from the standard limit, as well as other 
exemptions available under Exchange position limit rules. For example, 
if a member organization decides to facilitate customer orders in

[[Page 48199]]

ABC options, which is assumed not to be multiply-listed and also 
assumed to have a 10,500 contract standard position limit, the member 
organization may qualify for a firm facilitation exemption of up to 
twice that limit (21,000 contracts), as well as an equity hedge 
exemption of up to twice the standard limit (21,000 contracts), in 
addition to the 10,500 contract standard limit. If both exemptions are 
allowed, the facilitation firm may hold or control a combined position 
of up to 52,500 ABC contracts on the same-side of the market.\7\
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    \7\ In addition, exercise limits will continue to correspond to 
position limits, such that investors may exercise the number of 
contracts set forth as the position limit as well as those contracts 
exempted by this proposal, during five consecutive business days. 
See Exchange Rules 1002 and 1002A.
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    The Phlx notes, however, that the firm facilitation exemption would 
not presently extend to all options listed on the Exchange. Rather, 
until coordinated intermarket procedures are developed, the firm 
facilitation exemption will be extended only to non-multiply-listed 
options.
    Under the proposal, the facilitation exemption requires prior 
approval from two Floor Officials and submission of a Firm Facilitation 
Form.\8\ Although approval may be granted on the basis of verbal 
representation, the facilitation firm is required to furnish to the 
Market Surveillance Department, within two business days or such other 
time period designated by the Exchange, appropriate forms 
substantiating the basis for the exemption.\9\
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    \8\ According to the Phlx, the purpose of the Firm Facilitation 
Form is to detail the terms of the customer order and the resulting 
facilitation, as well as to ensure compliance with the exemption. In 
addition, pursuant to the existing requirements of Exchange Rule 
1064(b), facilitation orders must be marked with an ``F'' prior to 
executing facilitating trades. Lastly, Firm Facilitation Forms will 
be made available at the Exchange's Surveillance Post.
    \9\ The Exchange also notes that the facilitation firm need not 
have the customer order in hand when requesting the exemption, as 
long as the exemption is properly used to facilitate a customer 
order pursuant to the rule. Because the provision states the 
position ``will facilitate'' a customer order, a firm approaching 
the limit may request an exemption prior to receiving an order, in 
response to customer interest.
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    Within five business days after the execution of a facilitation 
exemption order, a facilitation firm must hedge all exempt option 
positions that have not previously been liquidated, and furnished to 
the Market Surveillance Department documentation reflecting the 
resulting hedged positions. In meeting this requirement, and to ensure 
fair and orderly markets, the facilitation firm must establish and 
liquidate its own as well as its customer's option and stock positions 
(or their equivalent) in an orderly fashion, and not in a manner 
calculated to cause unreasonable price fluctuations or unwarranted 
price changes.
    In addition, a facilitation firm is not permitted to use the 
facilitation exemption with a view toward taking advantage of any 
differential in the price between a group of securities and an 
overlying stock index option. According to the Phlx, this prohibition 
against index arbitrage should prevent undue market impact on the 
options or any underlying stock positions by preventing the increased 
positions from being used in a leveraged manner. Moreover, to 
facilitate surveillance and to ensure an accurate audit trail, the 
facilitation firm is required to promptly provide to the Exchange any 
information or documents requested concerning the exempted and hedged 
positions, to furnish copies of the relevant order tickets to the 
Market Surveillance Department on the day of execution, and to notify 
the Exchange of any material change in the exempted options position or 
the hedge.
    The Exchange is also proposing several minor changes to its rules. 
First, the introductory paragraph to Exchange Rule 1001 is to be 
amended to list the 20,000 and 25,000 contract position limit tiers, 
which were inadvertently omitted when Commentary .05(a) was amended to 
adopt these limits.\10\ Second, Exchange Rule 1064(b) is to be amended 
to eliminate the incorrect limitation to ``equity'' options, as this 
provision applies to index options as well. Third, the equity option 
hedge exemption contained in Commentary .07 to Exchange Rule 1001 is to 
be amended to state that the exemption is available up to ``two times 
above'' existing limits, as opposed to ``three times'' the limits, as 
currently stated. The maximum size of the exemption is not being 
changed, just rephrased in terms of the excess number of contracts 
above the applicable position limit. In this manner, the provision will 
be consistent with the index option hedge exemption of the Phlx as well 
as other exchanges.\11\ Fourth, the equity option hedge exemption is to 
be amended to state that it is separate from any other exemption 
available under Exchange rules.
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    \10\ See Securities Exchange Act Release No. 36409 (October 23, 
1995), 60 FR 55399 (October 31, 1995) (File No. SR-Phlx-95-71).
    \11\ See Phlx Rule 1001A, Commentary .01. See also CBOE Rule 
4.11, Interpretations and Policies .04(b).
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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 the requirements of Section 6(b)(5).\12\ Specifically, 
the Commission believes that the Phlx's proposal is reasonably designed 
to accommodate the needs of investors and other market participants 
without substantially increasing concerns regarding the potential for 
manipulation and other trading abuses. The Commission also believes 
that the proposed rule change has the potential to enhance the depth 
and liquidity of the options market by providing Exchange members 
greater flexibility in executing large customer orders. Accordingly, as 
discussed below, the Commission believes that the rule proposal is 
consistent with the requirements of Section 6(b)(5) that exchange rules 
facilitate transactions in securities while continuing to further 
investor protection and the public interest.
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    \12\ 15 U.S.C. 78f(b)(5) (1988).
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    The Phlx proposal contains several safeguards that will serve to 
minimize any potential disruption or manipulation concerns. First, the 
facilitation firm must receive approval from the Exchange prior to 
executing facilitation trades. Although Exchange approval maybe granted 
on the basis of verbal representations, the Commission believes that 
trading abuses are unlikely because the facilitation firm is required 
to furnish to the Exchange's Market Surveillance Department, within two 
business days or such other time period designated by the Exchange, 
forms and documentation substantiating the basis for the exemption.
    Second, a facilitation firm must, within five business days after 
the execution of a facilitation exemption order, hedge all exempt 
options positions that have not previously been liquidated, and furnish 
to the Exchange's Market Surveillance Department documentation 
reflecting the resulting hedging positions. In meeting this 
requirement, the facilitation firm must liquidate and establish its 
customer's and its own options and stock positions (or their 
equivalent) in an orderly fashion, and not in a manner calculated to 
cause unreasonable price fluctuations or unwarranted price changes. In 
addition, a facilitation firm is not permitted to use the facilitation 
exemption for the purpose of engaging in index arbitrage.

[[Page 48200]]

The Commission believes that these requirements will help to ensure 
that the facilitation exemption will not have an undue market impact on 
the options or any underlying stock positions.
    Third, the facilitation firm is required to promptly provide to the 
Exchange any information or documents requested concerning the exempted 
options positions and the positions hedging them, as well as to 
promptly notify the Exchange of any material change in the exempted 
options positions or the hedge.
    Fourth, neither the member's nor the customer's order may be 
contingent on ``all or none'' or ``fill or kill'' instructions, and the 
orders may not be executed until the procedures in Exchange Rule 
1064(b) have been satisfied and crowd members have been given a 
reasonable time to participate in the trade.
    Fifth, in no event may the aggregate exempted position exceed two 
times the applicable standard limit, in addition to the standard 
position limit.\13\
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    \13\ The Commission notes, however, that the firm facilitation 
exemption is in addition to any other exemption available under the 
Exchange's rules.
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    Sixth, the facilitation firm may not increase the exempted options 
position once it is liquidated, unless approval from the Exchange is 
again received pursuant to a reapplication.
    In summary, the Commission believes that the safeguards built into 
the facilitation exemption process discussed above should serve to 
minimize the potential for disruption and manipulation, while at the 
same time benefiting market participants by allowing member firms 
greater flexibility to facilitate large customer orders. This structure 
substantially mirrors the firm facilitation exemption processes that 
were recently approved for other option exchanges.\14\ Accordingly, the 
Commission believes it is appropriate to extend the benefits of a firm 
facilitation exemption to non-multiply-listed Phlx options.
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    \14\ See Securities Exchange Act Release Nos. 36964 (March 13, 
1996), 61 FR 11453 (March 20, 1996) (File No. SR-CBOE-95-68); 37178 
(May 8, 1996), 61 FR 24523 (May 15, 1996) (File No. SR-PSE-96-10); 
37179 (May 8, 1996), 61 FR 24520 (May 15, 1996) (File No. SR-Amex-
96-11).
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    In addition, because the other minor rule changes that the Exchange 
is proposing will make the Phlx's rules clearer and are non-substantive 
in nature, the Commission believes that they are consistent with 
Section 6(b)(5) of the Act.
    The Commission finds good cause to approve Amendment No. 1 to the 
proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. 
Specifically, Amendment No. 1 conforms the Exchange's firm facilitation 
exemption to the relief recently approved for the other options 
exchanges. Accelerated approval of the proposed rule change will 
thereby provide for the desired uniformity of the exchanges' position 
limit exemptions. Any other course of action could lead to unnecessary 
investor confusion. In addition, the Chicago Board Options Exchange's 
proposal was noticed for the entire twenty-one day comment period and 
generated no responses.\15\ Accordingly, the Commission believes that 
it is consistent with Sections 6(b)(5) and 19(b)(2) of the Act to 
approve Amendment No. 1 to the proposed rule change on an accelerated 
basis.
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    \15\ Id.
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    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1 to the rule proposal. 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 20549. Copies 
of such filing also will be available for inspection and copying at the 
principal office of the Phlx. All submissions should refer to File No. 
SR-Phlx-96-19 and should be submitted by October 3, 1996.

IV. Conclusion

    For the foregoing reasons, the Commission finds that the Phlx's 
proposal to establish a firm facilitation exemption, as well as the 
other non-substantive changes to the Phlx's rules, are consistent with 
the requirements of the Act and the rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) \16\ of the 
Act, that the proposed rule change (File No. SR-Phlx-96-19), as 
amended, is hereby 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. 96-23313 Filed 9-11-96; 8:45 am]
BILLING CODE 8010-01-M