[Federal Register Volume 61, Number 198 (Thursday, October 10, 1996)]
[Notices]
[Pages 53247-53253]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-26013]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37780; File No. SR-PSE-96-03]


Self-Regulatory Organizations; Pacific Stock Exchange, Inc.; 
Order Approving and Notice of Filing and Order Granting Accelerated 
Approval of Amendment Nos. 1 and 2 to Proposed Rule Change Relating to 
the Lead Market Maker Program

October 3, 1996.

I. Introduction

    On January 16, 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 relating to changes to its Lead Market Maker (``LMM'') 
Program. The proposed rule change was published for comment in the 
Federal Register on March 18, 1996.\3\ The Exchange filed an amendment 
(``Amendment No. 1'') \4\ to its proposal on August 11, 1996. The 
Exchange filed a second amendment (``Amendment No. 2'') \5\ to its 
proposal on September 26, 1996. No comments were received on the 
proposed rule change. This order approves the Exchange's proposal as 
amended.
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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. 36952 (March 11, 
1996), 61 FR 11072.
    \4\ Amendment No. 1 provides further justification and rationale 
for the PSE's proposed changes to the LMM Rule. Amendment No. 1 also 
provides revised language to the proposed Rule 6.82 changes. Letter 
from Michael D. Pierson, Senior Attorney, Regulatory Policy, PSE, to 
Michael A. Walinskas, Senior Special Counsel, Office of Market 
Supervision, Division of Market Regulation, Commission, dated August 
9, 1996.
    \5\ Amendment No. 2, like Amendment No. 1, provides further 
justification and rationale for the PSE's proposed changes to the 
LMM Rule and provides revised language to the proposed Rule 6.82 
changes. Letter from Michael D. Pierson, Senior Attorney, Regulatory 
Policy, PSE, to Janet Russell-Hunter, Special Counsel, Office of 
Market Supervision, Division of Market Regulation, Commission, dated 
September 26, 1996.
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II. Description of the Proposal

    PSE Rule 6.82 (``LMM Rule'') sets forth the basic rules and 
procedures applicable to LMMs and the LMM Program.\6\ The Exchange 
proposes to modify Rule 6.82 by adding several new substantive 
provisions and by restructuring the rule and clarifying some of its 
existing provisions. The purpose of the proposal is to enhance the LMM 
Program and to clarify and streamline the LMM Rule. The proposed 
changes include, more specifically, the following:
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    \6\ The LMM Rule was adopted in January 1990 as a pilot program. 
See Securities Exchange Act Release No. 27631 (January 17, 1990), 55 
FR 2462. The pilot program most recently was extended to September 
30, 1997. See Securities Exchange Act Release No. 37767 (September 
30, 1996).
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    1. Current PSE Rule 6.82(c)(6) provides that LMMs are guaranteed 
50% participation in transactions occurring at their disseminated bids 
and offers in their allocated issues. The Exchange is proposing to 
create an exception to this provision.\7\ Specifically, with regard to 
multiply-traded issues, the proposed rule will provide that if the 
average daily trading volume in an issue reached 3,000 contracts at the 
Exchange for three consecutive months, and if (i) in the case of an 
issue traded by two options exchanges, the Exchange's share of the 
total multi-exchange customer trading volume in the issue drops from 
above 70% to below 70%, or (ii) in the

[[Page 53248]]

case of an issue traded by three or more options exchanges, the 
Exchange's share of the total multi-exchange customer trading in the 
issue drops from above 45% to below 45%, the Options Allocation 
Committee shall evaluate the LMM's performance in that issue, and, 
based on that evaluation, may reduce the LMM's guaranteed participation 
in the issue from 50% to 40%. See proposed Rule 6.82(d)(2)(A)-(B).
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    \7\ Current Rule 6.82(b)(3)(iii) provides that, subsequent to 
appointment of an issue to an LMM, the issue may be reassigned to 
the market maker system, pursuant to subsection (b)(7), once trading 
volume in the issue reaches an average daily volume of 3,000 
contracts at the Exchange for four consecutive months, immediately 
preceded by an Exchange average of 75% of the total multi-exchange 
trading volume for three consecutive months. The Exchange is 
proposing to delete this provision and modify it as discussed below. 
It should be noted that both the provision being deleted and the one 
replacing it are permissive, not mandatory. See Amendment No. 1, 
supra note 4.
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    This proposed change is intended to give discretion to the Options 
Allocation Committee to reduce an LMM's guaranteed participation when 
trading volume levels are sufficiently high and the individual 
situation warrants such action. In making these determinations, the 
Options Allocation Committee would consider the factors specified in 
proposed Rule 6.83(e)(4) regarding evaluation of LMMs, including, among 
other things, consideration of the LMM's evaluation conducted pursuant 
to Options Floor Procedure Advice (``OFPA'') B-13, and the LMM's 
compliance with Exchange rules, including, but not limited to, Rules 
6.32 through 6.40 and Article XI, Section 2 of the Exchange 
Constitution. The proposal would prompt the Options Allocation 
Committee to review the performance of LMMs when issues they trade have 
substantial increases in order flow.\8\
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    \8\ Amendment No. 1, supra note 4.
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    These new provisions assure LMMs that they will continue to retain 
some guaranteed participation as long as their performance is adequate. 
Thus, they serve as incentives to attract and keep qualified LMMs who 
will participate in the LMM Program and offer competitive markets and 
services. With respect to issues traded only on the Exchange, the 
Exchange believes that the Options Allocation Committee should have the 
flexibility to reduce an LMM's guaranteed participation in a high-
volume issue from 50% to 25% if it finds, based upon review of an LMM's 
performance, that that issue has reached a high level of trading volume 
for reasons other than those for which the LMM is responsible.\9\
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    \9\ Amendment No. 1, supra note 5.
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    With respect to multiply-traded issues, the proposal would allow 
the Options Allocation Committee to take action in situations where an 
issue becomes heavily traded at the Exchange, but the Exchange begins 
to lose a certain share of order flow to a competing exchange.\10\ In 
such situations, if the Options Allocation Committee finds that the LMM 
was responsible for the loss of order flow, it would have the ability 
to encourage better performance by reducing an LMM's guaranteed 
participation.\11\
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    \10\ Id.
    \11\ The Options Allocation Committee could, of course, also 
reallocate the issue to another LMM or to the trading crowd pursuant 
to Rule 6.82(f)(1)(A) if the individual situation warranted such 
action.
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    The Exchange has selected the 40% and 25% figures (rather than 
other figures) because they take into account what the Exchange 
believes to be an appropriate balance of the factors that would be 
considered by the Options Allocation Committee in deciding whether to 
reduce an LMM's guaranteed participation. These factors include 
compensation to the LMM for taking on the responsibilities of an 
LMM,\12\ and the amount of guaranteed participation necessary for the 
LMM to compete in multiple trading.\13\
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    \12\ See Rule 6.82(c).
    \13\ The proposed reductions in guaranteed participation to 25% 
in exclusively-traded issues and to 40% in multiply-traded issues 
are based on the assumption that in multiply-traded issues, the LMM 
requires greater participation to compete for order flow with order 
exchanges.
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    With regard to the proposed change in the number of months (from 
four to three) that must pass before an LMM's guaranteed participation 
may be reduced, the Exchange seeks to accelerate the review process so 
that appropriate action may be taken more quickly.
    2. Commentary .02 to Rule 6.82 currently provides that for an LMM 
to be used in any options class opened for trading at the Exchange 
before January 1, 1990, such option class must have an average monthly 
contract volume for the previous six-month period that ranks that class 
in the bottom 20% of class activity for the options floor. It further 
provides that any dually-traded options class whose daily contract 
volume for the previous calendar year falls below 70% of the total 
multi-exchange volume and any options class subject to reallocation 
pursuant to OFPA B-13 may be converted to the LMM Program at the 
discretion of the Exchange. The Exchange is proposing in Amendment No. 
1 to eliminate Commentary .02 because the Exchange believes that all 
issues traded in the options floor should be eligible for trading under 
the LMM Program.\14\ The Exchange believes that Commentary .02 is 
unnecessarily restrictive. To the extent that it precludes LMMs from 
trading high volume issues, the Exchange believes that it is 
unwarranted based on the Exchange's experience with several high-
volume, multiply-traded issues that are, and have been, successfully 
traded under the LMM Program. The Exchange believes that there may be 
situations, other than those where reallocation currently is 
permissible, where reallocation to an LMM of a non-multiply-traded 
issue would be appropriate (e.g. where a trading crowd voluntarily 
requests an issue to be reallocated and an LMM offers to make better 
markets and to provide better customer service than any other applicant 
for the issue). Furthermore, the Exchange asserts that the current 
restrictions place the PSE at a competitive disadvantage to other 
exchanges. See e.q. CBOE Rule 8.80(a).\15\
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    \14\ Amendment No. 1, supra note 4.
    \15\ Amendment No. 2, supra note 5.
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    The Exchange also is proposing to delete the reference to 
Commentary .02 in Rule 6.82(a)(2) because, under the proposal, 
Commentary .02 will be deleted.\16\
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    \16\ Id.
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    3. Under the proposal, if an issue is reallocated from an LMM to a 
market maker trading crowd, the market quality and service provided by 
the crowd must equal or better that previously provided or guaranteed 
by the LMM. Otherwise, the Options Allocation Committee may determine 
that the issue revert to the LMM system. See proposed Rule 6.82(f)(2).
    4. The proposal would allow the Options Appointment Committee to 
designate a cooperative of market makers to act as an LMM in an issue 
provided the market makers in the cooperative together maintain a cash 
or liquid asset position in the amount required for LMM's, set forth in 
current Rule 6.82(c)(8).\17\ A cooperative would consist usually of two 
or three Exchange members who must be registered as market makers. They 
may not, however, have ``financial arrangements'' with one another as 
defined in PSE Rule 6.40, which restricts such members from trading in 
the same trading crowd.\18\ This provision further states that 
violations of the Exchange Constitution and Rules committed by a market 
maker cooperative that is not registered as a broker-dealer may render 
each market maker thereof personally liable for

[[Page 53249]]

disciplinary sanctions for such violations.\19\
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    \17\ Under the proposal, current Rule 6.82(c)(8) will be 
renumbered as Rule 6.82(c)(11) and will continue to require that an 
LMM maintain a cash or liquid asset position in the amount of 
$100,000 or in an amount sufficient to assume a position of 20 
trading units of the security underlying the option the LMM has been 
allocated, whichever amount is greater.
    \18\ The PSE recently amended its Rule 6.40, Financial 
Arrangements of Options Floor Members (formerly, Financial 
Arrangements of Market Makers) in Securities Exchange Act Release 
No. 37543, (August 8, 1996), 61 FR 42458. See also Discussion 
section, infra. at notes 39-42 and accompanying text.
    \19\ See proposed Rule 6.82(a)(3).
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    The Exchange believes that such cooperatives will serve a useful 
function by allowing for greater liquidity in an LMM issue together 
with greater accountability and service to customers than might 
otherwise be provided if only one member served as LMM in that 
issue.\20\
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    \20\ Amendment No. 1, supra note 4.
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    The Exchange believes that it is appropriate to allow such 
cooperatives to serve as LMMs so long as the capital requirements and 
customer service requirements of the LMM Rule are met, and the trading 
restrictions on members with financial arrangements are satisfied. If 
trading conditions were to become unduly complicated, however, the 
Options Allocation Committee could rectify the situation by disallowing 
more than one member to serve as LMM in that issue.\21\
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    \21\ Id.
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    5. The Exchange proposes that in the absence of extraordinary 
circumstances, as determined by the Options Allocation Committee, no 
LMM may be allocated more than 10% of the number of all option issues 
traded on the Options Floor. See proposed Rule 6.82(e)(3). The purpose 
of this proposed change is to reduce the Exchange's risk in the event 
that a member fails or a market break occurs and a number of option 
issues would then be required to be reallocated.\22\
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    \22\ Id.
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    6. The Exchange proposes to replace references to the LMM 
Appointment Committee in the current rule with references to either the 
Options Allocation Committee or the Options Appointments Committee. See 
passim. When Rule 6.82 first was adopted in 1990, it provided for the 
LMM Appointment Committee to administer virtually all of the provisions 
of the LMM Rule.\23\ In June 1992, however, the Commission approved an 
Exchange proposal that, among other things, eliminated the LMM 
Appointment Committee, whose functions were assumed by the Options 
Allocation Committee and the Options Appointment Committee.\24\ The 
current proposal conforms Rule 6.82 to Rules 11.10(a) and 11.10(c).\25\
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    \23\ See Securities Exchange Act Release No. 27631, supra note 
6.
    \24\ See Securities Exchange Act Release No. 20843 (June 19, 
1992), 57 FR 28889 (approving File No. SR-PSE-92-07); see also PSE 
Rule 11.10(a) (Options Appointment Committee), Rule 11.10(c) 
(Options Allocation Committee), and OFPA B-13 (Evaluations of 
Options Trading Crowd Performance).
    \25\ Amendment No. 1, supra note 4.
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    Currently, and as specified in the rule change proposal, the 
Options Appointment Committee is responsible for ``qualifying'' LLMs, 
i.e., approving their registration as LMMs based on capital 
requirements (and other factors). The Options Allocation Committee 
currently is responsible for allocating option issues to LMMs, 
evaluating LMM performance, and, if necessary, reallocating issues 
traded by LMMs. In addition, the Exchance notes that the Market 
Performance Subcommittee of the Options Floor Trading Committee 
currently is responsible for evaluating the performances of LMMs on a 
case by case basis when relevant issues arise, and making 
recommendations to the Options Allocation Committee on those 
issues.\26\
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    \26\ Id.
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    7. The proposal specifies that each LMM must designate an approved 
LMM to act as a substitute LMM (in case the designated LMM is unable to 
perform its duties), and notify Book Staff of such designation. See 
proposed Rule 6.82(c)(5). The term ``substitute LMM'' refers to a 
member who agrees to act for an LMM on a temporary basis when the 
registered LMM is unable to be present throughout a trading day. 
Substitute LMMs, agree to assume all of the registered LMM's duties as 
LMM. They must previously have been approved by the Options Appointment 
Committee and must currently meet all other requirements of the LMM 
Rule, including capital requirements.\27\
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    \27\ Id.
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    8. Rule 6.82(b)(8) currently provides that if an issue is 
reallocated pursuant to subsection (b)(7), the LMM shall receive an 
award of compensation based upon time of service, performance, capital 
commitment, and trading volume in the subject option issue. It further 
provides that this award shall not exceed two years. The Exchange 
proposes to change the term ``shall'' in that provision to ``may.'' See 
proposed Rule 6.82(f)(3). The Exchange believes that situations may 
arise where an issue is reallocated and the LMM should not be entitled 
to any compensation (e.g., due to lack of performance). Given that the 
current rule is sufficiently vague that its requirements could be 
satisfied by providing an LMM with nominal compensation, the Exchange 
believes that the proposed change is relatively insignificant.\28\
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    \28\ Id.
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    In addition, in Amendment No. 1, the Exchange is proposing to 
change the reference to subsection (f)(2) contained in subsection 
(f)(4) to a reference to subsection (f)(1), because the Exchange notes 
that an award of compensation may be appropriate in any of the 
circumstances set forth in subsection (f)(1). The Exchange notes that 
under Amendment No. 1, subsection (f)(2) will be deleted.
    9. The Exchange proposes to simplify the current provisions 
concerning appeals from Options Allocation Committee or Options 
Appointment Committee decisions so that in all cases such appeals are 
governed by Rule 11,\29\ and, during such appeals, the Options 
Allocation Committee shall appoint an interim LMM or trading crowd 
until such appeal has been resolved. See proposed Rule 6.82(g). The 
Exchange believes that such decisions are not disciplinary in nature 
and that such appeals are more properly addressed by Rule 11 relating 
to appeals of committee decisions, rather than Rule 10, which relates 
to appeals of disciplinary decisions.
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    \29\ PSE Rule 11 concerns generally committees of the Exchange. 
PSE Rule 11.7 concerns hearings and review of committee action.
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    10. The proposal would remove a provision requiring that LMM issues 
be traded in an area of the trading floor that is separate from other 
issues. See current Rule 6.82(a)(2). The Exchange does not believe that 
segregated areas for market maker and LMM trading posts should be 
required because the integration of LMMs with market maker trading 
crowds allows for greater competition and liquidity. In addition, with 
the limited amount of space on the trading floor, the Exchange needs 
maximum flexibility when it is necessary to move an issue to a new 
location on the floor. The Exchange also intends to allow individual 
members to trade issues as LMMs while continuing to trade other issues 
as market makers in various locations on the floor.\30\
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    \30\ Amendment No. 1, supra note 4.
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    11. Proposed Rule 6.82(c)(2) states that each LMM is obligated to 
honor guaranteed markets, including markets required by Rule 6.86 \31\ 
and any better market pledged during the allocation process. The term 
``better market pledged'' refers to the market depth or width that an 
applicant for a new issue agrees to provide if the Options Allocation 
Committee allocates that issue to that applicant. The Options 
Allocation Committee considers such pledges when choosing among 
applicants for allocations of new option issues. The rule change merely

[[Page 53250]]

reinforces the obvious requirements that LMMs must honor those 
pledges.\32\
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    \31\ PSE Rule 6.86 states that non-broker-dealer customer orders 
are entitled to a guaranteed minimum of twenty option contracts at 
the bid or offering prices being disseminated at the time the order 
is represented at the designated trading post.
    \32\ Amendment No. 1, supra note 4.
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    12. The Exchange proposes to replace existing language in Rule 
6.82(b)(10), which currently states that the ``Committee'' \33\ may 
perform all functions of the Market Performance Committee of the Board 
of Governors under the PSE rules with respect to review and evaluation 
of the conduct of LMMs in the classes of their LMM appointment. 
Instead, proposed Rule 6.82(e)(4) states that the Options Allocation 
Committee shall monitor and evaluate the performance of LMMs with 
regard to quality of markets. This will continue to be done at lease 
semiannually. In reviewing and evaluating an LMM`s performance, the 
Options Allocation Committee will consider, among other things, OFPA B-
13, and the LMM's compliance with Exchange rules, including, but not 
limited to, Rules 6.32 through 6.40 and Article XI, Section 2 of the 
Exchange Constitution. The Exchange notes that the reference to the 
Market Performance Committee should be deleted because that entity has 
been replaced by the Exchange's Board Oversight Committee.\34\
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    \33\ Securities Exchange Act Release No. 30843, supra note 24.
    \34\ Amendment No. 1, supra note 4.
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    13. Rules 6.82(b)(4) and (b)(9)(ii) currently provide that an LMM 
who is the subject of ``Committee'' \35\ review in connection with the 
termination of an LMM appointment will be advised of the review and, 
upon receipt of such notification, shall have ten (10) business days in 
which to submit a written statement for the consideration of the 
Committee, and that formal rules of evidence do not apply to these 
proceedings.\36\
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    \35\ Securities Exchange Act Release No. 30843, supra note 24.
    \36\ Amendment No. 1 supra note 4.
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    The Exchange proposes to delete this provision on the ground that 
it unnecessarily restricts the Options Allocation Committee, which may 
need to act promptly in reallocating issues, or the Options Appointment 
Committee, which may need to act quickly in disqualifying an LMM. The 
Exchange believes that these committees ought to have the ability to 
reallocate issues or disqualify LMMs in the normal course of business, 
and that no special procedures should be required, as is the case with 
virtually all other actions of committees.
    14. In Amendment No. 1, the Exchange is proposing to modify Rules 
6.82(b)(3) and 6.82(c)(13) so that members will be required to notify 
the Exchange, rather than specific committees (as stated in the 
original proposal), when certain events occur (i.e. notice of an LMM's 
resignation or notice of a material financial, operational or personnel 
change to the LMM). The Exchange believes that this change will make 
administration of the relevant rule provisions more efficient. The 
Exchange also is proposing to eliminate the phrase ``as determined by 
the Options Appointment Committee'' from the text of proposed Rule 
6.82(f)(1)(B) because under that rule, determinations may be made 
either by the Options Appointment Committee or the Options Allocation 
Committee, depending upon the issue or circumstances. The Exchange will 
assure that any such notices will be forwarded to the appropriate 
Committee.
    15. Rule 6.82(b)(7)(ii) currently provides that the use of an LMM 
in a particular option may be discontinued if ``it is * * * determined, 
considering all the facts and circumstances, that the trading in a 
particular option class would be better accommodated by the 
introduction of, or return to, the market maker system without an LMM. 
An LMM so affected shall be required to terminate his appointment in no 
fewer than three (3) business days subsequent to his receipt of written 
notice from the Exchange.'' The Exchange believes, based on its 
evaluation of the LMM Program over the past several years, that this 
vague provision is unnecessary for the operation of the LMM 
Program.\37\
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    \37\ Id.
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    16. In Amendment No. 1, the Exchange is proposing to modify OFPA B-
13 to provide expressly that all of the rules and procedures applicable 
to the semiannual evaluations of options trading crowd performance will 
also apply to evaluations of LMM performance. This change would codify 
an existing practice of the Options Allocation Committee. As stated in 
the rule change, trading crowds are compared with other trading crowds 
and LMMs are compared with other LMMs for determining which trading 
crowds and which LMMs rank in the bottom 10% of the floor, thereby 
subjecting them to the remedial action specified in subsection (a) of 
OFPA B-13. In addition, the Exchange is proposing to modify subsection 
(i) of OFPA B-13 so that appeals of remedial action taken by the 
Options Allocation Committee will be governed by Rule 11.7 (``Hearing 
and Review of Committee Action''), rather than by Rule 10.11(d), which 
relates to appeals of disciplinary decisions.
    17. The Exchange is proposing to eliminate the requirement in 
current Rule 6.82(c)(3) that the LMM disclose to the trading crowd the 
elements of any formula the LMM uses for automatically updating market 
quotations. The Exchange believes that this provision is unnecessary 
because the Exchange has a longstanding policy that any member who 
wants to know what formula is being used for automatically updating 
quotations in an issue can simply ask the Order Book Official, and he 
or she will provide the information to that member. The Exchange 
believes that this policy improves upon the existing rule, which is not 
specific as to when, or to whom the formula must be disclosed.
    18. In Amendment No. 2, the Exchange is proposing to strike the 
words ``dually-traded or'' from Rule 6.82(d)(2)(A) because they are 
superfluous.\38\ The Exchange also is replacing the term ``exclusively-
traded'' in proposed Rule 6.82(d)(2)(B) with the term ``non-multiply-
traded.''\39\ Finally, the Exchange proposes to restructure the rule, 
eliminate superfluous provisions, and make other revisions that would 
clarify the current text of the Rule. See passim.
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    \38\ Amendment No. 2, supra note 5.
    \39\ Id.
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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. The Commission 
finds generally that the proposed changes to the PSE's LMM Program may 
continue to enhance the market making mechanism at the PSE, thereby 
improving the market for listed options on the Exchange. Specifically, 
the Commission finds as follows:
    1. The Commission believes that the Exchange's proposal to provide 
the Options Allocation Committee with the discretion to reduce an LMM's 
guaranteed participation in a dually- or multiply-traded issue from 50% 
to 40%, and, in a non-multiply-traded issue, from 50% to 25%, if 
certain volume levels are reached, is consistent with the Act.
    The Commission agrees with the Exchange that once sufficient volume 
in an LMM issue has been developed it may be appropriate to undertake 
such action. The Commission also notes that with respect to multiply-
traded issues,

[[Page 53251]]

the Exchange proposal would provide for such reductions only if the 
Exchange's share of trading volume fell below certain thresholds. The 
Commission notes that in making the determination whether to reduce an 
LMM's guaranteed participation, the Options Allocation Committee will 
consider factors such as the LMM`s evaluation conducted pursuant to 
OFPA B-13, and the LMM's compliance with Exchange rules, including, but 
not limited to, Rules 6.32 through 6.40 and Article XI, Section 2 of 
the Exchange Constitution.\40\ The Commission also notes that these 
provisions are permissive, not mandatory.
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    \40\ Amendment No. 1, supra note 4.
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    The Commission finds that the distinction the Exchange makes 
between multiply-traded issues and non-multiply-traded issues is 
reasonable. As noted by the Exchange, this distinction, is intended to 
provide an LMM with greater participation for multiply-traded issues, 
given that it will be competing for order flow with other exchanges. As 
further noted by the Exchange, when an issue traded only on the 
Exchange reaches a high level of trading volume, there should be 
flexibility to reduce the LMM's guaranteed participation where the 
issue has reached high trading volume for reasons other than those 
attributable to LMM performance.
    The Commission also finds that the change from four to three as the 
number of months that must pass before an LMM's guaranteed 
participation may be reduced is reasonable given that it will permit 
appropriate action to be taken more quickly.
    2. Commentary .02 to Rule 6.82 currently restricts the use of an 
LMM to various options classes. The Exchange is proposing to make all 
issues traded on the options floor eligible for the LMM Program. The 
Commission notes that in the original proposal for the LMM Program, the 
Exchange made eligible new options classes, and those with 
comparatively low volume.\41\ The Exchange believes that Commentary .02 
is unnecessarily restrictive based on its successful experience trading 
several high-volume, multiply-traded issues in the LMM Program. The 
Commission finds that it is appropriate to open the LMM Program to all 
issues traded on the options floor because the broadening of the LMM 
Program may enhance the market making mechanism on the Exchange, 
thereby improving the markets for all listed options on the Exchange. 
Specifically, the Commission believes that expanding the LMM Program 
may improve the Exchange's market making capabilities by encouraging 
long-term commitments to options classes.
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    \41\ Securities Exchange Act Release No. 27631, supra note 6.
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    The Commission notes that the pilot LMM Program recently was 
extended for another year, and will expire in September 1997.\42\ In 
approving the modification to the LMM Program making all option issues 
eligible, the Commission notes, however, that before the LMM Program 
can be approved on a permanent basis, or further extended, the Exchange 
must provide the Commission with an updated report on the operation of 
the LMM Program.\43\ When the Commission receives this report, it will 
consider the impact of this modification in deciding whether to approve 
the LMM Program on a permanent basis, or to further extend it.
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    \42\ Securities Exchange Act Release No. 37767, supra note 6.
    \43\ Id.
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    3. The Commission believes that, if an issue is reallocated from an 
LMM to a market maker trading crowd, it is reasonable that the Exchange 
require that the market quality and service equal or better that 
previously provided or guaranteed by the LMM. The Commission notes that 
under the proposal the Options Allocation Committee is not required to 
reallocate the issue to the LMM system. The Commission believes that it 
is consistent with the Act to allow the Options Allocation Committee to 
take such action because it should result in options being reallocated 
in a manner designed to achieve improved market quality and service.
    4. The Commission believes that the Exchange's proposal to allow 
the Options Appointment Committee to designate a cooperative of market 
makers to act as an LMM in an issue is consistent with the Act. The 
Exchange states that it believes that such cooperatives should serve to 
increase liquidity in an LMM issue and provide for better service to 
customers than might otherwise exist. In addition, PSE Rule 6.40 should 
address concerns that may exist that a market maker cooperative might 
dominate the market in a given issue.\44\ Rule 6.40 provides that a 
member with a ``financial arrangement'' \45\ with another member may 
not bid, offer, and/or trade in the same trading crowd at the same time 
in the absence of an exemption from the Options Floor Trading 
Commission.\46\ The Commission expects that, as would generally be the 
case, in determining whether a market maker cooperative should to 
receive an exemption from the Rule 6.40 restrictions, the Options Floor 
Trading Committee will consider the potential for market domination the 
market maker cooperative could pose. The Commission notes that, in 
addition to a cooperative meeting the Exchange's capital requirements, 
each member of a cooperative of market makers that is acting as an LMM 
must comply with Rule 15c3-1 under the Act, the net capital rule.\47\
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    \44\ The purpose of Rule 6.40 is to prevent market makers who 
have financial arrangements with each other from unfairly dominating 
the market in any option issues or series. PSE Rule 6.40, Commentary 
.01. The Commission recently approved certain changes to PSE Rule 
6.40. Securities Exchange Act Release No. 37543, supra note 18.
    \45\ PSE Rule 6.40(a), Financial Arrangements Defined.
    \46\ PSE Rule 6.40(b)(1). PSE Rule 6.40 formerly imposed a 
narrower restriction on market makers with financial arrangements 
with floor brokers. Former PSE Rule 6.40, Commentary .01.
    \47\ 17 CFR 240.15c3--1.
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    5. The Commission finds that the Exchange's proposal to prevent a 
single LMM from being allocated more than 10% of the number of option 
issues traded on the options floor is consistent with the Act. The 
Commission agrees with the Exchange that this provision should help to 
address concerns regarding the potential adverse effects on the 
maintenance of a fair and orderly market that could arise from a LMM's 
insolvency or similar event.
    6. The Commission finds that the Exchange's proposal to replace 
references to the LMM Appointment Committee that exist in the current 
rule with references either to the Options Allocation Committee or the 
Options Appointment Committee is appropriate given that the LMM 
Appointment Committee no longer exists.\48\ The Commission believes 
that this aspect of the Exchange's proposal should add clarity to the 
LMM Rule.
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    \48\ See Securities Exchange Act Release No. 30843, supra note 
24.
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    7. The Commission believes that the Exchange's proposed requirement 
that each LMM designate an approved LMM to act as a substitute LMM is 
reasonable and should serve to benefit the LMM system by ensuring that 
the duties of an LMM absent on a particular day nevertheless will be 
undertaken by another LMM.
    8. The Exchange has proposed to permit, rather than require, the 
awarding of compensation to an LMM whose issue is reallocated pursuant 
to proposed Rule 6.82(f)(1). The Commission finds that it is 
appropriate for the Exchange to determine what compensation, if any, an 
LMM should receive in the event of reallocation of an issue.
    9. The Commission believes that the Exchange's proposal to have all 
appeals

[[Page 53252]]

from Options Allocation Committee or Options Appointment Committee 
decisions be governed by Rule 11 rather than Rule 10 is appropriate 
given that Rule 10 concerns disciplinary proceedings and appeals, 
whereas Rule 11 concerns committees of the Exchange. The Commission 
agrees with the Exchange that because decisions of the Options 
Allocation Committee and the Options Appointment Committee are not 
disciplinary in nature, they more properly are addressed by Rule 11.
    10. The Exchange has proposed to remove the provision requiring LMM 
issues be traded in an area of the trading floor that is separate from 
other issues. The Commission believes that this restriction is not 
necessary, and agrees with the PSE that removing it will afford the PSE 
increased flexibility in allotting limited space, and similarly will 
allow PSE members to trade issues as LMMs while continuing to trade 
other issues as market makers.
    11. The Commission agrees with the PSE that the provision that an 
LMM honor any ``better markets pledged during the allocation process'' 
reinforces and serves to formalize the implicit requirement that an LMM 
honor pledges made during the allocation process, and therefore is 
reasonable.
    12. The Commission believes that the Exchange's proposal to replace 
a reference to ``Committee'' with one to Options Allocation Committee 
is appropriate given that ``Committee'' in current Rule 6.82 refers to 
the LMM Appointment Committee which no longer exists.\49\ Similarly, 
the current reference to Market Performance Committee, now the Board 
Oversight Committee, is removed. The Commission believes that both 
these changes add clarity to the Exchange's proposal.
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    \49\ Id.
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    13. The Exchange proposes to remove the current provision that 
states that an LMM that is the subject of Committee review in 
connection with the termination of an LMM appointment shall have ten 
business days in which to submit a written statement for the 
consideration of the Committee. The Exchange has stated that this 
provision unnecessarily restricts the Options Appointment Committee and 
the Options Allocation Committee, which may need to act promptly to 
disqualify an LMM or to reallocate issues, as the case may be. 
Moreover, the Exchange states that the Options Allocation Committee 
should be able to effect reallocation in the normal course of its 
business, and that no special procedures should be required, given that 
other actions of committees require no such special procedures.
    The Commission believes that this aspect of the Exchange's proposal 
is appropriate, given that it would allow the Options Appointment 
Committee to disqualify an LMM due to a material financial, 
operational, or personnel change warranting immediate action, and 
furthermore, would permit the Options Allocation Committee to 
reallocate issues promptly. A ten day notification period is at odds 
with such a need for prompt action. The Commission finds that the 
removal of the ten day notice provision is consistent with the Act. 
Furthermore, the Commission finds that the elimination of this 
provision is consistent with appeals from Options Allocation Committee 
or Options Appointment Committee decisions being governed by Rule 11 
\50\ concerning committees of the Exchange.
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    \50\ See PSE Rule 11.7 (concerning hearings and review of 
committee action).
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    14. The Commission agrees that requiring members to notify the 
Exchange, rather than a specific committee, when certain events occur, 
such as notice of an LMM's resignation or notice of a material 
financial, operational, or personnel change to the LMM, will make 
administration of the relevant rule provisions more efficient. The 
Commission also agrees that deletion in Rule 6.82(f)(1)(B) of the 
phrase ``as determined by the Options Appointment Committee'' is 
appropriate, where determination of whether a material change in the 
LMM's operations or status has occurred may be made, depending on the 
circumstances, by either the Options Appointment Committee or the 
Options Allocation Committee.
    15. The Commission believes that the proposal to delete the 
provision in current Rule 6.82(b)(7)(ii) requiring an LMM to terminate 
his appointment within three business days of written notification by 
the Exchange of a determination that trading in a particular option 
would be better accommodated by the introduction of, or return to, the 
market maker system without an LMM, is appropriate. The Commission 
agrees with the Exchange that the provision is vague, and notes that 
Rule 6.82 contains more specific provisions for the reallocation of a 
particular option of another LMM or to the market maker trading 
crowd.\51\
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    \51\ See current Rule 6.82(b)(4); proposed Rule 6.82(f).
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    16. The Commission believes that the modification of OFPA B-13 to 
provide expressly that all of the rules and procedures applicable to 
the semiannual evaluations of options trading crowd performance will 
also apply to evaluations of LMM performance is appropriate. The 
Commission agrees that this modification is appropriate as the 
codification of existing practice of the Options Allocation Committee, 
and that it creates consistency in the treatment of LMMs and options 
trading crowds with respect to evaluations.
    The Exchange also is proposing to modify OFPA B-13 so that appeals 
of remedial action taken by the Options Allocation Committee will be 
governed by Rule 11 rather than Rule 10. The Commission believes this 
modification is consistent with the Exchange's proposal that appeals of 
decisions from the Options Allocation Committee and the Options 
Appointment Committee will be governed by Rule 11 concerning appeals of 
committee decisions, rather than Rule 10 concerning appeals of 
disciplinary decisions.
    17. The Commission finds that the elimination of the requirement to 
disclose to the trading crowd the formula used by the LMM to 
automatically update market quotations is appropriate in light of the 
longstanding Exchange policy, that this information is available upon 
request from the Order Book Official. The Commission considers the 
provision requiring LMM disclosure of this information therefore to be 
superfluous and unnecessary.
    18. The Commission finds appropriate the revisions to the proposal 
that would strike the words ``dually-traded or'' from Rule 
6.82(d)(2)(A) because they are superfluous, and replace the term 
``exclusively-traded'' in proposed Rule 6.82(d)(2)(B) with the term 
``non-multiply-traded.'' The Committee finds that the other revisions 
and restructurings to Rule 6.82 serve to add clarity to the Exchange's 
proposal, and therefore are appropriate.
    19. 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 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.\52\ Accordingly, the Commission believes there is good cause, 
consistent with Sections 6(b)(5) and 19(b)(2) of the Act, to approve

[[Page 53253]]

Amendment Nos. 1 and 2 to the proposal on an accelerated basis.
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    \52\ Securities Exchange Act Release No. 36952, 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. Sec. 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 File No. SR-PSE-96-03 and should 
be submitted by October 31, 1996.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\53\ that the proposed rule change (SR-PSE-96-03), as amended, is 
approved.

    \53\ 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.\54\
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    \54\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-26013 Filed 10-9-96; 8:45 am]
BILLING CODE 8010-01-M