[Federal Register Volume 61, Number 198 (Thursday, October 10, 1996)]
[Notices]
[Pages 53254-53256]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-26065]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37782; File No. SR-Phlx-96-36]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc. Relating to Index Value 
Calculations by the Index Calculation Engine (``ICE'') System

October 3, 1996
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on August 5, 1996, the 
Philadelphia Stock Exchange, Inc. (``Phlx'' or ``Exchange'') filed with 
the Securities and Exchage Commission (``Commission'') the proposed 
rule change as described in Items I, II, and III below, which Items 
have been prepared by the self-regulatory organization. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx, pursuant to Rule 19b-4 of the Act, proposes to utilize 
the Exchange's own internal system's calculation of index values as: 
(1) A ``back-up'' to the values currently calculated by an outside 
securities information vendor, as well as (2) the official index value 
for Phlx index options.\2\ Currently, the Exchange utilizes a 
securities information vendor to calculate the index value for all of 
its listed index options. Thus, this vendor is the ``reporting 
authority'' pursuant to Rule 1000A(b)(9), meaning the institution or 
reporting service designated by the Exchange as the official source for 
calculating and determining the current value or the closing index 
value of the index.
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    \2\ The Commission notes that the Phlx seeks to utilize the ICE 
system value as the official index value in three instances. First, 
the ICE system value would act as the official index value in the 
event the reporting authority designated by the Phlx is experiencing 
difficulties in disseminating an accurate value (e.g., computer 
failure). Under these circumstances, the ICE system value would be 
used as the official index value only for the time period that is 
necessary for the designated agent to correct its problem. This 
would allow trading to continue in the affected security without 
interruption.
    Second, if the Phlx believes that the problem is chronic, the 
Exchange may want to designate a different reporting authority or 
become the reporting authority itself. Therefore, the Phlx seeks the 
authority to continue to disseminate the ICE system index value 
during the time it takes the Exchange to make this decision. As soon 
as this decision is made, however, the Phlx would submit a rule 
filing pursuant to Section 19 of the Act to switch the reporting 
authority.
    Finally, due to economic and efficiency considerations, the Phlx 
may want to act as the reporting authority for certain Phlx index 
options on a permanent basis. Telephone call between Edith Hallahan, 
Special Counsel, Regulatory Services, Phlx, and Anthony P. Pecora, 
Attorney, Division of Market Regulation, SEC (Sept. 3, 1996).
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    Recently, the Exchange implemented its own index value calculation 
system, known as the Index Calculation Engine (``ICE''). ICE is a 
system administered by Regulatory Services, which currently serves as a 
back-up to the official reporting authority by separately calculating 
index values. Specifically,

[[Page 53255]]

the ICE system receives market price information from another 
securities information vendor respecting the securities underlying each 
Phlx index and, employing the particular methodology (i.e., 
capitalization-weighted), calculates an index value every 15 seconds. 
Daily, Exchange staff monitors the ICE terminal to ensure that its 
value coincides with that of the reporting authority, including the 
last sale prices, outstanding shares, component issues and divisor. The 
ICE system contains both the Bridge values and the Exchange-calculated 
values. The system is directed to disseminate the reporting authority's 
value as opposed to the ICE value at the start of each day. Alarms are 
established so that if a particular index value calculated by the 
reporting authority varies by more than a set amount from ICE's value, 
the alarm will ring to alert staff. If it is determined that the price 
disruption is due to incorrect information or a technical difficulty 
with the reporting authority, Exchange staff is able to immediately 
switch over to the ICE system to disseminate that value. Thus, ICE 
provides the Exchange with an independent, internal index value as a 
back-up.
    Accordingly, the Exchange proposes to temporarily utilize the ICE 
system as its reporting authority when ICE indicates that the reporting 
authority's value is incorrect or the data feed is subject to technical 
difficulties. The Exchange also proposes to cease using the designated 
outside vendor as the reporting authority in specific instances, 
implementing the ICE system as the reporting authority.

II Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    Currently, three market (broad-based) index options, seven industry 
(narrow-based or sector) index options and the Super Cap Index option 
trade on the Exchange. The reporting authority for each index option is 
currently Bridge Data. For each index option listed on the Exchange, 
the specifications and descriptions filed with the Commission detail 
how the index value is calculated and that the calculation is conducted 
by Bridge.
    In the course of reviewing inconsistencies in index value 
calculations as well as the disaster recovery implications of using a 
single, outside reporting authority, the Exchange determined to create 
and build its own internal system for the calculation and dissemination 
of index values. Recently, the ICE system was completed, tested, and 
implemented as a surveillance tool for Phlx Regulatory Services and 
Market Surveillance staff monitoring Exchange index options trading.
    In an effort to make use of the capabilities of the ICE system, the 
Exchange proposes its implementation where its official reporting 
authority is not able to accurately calculate an index value. This may 
occur for many reasons, including a system malfunction due to a power 
surge, cut cable, or line problem. The reporting authority's value may 
also be based on incorrect price information received from that 
vendor's source of such data, which the Exchange is able to verify and 
adjust using another vendor's values. Prior to the implementation of 
the ICE system, Exchange staff became aware of faulty index values by 
way of customer complaint, specialist or market maker notification (who 
generally calculate index values independently), and staff discovery 
due to routine monitoring of index values and news releases. None of 
these methods is instantaneous nor independently reliable.
    With the ICE system in place, Exchange staff can immediately detect 
an inconsistency in the value between the two systems and investigate 
further to identify where the discrepancy lies. Because the system 
automatically alerts staff to such inconsistencies, monitoring index 
values becomes less reliant on staff efforts. The staff role then 
becomes focused on researching and resolving the inconsistencies 
identified by the ICE system.
    The Exchange also believes that the development of the ICE system 
facilitates its ability to serve as the reporting authority for its own 
index values. Thus, the system will serve not only as a back-up, but 
also as the official reporting authority, replacing the outside 
securities information vendor. The Exchange is proposing to designate 
the ICE system as the reporting authority temporarily when the other 
value is not reliable, as described above. In addition, the Exchange 
proposes that the ICE system be implemented as the reporting authority 
for index values temporarily (replacing the official reporting 
authority instantaneously) unit another official reporting authority 
can be designated, whether it is ultimately ICE or another securities 
information vendor.
    Lastly, the Exchange proposes to utilize the ICE system to 
calculate index values for customized options that may be traded in the 
future on the Exchange. Because customization will allow for various 
methods of determining the index value, the Exchange must provide a 
method for calculating and disseminating such values. For instance, a 
P.M.-settled option such as the National Over-the-Counter Index option 
could be customized for A.M. settlement, requiring the calculation of a 
morning value for that option. The Exchange believes it will be more 
efficient and economical to rely on ICE for these functions, rather 
than contract with an outside vendor.
    The Exchange believes that its ICE system supports the integrity of 
index values on the Exchange in two ways. First, it serves as an 
automatic trigger that the official value may be incorrect, with 
independent verification of data. Second, the ICE system provides an 
automatic replacement value.
    The Exchange notes that pursuant to Rule 1102A, neither the 
Exchange nor its Reporting Authority shall have any liability stemming 
from the calculation or dissemination of the current or closing index 
value.\3\ The Exchange also notes that other exchanges' rules contain 
substantially similar definitions of reporting authority and liability 
provisions, and utilize a wide variety of reporting authorities, 
including calculating certain index values internally, thereby serving 
as their own reporting authority.\4\
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    \3\ See also Phlx By-Law Article XII, Section 12-11, Use of 
Facilities of Corporation (limiting the Exchanges' liability 
concerning damages sustained by a member or member organization 
utilizing the Exchange's facilities).
    The Commission notes, however, that blanket disclaimers may not 
apply in all instances. See letter from Murray L. Ross, Vice 
President and Secretary, Phlx, to Anthony P. Pecora, Attorney, 
Division of Market Regulation, SEC, dated August 21, 1996, in File 
No. SR-Phlx-96-11 (stating that the Phlx will not rely upon the 
limitation of liability clause concerning 3-D options in cases of 
intentional misconduct or any violation of the federal securities 
laws); 15 U.S.C. 78cc (limiting the ability to waive the protection 
of the federal securities laws).
    \4\ See, e.g., Chicago Board Options Exchange Rule 24.1, 
Interpretations and Policies .01.
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    Thus, the Exchange believes that the proposed rule change is 
consistent with

[[Page 53256]]

Section 6 of the Act \5\ in general, and in particular, with Section 
6(b)(5),\6\ in that it is designed to promote just and equitable 
principles of trade, prevent fraudulent and manipulative acts and 
practices, to foster cooperation and coordination with persons engaged 
in regulating, clearing, settling, processing information with respect 
to, and facilitating transactions in securities, as well as to protect 
investors and the public interest, by creating a back-up and 
alternative determination of index values on the Exchange. This, in 
turn, promotes the integrity of the index settlement process by 
improving both the responsiveness to erroneous values as well as 
providing a replacement value to ensure the accuracy of disseminated 
index values.
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    \5\ 15 U.S.C. 78f(b).
    \6\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange has neither solicited nor received written comments.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the publication of this notice in the Federal 
Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve the proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. 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. Sec. 552, will be available for inspection and copying at 
the Commission's Public Reference Section, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Also, copies of such filing will be available 
for inspection and copying at the principal office of the Phlx. All 
submissions should refer to File No. SR-Phlx-96-36 and should be 
submitted by October 31, 1996.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 C.F.R. 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-26065 Filed 10-9-96; 8:45 am]
BILLING CODE 8010-01-M