[Federal Register Volume 63, Number 32 (Wednesday, February 18, 1998)]
[Notices]
[Pages 8246-8248]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-3999]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39635; File No. SR-PCX-97-21]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to the Suspension of Its 
Automatic Execution System (``Auto-Ex'') During Unusual Market 
Conditions

    On June 4, 1997, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') a proposed rule change pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 
19b-4 thereunder.\2\ The filing was thereafter amended on August 8, 
1997.\3\ In this filing, as amended, the Exchange proposed amendments 
permitting suspension of its Automatic Execution System (``Auto-Ex'') 
during unusual market conditions, and related actions. Notice of this 
proposed rule filing was published in the Federal Register On August 
19, 1997 (``Notice'').\4\ The Commission did not receive comment 
letters on the filing.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Michael D. Pierson, Office of Regulatory 
Policy, Exchange to Mandy S. Cohen, Division of Market Regulation, 
Commission dated August 7, 1997. A further technical amendment was 
filed on February 9, 1998. See Letter from Michael D. Pierson, 
Office of Regulatory Policy, Exchange to Mandy S. Cohen, Division of 
Market Regulation, Commission dated February 9, 1998.
    \4\ See Securities Exchange Act Release No. 38927 (August 12, 
1997), 62 FR 44159 (August 19, 1997) (File No. SR-PCX-97-21).
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I. Description of Proposal

    The Exchange is proposing to modify its Rule 6.28 (``Unusual Market 
Conditions'') to address situations involving system failures, ranging 
from ``frozen screens'' in an issue (where quote changes are entered 
into the system, but such changes are not reflected in the market being 
disseminated) to a floor-wide system malfunction of the POETS system 
(where all screen displays on the floor fail).\5\ Rule 6.28 currently 
provides that whenever on Options Floor Official determines that ``an 
unusual condition or circumstance'' exists, because of an influx of 
orders or other unusual conditions or circumstances, and the interests 
of maintaining a fair and orderly market so require, such official may 
declare a ``fast market'' in one or more classes of option 
contracts.\6\ The

[[Page 8247]]

proposed amendments are designed to provide additional safeguards and 
procedures to deal with such situations.
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    \5\ ``POETS'' is an acronym for the Pacific Options Exchange 
Trading System.
    \6\ See also PCX Options Floor Procedure Advice G-9 (``Fast 
Market Procedures'').
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    First, the Exchange is proposing to modify subsection (a) of Rule 
6.28 to require the agreement of two Options Floor Officials before a 
``fast market'' can be declared. Second, the Exchange is proposing to 
add a new subsection (b)(7), to allow the Options Floor Officials who 
have declared a fast market to suspend Auto-Ex if, because of an influx 
of orders or other unusual market conditions or circumstances, they 
determine that such action is appropriate in maintaining a fair and 
orderly market. The initial suspension of Auto-Ex is limited to five 
minutes and a Floor Governor must be notified immediately. Suspension 
of Auto-Ex may be continued for a longer period following determination 
by two Options Floor Officials and one Floor Governor (or a senior 
operations officer if no Floor Governor is available) that such action 
is appropriate. In the event that the three officials do not agree, a 
two-thirds majority prevails.\7\ Upon suspension of Auto-Ex, all market 
and marketable limit orders thereafter entered through the Exchange's 
Member Firm Interface will be routed to a booth on the Exchange floor 
designated by the firm that entered the order. The order can then be 
taken to the crowd manually and represented by a floor broker.
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    \7\ Cf. CBOE Rule 6.6(e).
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    The Exchange is also proposing to amend its Rule 6.87 (``Automatic 
Execution System''), by adding three new subsections relating to 
suspensions of Auto-Ex. Whenever a POETS system or vendor quote feed 
malfunction affects the Exchange's ability to disseminate or update 
market quotes on a floor-wide basis, the senior person then in charge 
of the Exchange's Control Room will be able to halt Auto-Ex on a floor-
wide basis, upon declaration of a ``fast market'' by two Floor 
Officials.\8\
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    \8\ Proposed subsection (d)(1), Floor-Wide POETS System 
Malfunction.
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    Similarly, if a POETS malfunction occurs and market markers are 
physically unable to update their quotations in an issue or issues at 
the same trading post or trading quad, two Floor Officials may declare 
a ``fast market'' and direct the order book official (``OBO'') to turn 
off Auto-Ex in only the affected issue or issues.\9\ Under either 
scenario, once the system malfunction has been corrected and the market 
quotes have been updated, two Floor Officials (or the senior person 
then in charge of the Control Room in the event of a floor-wide 
malfunction) may re-start Auto-Ex.\10\
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    \9\ Proposed subsection (d)(2), Non-Floor-Wide POETS System 
Malfunction. Proposed subsection (d)(3) (``Other Unusual 
Conditions'') further provides that if there are other unusual 
market conditions not involving a POETS System malfunction, two 
Floor Officials may suspend Auto-Ex in accordance with Rule 6.28(b).
    \10\ Cf. CBOE Rule 6.8, Interpretation and Policy .03.
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    Finally, the Exchange is also proposing to amend Rule 6.37 
(``Obligations of Market Makers'') by adding a new subsection (b)(4), 
which provides that if the interest of maintaining a fair and orderly 
market so requires, two Floor Officials may declare a fast market and 
allow market makers in an issue to make bids and offers with spread 
differentials of up to two times, or in exceptional circumstances, up 
to three times, the legal limits permitted under Rule 6.37(b)(1). The 
rule further directs such Floor Officials to consider the following 
factors in making the determination to allow wider markets: (A) whether 
there is an extreme influx of option orders due to pending news, a news 
announcement of other special events; (B) whether there is an imbalance 
of option orders in one series or on one side of the market; (C) 
whether the underlying security is trading outside the bid or offer in 
such security then being disseminated; (D) whether PCX floor members 
receive no response to orders placed to buy or sell the underlying 
security; and (E) whether a vendor quote feed for POETS is clearly 
stale or unreliable.

II. Discussion

    The Commission has determined at this time to approve the 
Exchange's proposal. The standard by which the Commission must evaluate 
a proposed rule change is set forth in Section 19(b) of the Act. The 
Commission must approve a proposed PCX rule change if it finds that the 
proposal is consistent with the requirements of the Act and the rules 
and regulations thereunder that govern the PCX.\11\ In evaluating a 
given proposal, the Commission examines the record before it and all 
relevant factors and necessary information. In addition, Section 6 of 
the Act establishes specific standards for PCX rules against which the 
Commission must measure the Proposal.\12\
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    \11\ 15 U.S.C. 78s(b).
    \12\ 15 U.S.C. 78f.
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    The Commission has evaluated the PCX's proposed rule change in 
light of the standards and objectives set forth in the Act and the 
rules and regulations thereunder applicable to a national securities 
exchange, and, in particular, the requirements of Section 6(b)(5) of 
the Act.\13\ Specifically, the Commission finds that the proposed rule 
change provides a reasonable mechanism for the Exchange to respond to 
system malfunctions that impact the integrity of Auto-Ex.
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    \13\ 15 U.S.C. 78f(b)(5).
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    The Commission notes that this proposal only authorizes senior 
Exchange floor personnel to suspend Auto-Ex in circumstances that 
involve technical system malfunctions affecting the accuracy of Auto-
Ex, and is limited to five minutes, unless extension is approved by 
additional Exchange officials. The Exchange indicates in its filing 
that the proposed rule change is similar to certain procedures followed 
by the Chicago Board Options Exchange (``CBOE'') with regard to its 
automated system, the change to which were approved in 1995.\14\ The 
Commission further notes that the proposed rule change is more 
restrictive than the CBOE procedures and provides greater safeguards, 
in that it does now allow control room personnel to unilaterally 
disengage Auto-Ex prior to approval of Exchange floor officials.
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    \14\ Securities Exchange Act Release No. 35695 (May 9, 1995), 60 
FR 26058 (May 16, 1995).
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    Moreover, the Commission believes that the Exchange has provided 
adequate procedures for use in the event of Auto-Ex suspension. In the 
event that the system is shut down, all limit orders entered through 
the Exchange's Member Firm Interface will be forwarded to a booth on 
the Exchange floor designated by the firm that entered the order and 
then taken to the crowd manually and represented by a floor broker.
    Finally, the Commission believes that the allowing market makers to 
increase the spread differentials on particular issues in the event of 
a fast market by Exchange Officials and with such officials specific 
approval appropriately balances the interests of the various 
participants while allowing the Exchange and its market makers to 
respond to rapid changes in market conditions.

III. Conclusion

    The Commission believes that the proposed rule change is consistent 
with Act, and, particularly, with Section 6 thereof.\15\ Specifically, 
the changes contained in this rule filing are designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and 
in general, to protect investors and the

[[Page 8248]]

public interest.\16\ In addition, the Commission believes that the 
proposed rule change does not impose any burden on competition that is 
not necessary or appropriate to the purposes of Section 6 of the Act.
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    \15\ 15 U.S.C. 78f.
    \16\ In approving these rules, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. Sec. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-PCX-97-21), as amended, is 
approved.

    \17\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Margaret M. McFarland,
Deputy Secretary.
[FR Doc. 98-3999 Filed 2-17-98; 8:45 am]
BILLING CODE 8010-01-M