[Federal Register Volume 63, Number 228 (Friday, November 27, 1998)]
[Notices]
[Pages 65627-65630]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-31586]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40686; File No. SR-PCX-98-52]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Pacific Exchange, Inc. 
Relating to Amendments to Rule 2.6(e) on the Prevention of the Misuse 
of Material, Nonpublic Information

November 18, 1998.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934

[[Page 65628]]

(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 5, 1998, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') a proposed rule change as described in 
Items I, II and III below, which Items have been prepared by the 
Exchange.\3\ The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The PCX filed an amendment to the proposed rule change. See 
Letter from Robert Pacileo, Jr., Staff Attorney, PCX, to Kathy 
England, Assistant Director, Division of Market Regulation, 
Commission, dated October 29, 1998 (``Amendment No. 1''). The 
substance of Amendment No. 1 is incorporated into this Notice.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange is proposing to amend Rule 2.6(e) to modify and 
clarify its current guidelines established for the prevention of the 
misuse of material, non-public information by members and member 
organizations for whom the PCX is the Designated Examining Authority 
(``DEA''). Below is the test of the proposed rule change. The proposed 
new language is italicized and the deleted language is bracketed.
* * * * *
para. 3369

Prevention of the Misuse of Material, Nonpublic Information

    RULE 2.6(e) Every member or member organization must [shall] 
establish, maintain and enforce written policies and procedures 
reasonably designed, taking into consideration the nature of the 
member or member organization's business, to prevent the misuse of 
material, non-public information by such member or member 
organization or persons associated with such member or member 
organization. Members or member organizations for whom the Exchange 
is the Designated Examining Authority (``DEA'') that are required, 
pursuant to Rule 2.6, to file SEC Form X-17A-5 with the Exchange on 
an annual or more frequent basis must [shall] file contemporaneously 
with [those] the submissions for the calendar year end [attestations 
signed by such members] ITSFEA compliance acknowledgments stating 
that the procedures mandated by this Rule have been established, 
enforced and maintained. Any member or member organization or 
associated person who becomes aware of a possible misuse of 
material, non-public information must promptly notify the Exchange's 
Equities or Options Surveillance Department.
    Commentary.
    .01 For purposes of Rule 2.6(e), conduct constituting the misuse 
of material, non-public information includes, but is not limited to, 
the following:
    A. T[t]rading in any securities issued by a corporation, or in 
any related securities or related options or other derivative 
securities, while in possession of material, non-public information 
concerning that issuer; or
    B. T[t]rading in a security or related options or other 
derivative securities, while in possession of material non-public 
information concerning imminent transactions in the security or 
related securities; [and] or
    C. D[d]isclosing to another person or entity any material, non-
public information involving a corporation whose shares are publicly 
traded or an imminent transaction in an underlying security or 
related securities for the purpose of facilitating the possible 
misuse of such material, non-public information.
    .02 The terms ``associated person'' and ``person associated with 
a member or member organization'' mean anyone who directly is 
engaged in the member or member organization's trading-related 
activities, including General [any] partners, officers, directors, 
[or branch] managers [of a member] (or any person occupying a 
similar status or performing similar functions), or any person 
directly or indirectly controlling, controlled by, or under common 
control with a member, or any employee of the [a] member or member 
organization.
    For the purposes of this Rule, the term ``employee'' includes 
every person who is compensated directly or indirectly by the member 
or member organization for the solicitation or handling of business 
in securities, including individuals trading securities for the 
account of the member or member organization, whether such 
securities are dealt in on an exchange or are dealt over-the-
counter.
    .03 Rule 2.6(e) [requires] provides that [, at a minimum,] each 
member or member organization for which the Exchange is the DEA 
should establish, maintain, and enforce [the following] written 
policies and procedures similar to the following, as applicable:
    A. All associated persons must be advised in writing of the 
prohibition against the misuse of material, non-public information; 
and
    B. All associated persons of the member or [Each] member 
organization [and all persons associated with that member 
organization] must sign attestations affirming their awareness of, 
and agreement to abide by the aforementioned prohibitions. These 
signed attestations must be maintained for at least three years, the 
first two years in an easily accessible place; and
    C. Each member or member organization must receive and 
re[main]tain copies of trade confirmations and monthly account 
statements for each account in which an associated person: [(1)] has 
a direct or indirect financial interest [,] or [(2)] makes 
investment decisions. [These account statements and trade 
confirmations must be maintained for at least three years, the first 
two years in an easily accessible place.] The activity in [S]such 
brokerage accounts should [must] be reviewed at least quarterly by 
the member or member organization for the express purpose of 
detecting the possible misuse of material, non-public information; 
and
    D. All associated persons must disclose to the member or member 
organization whether they, or any person in whose account they have 
a direct or indirect financial interest, or make investment 
decision, [is] are an officer, director or 10% shareholder in a 
company whose shares are publicly traded. Any transaction in the 
stock (or option thereon) of such company shall be reviewed to 
determine whether the transaction may have involved a misuse of 
material non-public information. [(``Eligible members'' are member 
organizations and sole PSE members that do not carry or introduce 
customer accounts and for whom the Exchange is the Designated 
Examining Authority (``DEA'').]
    Maintenance of the foregoing policies and procedures may not, in 
all cases, satisfy the requirements and intent of Rule 2.6(e). The 
adequacy of each member or member organization's policies and 
procedures will depend upon the nature of each member or member 
organization's business.
    .04 [The Exchange has developed sample forms, denominated as the 
``ITSFEA Compliance Procedures'' (in reference to the Insider 
Trading and Securities Fraud Enforcement Act of 1998), that may be 
used by certain eligible member organizations to facilitate their 
compliance with the filing and record-keeping requirements of Rule 
2.6(e). Use of these forms does not create a presumption by the 
Exchange that any particular member has satisfied the requirements 
of this Rule.] An Exchange member who is solely a lessor of a 
membership and is not registered and not required to register as a 
broker-dealer under Section 15 of the Exchange Act is not subject to 
the requirement of Exchange Rule 2.6(e) concerning the 
establishment, maintenance, and enforcement of written policies and 
procedures respecting the misuse of material, non-public 
information.
* * * * *

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 Exchange 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 
test of these statement may be examined at the placed specified in Item 
IV below. The Exchange has prepared summaries, set forth in sections, 
A, B and C below, of the most significant aspects of such statements.

[[Page 65629]]

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

Purpose
    Background: In November 1988, Congress enacted the Insider Trading 
and Securities Fraud Enforcement Act of 1988 (``ITSFEA''), designed to 
prevent, deter, and prosecute insider trading. ITSFEA requires broker-
dealers to maintain written procedures reasonably designed to prevent 
the misuse of material, non-public information by broker-dealer or any 
person associated with them.\4\ ITSFEA also provides for penalties of 
up to $1 million or three times the amount gained or amount of loss 
avoided, whichever is greater, for the misuse of material non-public 
information.\5\ ITSFEA clearly anticipates liability where written 
procedures have not been established or have not been enforced. In 
December 1992, the Commission approved a PCX proposal to adopt new Rule 
2.6(e) relating to the establishment, maintenance and enforcement of 
procedures designated to prevent the misuse of material non-public 
information.\6\ The Commission also approved similar proposals of other 
self-regulatory organizations relating to ITSFEA requirements.\7\
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    \4\ 15 U.S.C. 78o(f).
    \5\ 15 U.S.C. 78u-1.
    \6\ See Securities Exchange Act Release No. 33171 (November 9, 
1993), 58 FR 60892 (November 18, 1993) (SR-PSE-92-20).
    \7\ See Securities Exchange Act Release No. 30597 (April 16, 
1992), 57 FR 14855 (April 23, 1992) (SR-Phlx-91-47); Securities 
Exchange Act Release No. 33008 (October 4, 1993), 58 FR 52518 
(October 8, 1993) (SR-Phlx-93-36); Securities Exchange Act Release 
No 30557 (April 6, 1992) 57 FR 13393 (April 16, 1992) (SR-CBE-91-
14); Securities Exchange Act Release No. 33937 (April 20, 1994), 59 
FR 22030 (April 28, 1994) (SR-CBOE-93-58). See also New York Stock 
Exchange Rule 342.
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    Proposal: The Exchange is proposing to modify its Rule 2.6(e) to 
clarify the guidelines established for the prevention of the misuse of 
material, non-public information by members and member organizations 
for whom the PCX is the DEA. Currently, the rule states: ``Members that 
are required, pursuant to Rule 2.6, to file SEC Form X-17A-5 with the 
Exchange on an annual basis shall file contemporaneously with those 
submissions attestations signed by such members stating that the 
procedures mandated by this Rule have been established, enforced and 
maintained.'' The proposed rule change would state that only those 
organizations for which the Exchange is the DEA are required to file 
ITSFEA compliance acknowledgments stating that the procedures mandated 
by this rule have been established, enforced and maintained. In that 
regard, the rule change will codify the existing practices of the 
Exchange.
    The Exchange also proposes to modify the definition of ``associated 
person'' in Rule 2.6(e). The current rule defines associated person as 
``any partner, officer, directors or branch manager of a member (or any 
person occupying a similar status or performing similar functions), any 
person directly or indirectly controlling, controlled by or under 
common control with a member, or any employee of a member.'' The 
Exchange is proposing to change the definition to ``anyone who directly 
is engaged in the member or member organization's trading-related 
activities, including general partners, officers, directors, managers 
(or any person occupying a similar status or performing similar 
functions), any person directly or indirectly controlling, controlled 
by or under common control with a member, or any employee of the member 
or member organization.'' The rule change would exclude limited 
partners from this definition, unless such limited partners are 
directly involved in the member organization's trading-related 
activities. The Exchange believes that the current requirement, which 
covers limited partners who are not directly involved in the member 
organization's trading-related activities, goes to far because it would 
impose unnecessary affirmative obligations on PCX members. For example, 
if a floor trader's grandmother, who lives across the country, is a 
small investor in that trader's market making operation, under the 
current rule, the trader would be required to review his grandmother's 
securities account statements pursuant to Commentary .03(C), which the 
Exchange believes would be an unreasonable requirement.
    The Exchange further proposes to define ``employee'' as ``every 
person who is compensated directly or indirectly by the member or 
member organization for the solicitation or handling of business in 
securities, including individuals trading securities for the account of 
the member or member organization, whether such securities are dealt in 
on the exchange or dealt over-the-counter.'' \8\ Thus, independent 
contractors \9\ as well as actual employees will be subject to the 
requirements of the rule.
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    \8\ The Commission approved a similar definition that the 
Philadelphia Stock Exchange proposed in 1997. See Securities 
Exchange Act Release No. 39178 (October 1, 1997), 62 FR 52804 
(October 9, 1997).
    \9\ See, e.g., Letter from Douglas Scarff, Director, Division of 
Market Regulation, SEC to Gordon S. Macklin, President, National 
Association of Securities Dealers, Inc., dated June 18, 1982 
(clarifying the status of independent contractors under the Act).
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    The Exchange proposes to delete superfluous language regarding 
record keeping in Commentary .03 of Rule 2.6(e). In Commentary .03(C), 
the Exchange proposes to delete language that reads ``These account 
statements and trade confirmations must be maintained for at least 
three years, the first two years in an easily accessible place.'' The 
Exchange believes this language is superfluous given requirements under 
Rule 17a-3 of the Act. Specifically, Rule 17a-3 sets requirements for 
records to be made by certain Exchange Members, Brokers and Dealers and 
would require the members or member organizations to maintain account 
statements and trade confirmations.
    Finally, the Exchange proposes to clarify that an Exchange member 
who is a lessor of a membership, and is not registered and required to 
register as a broker-dealer under Section 15 of the Act, is not subject 
to the requirements of Exchange Rule 2.6(e) concerning the 
establishment, maintenance and enforcement of written policies and 
procedures respecting the misuse of material, non-public information. A 
lessor of a membership that is not registered as a broker-dealer under 
section 15 of the Act cannot engage in trading operations and is 
therefore not required, pursuant to Rule 2.6, to file SEC Form X-17A-5 
with the Exchange.
Basis
    The Exchange believes the proposed rule change is consistent with 
section 6(b)\10\ of the Act, in general, and furthers the objectives of 
section 6(b)(5),\11\ in particular, because it is designed to perfect 
the mechanisms of a free and open market and to protect investors and 
the public interest.
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    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

[[Page 65630]]

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

    Written comments on the proposed rule change were neigher solicited 
nor received.

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

    Within 35 days of the date of 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 such 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, including whether the proposed rule 
change is consistent with the Act. 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 provision 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
PCX. All submissions should refer to File SR-PCX-98-52 and should be 
submitted by December 18, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-31586 Filed 11-25-98; 8:45 am]
BILLING CODE 8010-01-M