[Federal Register Volume 64, Number 22 (Wednesday, February 3, 1999)]
[Notices]
[Pages 5335-5336]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-2533]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40980; File No. SR-PCX-98-55]


Self-Regulatory Organizations; Pacific Exchange, Inc.; Order 
Approving Proposed Rule Change and Amendment No. 1 Relating to Crossed 
Market Adjustments

January 26, 1999.

I. Introduction

    On November 5, 1998, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder, \2\ a proposed rule change to clarify its rules on the 
automatic execution of options orders. Amendment No. 1 was submitted to 
the Commission on November 30, 1998.\3\ The proposed rule change was 
published for comment in the Federal Register on December 9, 1998.\4\ 
The Commission did not receive any comments on the proposal. This order 
approves the proposal, as amended.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The proposed rule change was originally filed pursuant to 
Section 19(b)(3)(A)(ii) of the Act. The amendment converted the 
proposed rule change to a filing pursuant to Section 19(b)(2) of the 
Act. Letter from Michael D. Pierson, Senior Attorney, Regulatory 
Policy, PCX to Kelly McCormick, Attorney, Division of Market 
Regulation, SEC, dated November 27, 1998 (``Amendment No. 1'').
    \4\ Securities Exchange Act Release No. 40734 (December 1, 
1998), 63 FR 67971 (December 9, 1998).
---------------------------------------------------------------------------

II. Description of the Proposal

    The Exchange proposes to clarify its rules on the automatic 
execution of orders when the PCX market and the market of a competition 
exchange are crossed or locked (i.e., the bid disseminated through the 
facilities of one exchange is higher than or equal to the offer 
disseminated through the facilities of another exchange. The Exchange 
believes the proposal will make consistent the handling of electronic 
orders in such circumstances.
    On September 8, 1998, the Commission approved a PCX proposal to 
amend PCX Rule 6.87(d) regarding the automatic execution of options 
orders.\5\ The rule change provided that the Exchange's Options Floor 
Trading Committee (``OFTC'') may designate electronic orders in an 
option issue to receive automatic executions at prices reflecting the 
National Best Bid or Offer (``NBBO''). The rule change further provided 
that the OFTC may designate a customer order to exit the automatic 
execution system and receive floor broker representation in the trading 
crowd if the NBBO is crossed (e.g. 6\1/8\ bid, 6 asked) or locked (e.g. 
6 bid, 6 asked).
---------------------------------------------------------------------------

    \5\ Securities Exchange Act Release No. 40412 (September 8, 
1998), 63 FR 49626 (September 16, 1998) (File No. SR-PCX-98-27).
---------------------------------------------------------------------------

    After the Commission approved the amendment to PCX Rule 6.87(d), 
the Exchange became aware that the rule implied that the OFTC could 
designate an option issue for floor broker representation in crossed or 
locked markets only if the issue was eligible to receive automatic 
execution at the NBBO. The Exchange's intention was to allow OFTC the 
discretion to designate orders in an option issue for floor broker 
representation if the NBBO is crossed or

[[Page 5336]]

locked, regardless of whether the orders are eligible for automatic 
execution at the NBBO. Accordingly, the Exchange is now proposing to 
amend PCX Rule 6.87 to clarify that the OFTC may designate customer 
orders, for any option issue, to default to floor broker representation 
in the trading crowd if the NBBO is crossed or locked, regardless of 
whether the Exchange's Auto-Ex system is set to execute orders at 
prices reflecting the NBBO.
    The Exchange stated that the proposal should prevent customer 
orders from being executed at inferior prices. The Exchange illustrated 
this potential problem as follows. If the PCX market is 5 bid, 5\1/4\ 
asked, and exchange B's market is 4 bid, 4\1/4\ asked, the NBBO would 
be 5 bid, 4\1/4\ asked. If the 5 bid is based on a public order for 10 
contracts, and the order is automatically executed, the customer would 
be deprived of an opportunity to cancel the order at 5 and buy 10 
contracts at exchange B at 4\1/4\. This result would occur regardless 
of whether the PCX Auto-Ex system is using the NBBO or PCX quotes.
    The Exchange also explained that in many cases crossed or locked 
markets occur because of communications or systems problems, or due to 
keystroke errors, or quotation dissemination delays. The Exchange 
stated that it believes that the proposal allow floor brokers to 
determine if the locked or crossed market is actually a true market. 
The Exchange stated that it plans to implement a systems change to 
accommodate the potential for floor broker representation of options 
orders during crossed or locked markets after this proposal is 
approved.

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.\6\ In 
particular, the Commission finds that the proposed rule change is 
consistent with the requirements of Section 6(b)(5) of the Act.\7\
---------------------------------------------------------------------------

    \6\ In reviewing this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \7\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Section 6(b)(5) of the Act \8\ requires, among other things, that 
the rules of an exchange be designed to facilitate transactions in 
securities and, in general, to protect investors and the public 
interest. The proposed rule change should protect customer orders from 
being executed at inferior prices. Currently if the NBBO is crossed or 
locked, a customer's order could potentially be executed at an inferior 
price. If an order is placed for an option issue that is not eligible 
for automatic execution at the NBBO, the order would be automatically 
executed at a price that may be inferior to a price listed on another 
market. The proposed amendment to PCX Rule 6.87 would prevent this 
situation from occurring. The customer order would default to the PCX 
floor brokers who would then handle that order consistent with their 
best execution obligations.
---------------------------------------------------------------------------

    \8\ Id.
---------------------------------------------------------------------------

    The proposed rule change provides floor brokers with the 
opportunity to determine if the crossed or locked markets are true 
markets. As explained by the Exchange, a locked or crossed market may 
be caused by external factors unrelated to the option issue. The 
default provision will allow floor brokers to ascertain whether the 
crossed or locked market is in fact a true market, before assessing 
what the best execution would be for a particular customer's order.
    Accordingly, the Commission believes the proposed rule change will 
facilitate transactions when markets are crossed or locked and will 
protect investors and the public interest consistent with the 
requirements of Section 6(b)(5) of the Act.\9\
---------------------------------------------------------------------------

    \9\Id. 
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\10\ that the proposed rule change (SR-PCX-98-55) is approved.

    \10\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
---------------------------------------------------------------------------

    \11\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-2533 Filed 2-2-99; 8:45 am]
BILLING CODE 8010-01-M