[Federal Register Volume 64, Number 175 (Friday, September 10, 1999)]
[Notices]
[Pages 49263-49265]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-23613]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41824; File No. SR-PCX-99-24]


Self-Regulatory Organizations; Notice of Filing of Amendment No. 
2 and Order Granting Partial Accelerated Approval to a Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to Automated Opening 
Rotations

September 1, 1999.

I. Introduction

    On July 13, 1999, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') 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 related to automated opening 
rotations (``AOR''s). On August 4, 1999, the PCX filed with the 
Commission Amendment No. 1 to the proposal.\3\ Notice of the proposed 
rule change appeared in the Federal Register on August 30, 1999.\4\ On 
September 1, 1999, the PCX filed Amendment No. 2 to the proposal.\5\ 
The Commission is publishing this notice to solicit comments on 
Amendment No. 2. In addition, for the reasons discussed below, the 
Commission has determined to grant accelerated approval of PCX's 
request in Amendment No. 2 to implement automated opening rotations for 
16 issues on a thirty day pilot basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange further clarifies the 
operation of automated openings, provides rule text related to the 
new procedures, and justifies its request for accelerated approval. 
See letter from Michael D. Pierson, Director, Regulatory Policy, 
PCX, to Michael A. Walinskas, Associate Director, Division of Market 
Regulation (``Division''), SEC, dated August 3, 1999 (``Amendment 
No. 1'').
    \4\ See Securities Exchange Act Release No. 41774 (August 20, 
1999), 64 FR 47210.
    \5\ In Amendment No. 2, the Exchange provides additional details 
about the operation of automated openings and proposes limited use 
of such openings for certain issues on a pilot basis. See letter 
from Michael D. Pierson, Director, Regulatory Policy, PCX, to 
Richard Strasser, Assistant Director, Division, SEC, dated September 
1, 1999 (``Amendment No. 2'').
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II. Description of the Proposal

A. Introduction

    The Exchange is proposing to adopt a new procedure to facilitate 
trading of option contracts during the opening rotation.\6\ Opening 
rotations are held promptly following the opening of the underlying 
security on the principal market where it is traded.\7\ Opening 
rotations are conducted by an Order Book Official (``OBO''), who is an 
Exchange employee.\8\ The PCX rules on opening rotations apply to both 
index and equity options contracts.\9\
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    \6\ The Exchange intends to continue to employ the current 
(manual) procedures for closing rotations.
    \7\ See PCX Rule 6.64, Comment .01(a).
    \8\ See PCX Rules 6.51 and 6.64.
    \9\ See PCX Rule 7.10.
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    In its initial filing, as amended by Amendment No. 1, the PCX 
proposed a new process that would allow the Exchange to conduct AORs. 
The Exchange proposed a procedure to allow the OBO to establish 
electronically a single price opening for executing eligible market and 
marketable limit orders in the POETS system. In the event of an 
imbalance, any remaining orders in the system that are eligible to be 
executed will be assigned to market makers participating on the Auto-Ex 
System. The new process involves three basic steps: first, the markets 
are established; second, the opening rotation is automatically 
processed for the majority of series; and finally, any series with 
manual orders or compilation is opened manually, i.e., pursuant to the 
current procedures for opening rotations.
    More specifically, under the new AOR process, opening rotations on 
the PCX will occur in the following manner: Prior to the opening, the 
OBO will determine whether there are any orders in the trading crowd to 
be executed at the opening. Once the underlying security has opened, 
the OBO will request from the trading crowd bids and offers in the 
specific option issue. The trading crowd may determine that the posted 
bids and offers are accurate, or alternatively, may request by public 
outcry that certain quotes be modified.\10\ Once the bid and asking 
price in each series has been ascertained, the OBO and AOR system will 
identify all series that are eligible for the AOR and that can be 
opened immediately, and will also identify all series that are not 
eligible for the AOR. Those that are not eligible for the AOR must be 
opened manually.\11\
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    \10\ Prior to an automated opening, the members of the trading 
crowd must establish a bid and offer for each series in a given 
issue. This occurs basically as follows: The OBO will first display 
a bid price and an offering price for a particular series. (These 
prices will have been established either by the Auto-Quote feature 
of POETS or by a manual process, i.e., a member or members of the 
trading crowd will vocalize bids and offers that a Market Quote 
Terminal Operator will enter into the system and display on the 
overhead screen.) The OBO will then ask the crowd if the displayed 
prices are ``all right'' (or other words to that effect). There will 
then be a short window period when the displayed prices may be 
adjusted. While the trading crowd is establishing the market, any 
member may vocalize a bid or offer that improves the market, and the 
OBO will be required to update the market accordingly. See Amendment 
No. 1.
    \11\ For a more detailed description of the current and proposed 
processes, see Securities Exchange Act Release No. 41774 (August 20, 
1999), 64 FR 47210 (August 30, 1990).
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B. Amendment No. 2

    In Amendment No. 2, the PCX requests that the Commission grant 
accelerated approval of a thirty day pilot program (``Pilot'') that 
would allow the Exchange to use automated openings for 16 issues during 
the pilot period. The 16 issues are Microsoft Corp. (MSQ), Compaq 
Computer Corp. (CPQ), Sun Microsystems, Inc. (SUQ), Applied Materials 
(AMAT), 3Com Corp. (THQ), Advanced Micro Devices (AMD), Tellabs, Inc. 
(TLAB), Schering-Plough Corp. (SGP), McKesson HBOC, Inc. (MCK), ALZA 
Corp. (AZA), R&B Falcon Corp. (FLC), First Union Corp. (FTU), NIKE, 
Inc. (Class B) (NKE), Newbridge Networks Corp. (NN), Data General

[[Page 49264]]

Corp. (DGN), and Baker Hughes Inc. (BHI). These issues, previously 
traded only on the PCX, now will be approved for trading on other 
options exchanges.
    Amendment No. 2 also further details how the proposed automated 
openings would work during the Pilot period and beyond. First, the 
Exchange clarifies when manual openings will be held. Generally, a 
series will not be eligible for an AOR if one or more members of the 
trading crowd has reasonably requested a manual opening rotation in 
that series. The Exchange anticipates that such requests will fall into 
two general categories. The first category involves mergers and 
takeovers. The second category would cover system problems or system 
limitations. For example, the POETS system may be unable to generate an 
accurate market because it is unable to take into account the fact that 
a takeover will occur on the following day, and as such, the system is 
unable to factor in the correct model. In these situations, the series 
will be opened manually.
    As for the provision allowing manual openings when imbalance 
thresholds are exceeded, the Exchange proposes to implement this 
provision in the following manner. Initially, each option issue will 
have a minimum imbalance threshold of 20 contracts. However, a Lead 
Market Maker in an issue may increase the imbalance threshold in that 
issue to a number greater than 20, but not exceeding 999 contracts (due 
to system constraints). The decision to change the imbalance threshold 
will be made pursuant to proposed Rule 6.64(b)(2)(D). Language in 
subsection D was previously in subsection C. The modified rule text 
follows. Proposed text is italicized.
    (C) Series for which one or more members of the trading crowd has 
reasonably requested that a manual opening rotation be conducted. Two 
Floor Officials may deny member requests for manual opening rotations 
in the absence of reasonable justification for doing so.
    (D) Series in which the ``imbalance threshold'' has been exceeded. 
Prior to the opening, the OBO, in conjunction with the Lead Market 
Maker in the issue, will set for each option issue a number of 
contracts that constitutes an imbalance threshold, i.e., a specific 
number of option contracts to buy in excess of the number of contracts 
to sell or a specific number of contracts to sell in excess of the 
number of contracts to buy. The POETS system will not automatically 
open any series with an imbalance exceeding the threshold for that 
issue.
    Second, the Exchange amends the proposed rule text to explicitly 
provide for the manual accommodation of non-bookable orders when 
automated openings occur. The text of additional subsection, PCX Rule 
6.64(b)(4), follows. New text is italicized.
    (4) Manual Accommodations of Non-Bookable Orders. If a non-bookable 
order is represented in the trading crowd and disclosed to the Order 
Book Official prior to the opening rotation, and if the order is either 
a market order or a limit order with a limit price equal to the opening 
price of the particular series, then that order will be entitled to an 
execution immediately following the opening of that series as follows:
    (A) If the order is a market order or limit order for a public 
customer, the order will be filled in its entire size by the Market 
Makers in the trading crowd (assuming that any contingency accompanying 
the order is satisfied).
    (B) If the order is a limit order for a broker-dealer, the order 
will be entitled to be filled up to a number of contracts equal to a 
pro rata share of the number of contracts that the Auto-Ex system 
assigns to the Market Makers pursuant to subsection (3), above. If a 
broker is holding more than one order to trade at the same limit price, 
then that broker is limited to no more than one pro rata share of the 
number of contracts that the Auto-Ex System assigns to the Market 
Makers.

III. Discussion

    The Commission finds that the proposed rule change relating to the 
establishment of a Pilot for a 30-day period is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\12\ Specifically, the 
Commission believes the Pilot is consistent with the Section 6(b)(5) 
\13\ requirements that the rules of an exchange be designed to promote 
just and equitable principles of trade, to remove impediments to and 
perfect the mechanisms of a free and open market and a national market 
system, and not be designed to permit unfair discrimination between 
customers, issuers, brokers or dealers. The proposed rule change 
represents an effort to facilitate the execution of orders at the 
opening by providing market-makers with a means of establishing 
electronically a single opening price. By facilitating an expedited 
opening of options series included in the Pilot, AOR should remove an 
impediment to and help perfect the mechanism of a free and open market 
consistent with the Exchange's responsibilities under Section 6 of the 
Act.\14\ Moreover, by integrating features into AOR, such as the 
crossing of customer orders, and by providing procedures for handling 
non-bookable orders in the opening process, the Commission believes 
that the proposal should promote fair participation in AOR by all 
market participants.
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    \12\ In approving Amendment No. 2, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
    \13\ 15 U.S.C. 78f(b)(5).
    \14\ 15 U.S.C. 78f.
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    The Commission finds good cause for approving the Pilot prior to 
the thirtieth day after the date of publication of notice thereof in 
the Federal Register. The Commission notes that the Pilot will only be 
for a limited duration and for a limited number of issues. Thus, the 
Commission believes that accelerated approval of the Pilot will enable 
the Commission and the Exchange to gain experience with AOR before the 
Commission considers permanent approval of the Pilot.\15\
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    \15\ The Commission notes the issues selected for the Pilot are 
newly introduced for trading on more than one exchange. ROS, an 
electronic opening system for the Chicago Board Options Exchange, 
Inc., has already received Commission approval. The Commission 
expects the PCX to report back on if and how the existence of 
automatic opening systems at multiple exchanges for newly multiply 
listed options affects the efficiency of trading and competition 
among exchanges.
    Approval of the 30-day Pilot period should not be interpreted as 
suggesting that the Commission is predisposed to approving the 
proposal on a permanent basis or that the Commission is predisposed 
to extending the Pilot to all issues.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2, including whether Amendment No. 2 
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 20549-0609. 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. 
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

[[Page 49265]]

submissions should refer to File No. SR-PCX-99-24 and should be 
submitted by October 1, 1999.

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\16\ that the Pilot program proposed in Amendment No. 2 to SR-PCX-
99-24 be and hereby is approved on an accelerated basis to expire 
October 1, 1999.\17\

    \16\ 15 U.S.C. 78s(b)(2).
    \17\ In approving Amendment No. 2, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
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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 H. McFarland,
Deputy Secretary.
[FR Doc. 99-23613 Filed 9-9-99; 8:45 am]
BILLING CODE 8010-01-M