[Federal Register Volume 64, Number 175 (Friday, September 10, 1999)]
[Notices]
[Pages 49265-49267]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-23614]


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SECURITES AND EXCHANGE COMMISSION

[Release No. 34-41823; File No. SR-PCX-99-04]


Self-Regulatory Organizations; Order Granting Approval of 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval of Amendment No. 4 by the Pacific Exchange, Inc. 
Relating to the Maximum Size of Option Orders That My Be Executed 
Automatically

September 1, 1999.

I. Introduction

    On February 10, 1999, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with 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 amending its rules on the 
automatic execution of options orders to increase the maximum number of 
contracts that may be designated for automatic execution on an issue-
by-issue basis. On February 25, 1999 the Exchange submitted Amendment 
No. 1 to the proposed rule change.\3\ On May 25, 1999 the Exchange 
submitted Amendment No. 2 to the proposed rule change.\4\ On July 2, 
1999 the Exchange submitted Amendment No. 3 to the proposed rule 
change.\5\ Notice of the proposal was published in the Federal Register 
on July 22, 1999.\6\ On September 1, 1999 the Exchange filed Amendment 
No. 4 to the proposed rule change. The Commission received no comment 
on the proposal. This order approves the proposal.\7\
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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 proposed to set the maximum 
order size for execution through its Automatic Execution System 
(``Auto-Ex'') for equity options and for index options on the PSE 
Technology Index, the Wilshire Small Cap Index, and the Morgan 
Stanley Emerging Growth Index at fifty contracts. Additionally, in 
Amendment No. 1 the PCX withdrew SR-PCX-99-05, which was filed with 
the Commission on February 22, 1999. See Letter from Robert P. 
Pacileo, Staff Attorney, PCX, to Micheal A. Walinskas, Deputy 
Associate Director, Division of Market Regulation, Commission, dated 
February 24, 1999.
    \4\ In Amendment No. 2 the Exchange proposed to add subsection 
(k) to PCX Rule 6.87 to address the allocation of Auto-Ex orders. 
See letter from Robert P. Pacileo, Staff Attorney, PCX, to Michael 
A. Walinskas, Associate Director, Division of Market Regulation, 
Commission, dated May 24, 1999.
    \5\ In Amendment No. 3 the Exchange replaced the proposal in its 
entirety to restate and clarify the purpose of the proposal, to 
address technical modifications to PCX Rule 6.87 made in a separate 
filing with the Commission (SR-PCX-99-23), and to add a proposal to 
amend PCX Rule 6.86 regarding trading crowd firm disseminated market 
quotes. See letter from Robert P. Pacileo, Staff Attorney, PCX, to 
Michael A. Walinskas, Associate Director, Division of Market 
Regulation, Commission, dated July 1, 1999.
    \6\ See Securities Exchange Act Release No. 41611 (July 9, 
1999), 64 FR 39548.
    \7\ In Amendment No. 4 the Exchange proposed to allow a notice 
and comment period for market makers and Lead Market Makers 
(``LMMs'') subject to PCX Rule 6.87(k)(1)(C). See letter from Robert 
P. Pacileo, Staff Attorney, PCX, to Michael A. Walinskas, Associate 
Director, Division of Market Regulation, Commission, dated August 
31, 1999 (``Amendment No. 4'').
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II. Description of the Proposal

    Generally, public customer market and marketable limit orders for 
up to twenty options contracts may be automatically executed through 
the Exchange's Auto-Ex system. The Exchange proposes to change its 
rules on the automatic execution of equity and index option orders by 
increasing the maximum number of contracts that may be designated for 
automatic execution, on an issue-by-issue basis, to fifty contracts.\8\ 
The PCX proposes to distinguish between equity and index options for 
matters relating to increasing the maximum number of contracts that may 
be designated for automatic execution.\9\ The Exchange proposes to 
increase the maximum size of equity option orders that the Options 
Floor Trading Committee (``OFTC'') may designate for automatic 
execution in an increase from twenty to fifty contracts and to allow 
the OFTC to determine the size of index options orders that are 
eligible to be executed through Auto-Ex with a maximum order size of 
fifty contracts for the following Index Options: (1) The PSE Technology 
Index; (2) the Wilshire Small Cap Index; and (3) the Morgan Stanley 
Emerging Growth Index.\10\
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    \8\ The Commission approved the Pacific Options Exchange Trading 
System (``POETS'') and its Auto-Ex feature as a pilot program in 
January 1990. See Securities Exchange Act Release No. 27633 (January 
18, 1990), 55 FR 2466 (January 24, 1990) (order approving File No. 
SR-PSE-89-26). On July 30, 1993, the Commission approved the program 
on a permanent basis. See Securities Exchange Act Release No. 32703 
(July 30, 1993), 58 FR 42117 (August 6, 1993). The Auto-Ex system 
permits eligible market or marketable limit orders sent from member 
firms to be executed automatically at the displayed bid or offering 
price. Participating market makers are designated as a contra side 
to each Auto-Ex order. Participating market makers are assigned by 
Auto-Ex on a rotating basis, with the first market maker selected at 
random from the list of signed-on market makers. Auto-Ex preserves 
Book priority in all options. Automatic executions through Auto-Ex 
are currently available for public customer orders of ten contracts 
or less (or in certain issues, for twenty contracts or less) in all 
series of options traded on the Options Floor of the Exchange.
    \9\ Currently, PCX Rule 6.87(c) provides: ``The Options Floor 
Trading Committee may increase the size of Auto-Ex-eligible orders 
in one or more classes of multiply traded equity options to the 
extent that other options exchanges permit such larger-size orders 
in multiply traded equity options of the same class or classes to be 
entered into their own automated execution systems. If the Options 
Floor Trading Committee intends to increase the Auto-Ex order size 
eligibility pursuant to this subsection, the Exchange will notify 
the Securities and Exchange Commission pursuant to Section 
19(b)(3)(A) of the Exchange Act.'' In addition, PCX Rule 6.28(9) 
provides that the Exchange may increase the permissible size of 
orders that may be automatically executed over the Auto-Ex system to 
up to 50 contracts only during high volume or high volatility 
emergency situations. See Securities Exchange Act Release No. 41481 
(June 4, 1999), 64 FR 31674 (June 11, 1999).
    \10\ The PCX Technology Department has confirmed that POETS is 
capable of, and has the capacity to, execute trade at 50-up on an 
issue-by-issue basis, which can equate to floor-wide 50-up if done 
for all issues.
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    In addition, the Exchange proposes to add subsection (k) to PCX 
Rule 6.87 to address the allocation of Auto-Ex orders. Specifically, 
the Exchange proposes that the OFTC will determine, on an issue-by-
issue basis, the manner in which orders entered through the Auto-Ex 
system will be assigned to individual market makers for execution. Each 
market maker who is participating on the Auto-Ex system will be 
required to execute a maximum of ten option contracts per Auto-Ex 
trade, except that the OFTC may permit individual market makers and LMM 
to be allocated a number of contracts greater than ten and no more than 
fifty, upon the request of the individual market maker or LMM. Further, 
the Exchange proposes that, in accordance with the provision of LMMs' 
guaranteed participation in PCX Rule 6.82(d)92), the LMM in an issue 
will be required to either (i) participate in every other trade 
executed on Auto-Ex in that issue or (ii) participate in a percentage 
of every trade consistent with the amount of the LMM's guaranteed 
participation.

[[Page 49266]]

    The Exchange also proposes that the OFTC may require market makers 
or an LMM who is participating on Auto-Ex in a particular issue to 
execute a number of contracts greater than ten. Before doing so, 
however, the OFTC must take into account whether this would place a 
market maker at undue risk based on that market maker's capitalization. 
In addition, prior to imposing any requirement to increase to a number 
of contracts greater than ten under proposed PCX Rule 6.87(k)(1)(C), 
the Exchange proposes to allow market makers and LMMs a one-day notice 
and comment period to express their views and opinions on the proposed 
increase.\11\
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    \11\ See Amendment No. 4, supra note 7.
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    The Exchange proposes that the OFTC seek to assure that each market 
maker participating on Auto-Ex in a particular issue will be assigned 
up to the same maximum number of option contracts per Auto-Ex trade. 
The OFTC may permit exceptions to this procedure only in unusual 
situations where the OFTC finds good cause for permitting differences 
in the maximum number of contracts executed by individual market 
makers.
    The Exchange believes that these changes will help it to meet the 
changing needs of customers in the market place and give the Exchange 
better means of competing with other options exchanges for order flow, 
particularly in multiply traded issues. The exchange also believes that 
the proposal will allow the Exchange to enhance its operational 
efficiency, particularly during times when large influxes of manual 
orders create undue congestion in particular trading crowds.
    The Exchange also proposes to amend PCX Rule 6.86, governing 
trading crowd firm disseminated market quotes. Specifically, the 
Exchange proposes to add subsection (g) to PCX Rule 6.86 to require 
that, if the OFTC determines, pursuant to PCX Rule 6.87(b), the size of 
orders in an issue that are eligible to be executed on Auto-Ex will be 
greater than twenty contracts, then the trading crowd will be required 
to provide a market depth in that greater amount. The exchange proposes 
this rule change to update, clarify and keep consistent PCX rules 
governing size of market orders and market depth.

III. Discussion

    After careful review, 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.\12\ 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 
and, in particular, the requirements of Section 6 of the Act.\13\ 
Section 6(b)(5) \14\ of the Act states that the rules of an exchange 
must be designed to foster cooperation and coordination with persons 
engaged in regulating, clearing, settling, processing information with 
respect to, and facilitating securities transactions. These rules also 
must help to remove impediments to and perfect the mechanism of a free 
and open market.
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    \12\ The Commission has considered the proposed rule's impact on 
efficiency, competition and capital formation. 15 U.S.C. 78c(f).
    \13\ 15 U.S.C. 78f.
    \14\ 15 U.S.C. 78f(b)(5).
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    Moreover, the Commission finds good cause for approving Amendment 
No. 4 prior to the 30th day after notice of the Amendment is published 
in the Federal Register pursuant to Section 19(b)(2) of the Act.\15\ 
Amendment No. 4 provides that market makers or LMMs must receive notice 
and the opportunity to comment prior to an OFTC requirement to execute 
a number of contracts greater than ten under proposed PCX Rule 
6.87(k)(1)(C). The Commission finds that accelerated approval of 
Amendment No. 4 is appropriate due to the immediate need for market 
makers and LMMs to be informed of and comment on any proposed 
requirement to execute an increased number of contracts on Auto-Ex.
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    \15\ 15 U.S.C. 78s(b)(2).
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    The Commission does not object at this time to extending the 
benefits available through the use of the Exchange's Auto-Ex system to 
larger-size customer orders up to 50 contracts. The Commission believes 
that increasing to 50 the number of option contracts executable through 
the Exchange's Auto-Ex order execution system will enable the Exchange 
to more effectively and efficiently manage increased order flow in 
actively traded option classes consistent with its obligations under 
the Act. In addition, this increase should bring to speed and 
efficiency of automated execution to a greater number of retail orders. 
We also believe that the PCX should have flexibility to compete for 
order flow with other exchanges without being limited to responding to 
increases in automatic execution eligibility levels initiated by those 
other exchanges. The Commission notes that it has approved similar 
proposals by other exchanges that increased to fifty the maximum size 
of orders that may be executed automatically.\16\
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    \16\ See Securities Exchange Act Release No. 36601 (December 18, 
1995), 60 FR 66817 (December 26, 1995) (SR-PHLX-95-39) and 
Securities Exchange Act Release No. 41821 (September 1, 1999) (SR-
CBOE-99-17).
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    The Commission believes, based on representations by the Exchange, 
that the increase will not expose the Exchange's Auto-Ex system to risk 
of failure or operational break-down. Our approval of this increase is 
expressly conditioned on PCX's representation that its systems capacity 
is sufficient to accommodate the increased number of automatic 
executions anticipated to result from implementation of this 
proposal.\17\
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    \17\ See supra note 10.
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    Although we have a degree of comfort with respect to the proposed 
increase, we note that any proposed increases above fifty contracts may 
raise additional issues, including such matters as market maker 
financial exposure, price improvement, and quote dissemination. Because 
of these concerns, the Commission welcomes the opportunity to review 
the Exchange's experience with any increase in maximum order size to 
fifty contracts. If, in the future, exchanges seek to increase order 
size levels above fifty contracts, this examination will help us assess 
whether any such increases are appropriate and, if so, whether we 
should seek additional assurances regarding such increases.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 4, including whether it 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 
submissions should refer to File No. SR-PCX-99-04 and should be 
submitted by October 1, 1999.

[[Page 49267]]

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with Section 6(b)(5).\18\
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    \18\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\19\ that the proposed rule change (SR-PCX-99-04) is approved; and 
that Amendment No. 4 is approved on an accelerated basis.

    \19\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-23614 Filed 9-9-99; 8:45 am]
BILLING CODE 8010-01-M