[Federal Register Volume 64, Number 206 (Tuesday, October 26, 1999)]
[Notices]
[Pages 57674-57676]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-27881]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42029]


Order Directing Options Exchanges To Submit an Inter-Market 
Linkage Plan Pursuant to Section 11A(a)(3)(B) of the Securities 
Exchange Act of 1934

October 19, 1999.
    Notice is hereby given that pursuant to Section 11A(a)(3)(B) of the 
Securities Exchange Act of 1934 (the ``Act'').\1\ the Securities and 
Exchange Commission (``SEC'' or ``Commission'') orders the American 
Stock Exchange LLC (``AMEX''), the Chicago Board Options Exchange, Inc. 
(``CBOE''), the Pacific Exchange Inc. (``PCX''), and the Philadelphia 
Stock Exchange, Inc. (``PHLX''), as well as requests the International 
Securities Exchange (``ISE'') \2\ (collectively, the ``Options 
Exchanges''), to act jointly in discussing, developing, and submitting 
for Commission approval an inter-market linkage plan for multiply-
traded options (``Linkage Plan''). The Commission further directs the 
Options Exchanges to submit for Commission approval a Linkage Plan no 
later than 90 days after the issuance of this Order.
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    \1\ Section 11A(a)(3)(B) authorizes the Commission, in 
furtherance of its statutory directive, to facilitate the 
establishment of a national market system, by rule or order, ``to 
authorize or require self-regulatory organizations to act jointly 
with respect to matters as to which they share authority under [the 
Act] in planning, developing, operating or regulating a national 
market system (or a subsystem thereof) or one or more facilities 
thereof.''
    \2\ The ISE has filed an application with the Commission to 
register as a national securities exchange. See Securities Exchange 
Act Release No. 41439 (May 24, 1999) 64 FR 29367 (June 1, 1999).
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I. Background

    In 1975, Congress directed the Commission to oversee the 
development of a national market system.\3\ At the time, the trading of 
standardized options was relatively new.\4\ As a result, the Commission 
deferred applying to the options markets many of the national market 
system initiatives that applied to the equity markets to give options 
trading an opportunity to develop. Nevertheless, since the 
establishment of the options exchanges, the Commission has repeatedly 
called for market integration facilities for the options markets.\5\ In 
1980, the Commission ended a voluntary moratorium on expansion of the 
standardized options markets. The Commission deferred the general 
expansion of multiple trading to afford the options exchanges ``an 
opportunity to consider whether, and to what extent, the development of 
market integration facilities would minimie concerns regarding market 
fragmentation and maximize competitive opportunities in the options 
markets.'' \6\
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    \3\ Pub. L. 49-29 Stat. 97 (1975).
    \4\ The trading of standardized options on securities exchanges 
began in 1973, with the organization of CBOE as a national 
securities exchange. See Securities Exchange Act Release No. 9985 
(February 1, 1973) 1 S.E.C. Doc. 11 (February 13, 1973). 
Subsequently, the Commission approved options pilot programs at 
AMEX, PHLX, PCX, and the Midwest Stock Exchange (``MSE''). The New 
York Stock Exchange (``NYSE'') began trading options in 1985. See 
Securities Exchange Act Release No. 11144 (December 19, 1974) 40 FR 
3258 (January 20, 1975); Securities Exchange Act Release No. 11423 
(May 15, 1975) 6 S.E.C. Doc. 894 (May 28, 1975); Securities Exchange 
Act Release No. 12283 (March 30, 1976) 41 FR 14454 (April 5, 1976); 
Securities Exchange Act Release No. 13045 (December 8, 1976) 41 FR 
54783 (December 15, 1976); and Securities Exchange Act Release No. 
21759 (February 14, 1985) 50 FR 7250 (February 21, 1985). The MSE's 
options program was merged into the CBOE's program in 1979. The NYSE 
sold its options business to CBOE in 1997. Currently, AMEX, CBOE, 
PCX, and PHLX are the only national exchanges that trade 
standardized options.
    \5\ See Report of the Special Study of the Options Markets to 
the Securities and Exchange Commission, 96th Cong., 1st Sess. (Comm. 
Print No. 96-IFC3, December 22, 1978) (examining the major issues of 
market structure in standardized options markets, including multiple 
trading); Securities Exchange Act Release No. 16701 (March 26, 1980) 
45 FR 21426 (April 1, 1980) (deferring expansion of multiple trading 
to afford the options exchanges an opportunity to consider the 
development of market integration facilities); Securities Exchange 
Act Release No. 22026 (May 8, 1985) 50 FR 20310 (May 15, 1985) 
(urging options market participants to consider the development of 
market integration facilities); Directorate of Economic and Policy 
Analysis, ``The Effects of Multiple Trading on the Market for OTC 
Options'' (November 1986); Office of the Chief Economist, 
``Potential Competition and Actual Competition in the Options 
Market'' (November 1986); Securities Exchange Act Release No. 26871 
(May 26, 1989) 54 FR 24058 (June 5, 1989) (requesting comment on 
three measures, including an inter-market linkage).
    \6\ See  Securities Exchange Act Release No. 16701 (March 26, 
1980) 45 FR 21426 (April 1, 1980). In 1997, the Commission had 
requested that the options exchanges refrain from listing any 
options classes beyond those already listed as of July 15, 1997, 
because of concerns over the rapid growth in listed options trading 
and possible trading and sales practice abuses.
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    In 1989, the Commission adopted Exchange Act Rule 19c-5, which 
generally prohibits any exchange from adopting rules limiting its 
ability to list any stock option class because that option class is 
listed on another exchange.\7\ In proposing Rule 19c-5, the Commission 
acknowledged that market

[[Page 57675]]

integration facilities were unlikely to be built voluntarily if they 
were a prerequisite to multiple trading.\8\ In 1990, then Chairman 
Breeden requested that the options exchanges develop an inter-market 
linkage plan.\9\ The exchanges submitted proposals for the development 
of a linkage. However, unlike the equity markets,\10\ the options 
exchanges never adopted an inter-market linkage plan.\11\
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    \7\ See Securities Exchange Act Release No. 26870 (May 26, 1989) 
54 FR 23963 (June 5, 1989).
    \8\ See Securities Exchange Act Release No. 24613 (June 18, 
1987) 52 FR 23849 (June 25, 1987).
    \9\ See Letter from Chairman Breeden to the Registered Options 
Exchanges dated January 9, 1990.
    \10\ See Securities Exchange Act Release No. 14661 (April 14, 
1978) (issuing a provisional order authorizing ITS).
    \11\ See  Securities Exchange Act Release No. 30187 (January 14, 
1992) 57 FR 2612 (January 22, 1992) (soliciting comments on an 
inter-market linkage plan submitted by four out of five options 
exchanges). The exchanges never came to an agreement on an 
acceptable proposal and the Commission never approved it.
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    Recent increases in the multiple listing of options previously 
listed on a single exchange have heightened the need for an inter-
market linkage. The registered options exchanges have been given ample 
opportunity to create a linkage but have not done so in the absence of 
a Commission directive. Ultimately, the Commission has concluded that 
the options markets have developed sufficiently to make market 
integration not only possible but also critical to promoting vigorous 
competition among the option exchanges. Therefore, the Commission is 
now directing the Options Exchanges to develop an acceptable Linkage 
Plan to be submitted to the Commission for its consideration.

II. Discussion

    Section 11A(a)(2) of the Act \12\ directs the Commission, having 
due regard for the public interest, the protection of investors, and 
the maintenance of fair and orderly markets, to use its authority under 
the Act to facilitate the establishment of a national market system for 
securities. In exercising its authority to facilitate the establishment 
of a national market system, the Commission must protect the public 
interest in maintaining fair and orderly markets in the face of new 
technology and other significant market developments.\13\ As part of 
this authority, Congress gave the Commission the ability to authorize 
or require by order the self-regulatory organizations ``to act jointly 
* * * in planning * * * operating, or regulating a national market 
system.'' \14\ This authority is intended, among other things, to 
enable the Commission to require joint activity that otherwise might be 
asserted to have a negative impact on competition, where the activity 
serves the public interest and the interests of investors.
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    \12\ 15 U.S.C. 78K-1(a)(2).
    \13\ See generally, Section 11A(a)(1)(B) of the Act, 15 U.S.C. 
78k-1(a)(1)(B), and Section 11A(a)(1)(C) of the Act, 15 U.S.C. 78k-
1(a)(1)(C).
    \14\ Section 11A(a)(3)(B) of the Act, U.S.C. 78k-1(a)(3)(B).
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    The Commission believes that establishing a linkage among options 
markets will benefit investors by increasing competition among markets 
(and market participants) to provide the best execution of customer 
orders. The Commission considers ensuring competition among options 
market and the best execution of customer options orders to be in the 
public interest and for the benefit of investors. The Commission 
further believes that an inter-market linkage is essential to achieving 
these goals. In the absence of a linkage, which includes a prohibition 
against trade-throughs, the likelihood of inter-market trade-throughs 
increases. As a result, there is a risk that investors will not receive 
the best price available. This concern is heightened given the recent 
increase in multiple listing of the most active options.
    The Commission finds that the public interest in maintaining fair 
and orderly markets is furthered by requiring the Options Exchanges to 
work jointly in discussing, developing, and implementing a Linkage 
Plan. Accordingly, the Commission has determined to order the Options 
Exchanges to cooperate with each other and to conduct joint discussions 
and to take such joint action as is necessary to develop and implement 
a single Linkage Plan to permit the efficient transmission of orders 
among the various Options Exchanges on a nondiscriminatory basis. The 
Commission believes that a linkage of all the Options Exchanges that 
permits orders to be transmitted between Options Exchanges on a 
nondiscriminatory basis is necessary to increase the opportunities for 
brokers to secure the best execution of their customers' orders, to 
ensure effective competition among the Options Exchanges, and to 
further facilitate the establishment of a national market system as 
directed by Congress in Section 11A of the Act.\15\
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    \15\ 15 U.S.C. 78k-1.
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    The Commission further believes that it is in the best interest of 
the Options Exchanges to develop and implement a Linkage Plan, which 
can be integrated with the Options Exchanges' existing technology at 
the lowest possible cost, that is acceptable to all of the Options 
Exchanges. As a result, the Commission is not mandating the details of 
a linkage at this time. At the same time, however, the Commission 
believes that to operate effectively any Linkage Plan submitted by the 
Options Exchanges for approval by the Commission must contain the 
following elements:
     Uniform Trade-Through Rules
    Uniform trade-through rules are a necessary part of a national 
market system. Trade-through rules should generally prohibit a trade 
from being executed on one options market in a multiply-listed option 
at a price inferior to the price quoted on another options market. The 
absence of clear trade-through rules removes one incentive that firms 
would otherwise have to seek out better prices at away markets. In 
addition, as part of the implementation of uniform trade-through rules, 
the Options Exchanges should submit to the Commission proposed rule 
changes repealing existing trade-or-fade rules that become unnecessary 
with the adoption of trade-through rules.\16\
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    \16\ See AMEX Rule 958A, Commentary .01; CBOE Rule 8.51(b); PCX 
Rule 6.37(d); PHLX Rule 1015(b); and proposed ISE Rule 804(d)(2).
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     Expansion of Public Customer Definition
    The Commission believes that the firm quote requirement of the four 
currently-registered options exchanges \17\ should be expanded to 
include agency orders presented by competing exchanges.\18\ Therefore, 
an agency order received by one exchange that is routed to another 
exchange displaying the best bid or offer would receive the same 
protection as customer orders that originate on the exchange showing 
the best bid or offer.
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    \17\ See AMEX Rule 958A; CBOE Rule 8.51(a); PCX Rule 6.86(a); 
and PHLX Rule 1015(a). This change should be reflected in ISE's 
rules when approved by the Commission.
    \18\ Accordingly, the Options Exchanges should submit to the 
Commission proposed rule changes to expand the public customer 
definition together with any Linkage Plan.
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    Although the Commission is not mandating that the Options Exchanges 
include a uniform firm quote rule requirement as part of the Linkage 
Plan, the Commission anticipates that the Options Exchanges will 
address this issue in the proposal they submit to the Commission for 
approval. The Commission also anticipates that the options Exchanges 
will address the issue of fees charged by exchanges that receive orders 
through the proposed linkage.
    It is hereby ordered, pursuant to Section 11A(a)(3)(B) of the 
Act,\19\ that the AMEX, CBOE, PCX, and PHLX act jointly with ISE in 
discussing,

[[Page 57676]]

developing, and submitting for Commission approval a Linkage Plan no 
later than 90 days after the issuance of this Order.\20\
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    \19\ 15 U.S.C. 78k-1(a)(3)(B).
    \20\ Although Commission staff may be consulted in discussing 
the proposed Linkage Plan, staff presence at joint discussions is 
not required by this Order. In issuing this Order, the Commission 
does not address: (a) any joint or other conduct that occurred prior 
to the issuance of this Order, and (b) any joint or other conduct 
occurring after the date of this Order which is not ordered or 
requested by this Order.
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    This Order will be effective until such time as the options 
exchanges submit a Linkage Plan to the Commission for approval.

    By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 99-27881 Filed 10-25-99; 8:45 am]
BILLING CODE 8010-01-M