[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