[Federal Register Volume 65, Number 143 (Tuesday, July 25, 2000)]
[Notices]
[Pages 45810-45813]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-18742]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43049; File No. SR-PCX-00-05]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to Its Automatic 
Execution System

July 18, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ Rule 19b-4 thereunder,\2\ notice is hereby given that on 
March 8, 2000, the Pacific Exchange, Inc. (``PCX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the Exchange. On June 27, 2000, PCX 
submitted Amendment No. 1 to the proposed rule change.\3\ The

[[Page 45811]]

Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Michael Pierson, Vice President, Regulatory 
Policy, PCX, to Gordon Fuller, Special Counsel, Division of Market 
Regulation, Commission, dated June 26, 2000 (``Amendment No. 1''). 
In Amendment No. 1, PCX revised some of the text of the proposed 
rule and submitted this revised text.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The PCX proposes to allow broker-dealer orders to be eligible for 
automatic execution through the Exchange's Automatic Execution System 
(``Auto-Ex'') on an issue-by-issue basis. The Exchange also proposes to 
adopt new rules and procedures to establish means of assuring better 
compliance with rules pertaining to the use of Auto-Ex. Below is the 
text of the proposed rule change. Proposed new language is italicized; 
proposed deletions are in brackets.

para.5231  Automatic Execution System

Rule 6.87
    (a). Definitions. For purposes of Rule 6.87:
    (1) The term ``Auto-Ex'' means the automated execution system 
feature of POETS that is owned and operated by the Exchange and that 
provides automated order execution and reporting services for options.
    (2) The term ``User'' means any person or firm that obtains 
electronic access to Auto-Ex through an Order Entry Firm.
    (3) The term ``Order Entry Firm'' means a member organization of 
the Exchange that is registered as an Order Entry Firm for purposes of 
sending orders to the Exchange for execution by Auto-Ex.
    (b) Eligible Orders.
    (1) [(a)] [Only] Except as provided in Subsection (A) below, only 
non-broker/dealer customer orders are eligible for execution on the 
Exchange's Auto-Ex system [Automatic Execution System (``Auto-Ex'')].
    (A) The Options Floor Trading Committee (``OFTC'') may determine, 
on an issue-by-issue basis, to allow orders for the accounts of broker-
dealers to be executed on Auto-Ex, except for orders for Market Makers 
or Specialists on an exchange who are exempt from the provisions of 
Regulation T of the Federal Reserve Board pursuant to Section 7(c)(2) 
of the Securities Exchange Act of 1934. For purposes of this Rule, the 
term ``broker/dealer'' includes foreign broker/dealers.
    (2) [(b)] The Options Floor Trading Committee shall determine the 
size of orders that are eligible to be executed on Auto-Ex. Although 
the order size parameter may be changed on an issue-by-issue basis by 
the Options Floor Trading Committee, the maximum order size for 
execution through Auto-Ex is fifty contracts.
    (3) [(c)] 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 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 Rule, the Exchange will notify 
the Securities and Exchange Commission pursuant to Section 19(b)(3)(A) 
of the Exchange Act.
    (c) Order Entry Firm Registration. Participation in Auto-Ex as an 
Order Entry Firm requires registration with the Exchange. Continued 
registration depends upon the Order Entry Firm's initial and continuing 
compliance with the following requirements:
    (1) execution of an Auto-Ex Order Entry Firm Application Agreement 
with the Exchange;
    (2) compliance with all applicable PCX options trading rules and 
procedures;
    (3) written notice must be provided to all Users regarding the 
proper use of Auto-Ex; and
    (4) maintenance of adequate procedures and controls that will 
permit the Order Entry Firm to effectively monitor and supervise the 
entry of electronic orders by all Users. Order Entry Firms must monitor 
and supervise the entry of orders by Users to prevent the prohibited 
practices set forth in subsection (d).
    (d) Prohibited Practices. Prohibited practices include, but are not 
limited to, the following:
    (1) Entering an order for an account that is ineligible for 
execution on Auto-Ex pursuant to subsection (b), above:
    (2) Dividing an order involving a single investment decision into 
multiple smaller lots for the purpose of meeting the order size 
requirements for Auto-Ex eligibility. Multiple orders to trade the same 
series, multiple orders in the same call class, or multiple orders in 
the same put class entered within any 15-second period for the account 
of the same beneficial owner will be presumed to be based on a single 
investment decision. If multiple orders involving a single investment 
decision have been entered for automatic execution, only the first of 
such orders that equals or add up to less than the firm Auto-Ex size 
requirement will be entitled to an execution.
    (3) Entering orders via Auto-Ex to perform a market making 
function. No member or person associated with a member may use Auto-Ex 
on a regular and continuous basis to simultaneously execute orders to 
buy and sell series for the account of the same beneficial holder. In 
making the determination of whether a member or person associated with 
a member is using the Auto-Ex system to perform a market making 
function, the Exchange will consider the following factors: the 
simultaneous or near-simultaneous entry of limit orders to buy and sell 
the same option; and the entry of multiple limit orders at different 
prices in the same option series.
    (4) Effecting transactions that constitute manipulation as provided 
in PCX Rule 4.6(a) and SEC Rule 10b-5.

    [(d) Firms entering orders for execution on Auto Ex may not divide 
them up in order to make their parts eligible for entry into Auto-Ex.]
    (e)-(k)--[(d)-(j)]--No change.
* * * * *

para. 5151  Contract Made on Acceptance of Bid or Offer

Rule 6.77
    All bids or offers made and accepted in accordance with the Rules 
shall constitute binding contracts, subject to applicable requirements 
of the Constitution and Rules of the Exchange and the Rules of the 
Options Clearing Corporation.

Commentary:

    .01 Two Options Floor Officials may nullify a transaction or adjust 
its terms if they determine the transaction to have been in violation 
of any of the following:
    (a) Rule 6.73 (Manner of Bidding and Offering);
    (b) Rule 6.75 (Priority of Bids and Offers);
    (c) Rule 6.56 (Transactions Outside Order Book Official's Last 
Quoted Range);
    (d) Rule 6.76 (Priority on Split Price Transactions);
    (e) Rule 6.86 (Trading Crowd Firm Disseminated Market Quotes);
    (f) Rule 6.66(c) (Order Identification: Broker-Dealer Orders: 
Failure to identify a broker-dealer order, provided that the 
transaction may be nullified or its terms may be adjusted only if the 
transaction is for 20 contracts or less);
    (g) Rule 6.87 (Automatic Execution System).
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the PCX included statements 
concerning the purpose of and basis for the proposed

[[Page 45812]]

rule change and discussed any comments it received on the proposed rule 
change. The text of these statements may be examined at the places 
specified in Item IV below. The PCX has prepared summaries, set forth 
in Sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Commission approved the Exchange's Pacific Options Exchange 
Trading System (``POETS'') on a pilot program basis in 1990 and on a 
permanent basis in 1993.\4\ POETS is comprised of an options order 
routing system (``ORS''), an automatic and semi-automatic execution 
system (``Auto-Ex''), an on-line book system (``Auto-Book''), and an 
automatic market quote update system (``Auto-Quote''). Currently, PCX 
Rule 6.87 allows only non-broker-dealer customer orders to be executed 
through the Exchange Auto-Ex system. The Exchange now proposes to 
permit broker-dealer orders to be eligible for automatic execution 
through Auto-Ex on an issue-by-issue basis and to establish means of 
assuring better compliance with rules pertaining to the use of Auto-Ex.
---------------------------------------------------------------------------

    \4\ See Securities Exchange Act Release No. 27633 (January 18, 
1990), 55 FR 2466 (January 24, 1990) (approving POETS on a pilot 
basis); Securities Exchange Act Release No. 32703 (July 30, 1993), 
58 FR 42117 (August 6, 1993) (approving POETS on a permanent basis). 
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 the 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. Automatic executions through Auto-Ex are currently 
available for public customer orders of twenty contracts or less (or 
in certain issues, for fifty contracts or less) in all series of 
options traded on the Options Floor of the Exchange.
---------------------------------------------------------------------------

    a. Definitions. The Exchange proposes several definitional changes 
to PCX Rule 6.87 pertaining to Auto-Ex. Specifically, the Exchange 
proposes to add new rule 6.87(a) to codify the terms ``Auto-Ex,'' 
``User,'' and ``Order Entry Firm.'' First, the Exchange proposes to 
define the term ``Auto-Ex'' to mean the automated execution system 
feature of POETS that is owned and operated by the Exchange and that 
provides automated order execution and reporting services for options. 
Second, the Exchange proposes to define the term ``User'' to mean any 
person or firm that obtains electronic access to Auto-Ex through an 
Order Entry Firm. Third, the Exchange proposes to define the term 
``Order Entry Firm'' to mean a member organization of the Exchange that 
is registered as an Order Entry Firm for purposes of sending orders to 
the Exchange for execution by Auto-Ex. The Exchange proposes to codify 
these terms in order to provide users of Auto-Ex with clear and precise 
definitions for terms used in Rule 6.87.
    b. Eligible Orders. The Exchange proposes to change its rules to 
allow broker-dealer orders to be executed, on an issue-by-issue basis, 
on the Exchange's Auto-Ex system, subject to the approval of the 
Options Floor Trading Committee. The Exchange also proposes to allow 
market and marketable limit orders for the accounts of certain broker-
dealers to be executed via Auto-Ex, except for those orders for Marker 
Makers or Specialists on an exchange that are exempt from the 
provisions of Regulation T \5\ pursuant to Section 7(c)(2) of the 
Act.\6\ The Exchange proposes this rule change to remain competitive, 
and to improve the efficiency by which orders for broker-dealers are 
currently executed. Further, the Exchange proposes this change to 
reduce the burden on Floor Brokers for executing small market and 
marketable limit orders. In addition, the Exchange proposes to renumber 
Rule 6.87(a) as Rule 6.87(b)(1) and Rules 6.87(b) and (c) as rules 
6.87(b)(2) and (3).
---------------------------------------------------------------------------

    \5\ 12 CFR 200 et seq.
    \6\ 15 U.S.C. 78g(c)(2).
---------------------------------------------------------------------------

    c. Order Entry Firm Registration. The Exchange proposes to add new 
Rule 6.87(c) to require Order Entry Firms, as defined in proposed Rule 
6.87(a), to register with the Exchange as a condition of having access 
to Auto-Ex. Such registration will require that an Order Entry Firm 
execute an Order Entry Firm Application Agreement with the Exchange; 
comply with all applicable PCX options trading rules and procedures; 
provide written notice to all Users regarding proper use of Auto-Ex; 
and maintain adequate procedures and controls that will permit the 
Order Entry Firm to effectively monitor and supervise the entry of 
electronic orders by all Users. The Exchange proposes these rule 
changes to safeguard the use of Auto-Ex and to obligate Order Entry 
Firms to inform and supervise Users to ensure compliance with PCX Rules 
and procedures. The Exchange also proposes these changes to protect 
investors and the public from changes in options prices or markets 
caused by uses of Auto-Ex that the Exchange believes are prohibited.
    d. Prohibited Practices. In addition, the Exchange proposes to add 
new Rule 6.87(d) to codify practices it believes are prohibited on 
Auto-Ex. Specifically, the Exchange proposes to codify the most common 
prohibited practices and abuses of Auto-Ex.\7\ Proposed Rule 6.87(d) 
lists four prohibited uses of Auto-Ex: entering an order for an account 
that is ineligible for execution on Auto-Ex; dividing an order 
involving a single investment decision into multiple smaller lots for 
the purposes of meeting the order size requirements for Auto-Ex 
eligibility, which includes entering multiple orders in the same call 
class or put class for the account of the same beneficial owner within 
the same 15-second period; entering orders via Auto-Ex to perform a 
market making function; and effecting transactions that constitute 
manipulation as provided in PCX Rule 4.6(a) \8\ and Rule 10b-5 \9\ 
under the Act. A detailed explanation of each prohibited practice 
follows.
---------------------------------------------------------------------------

    \7\ The codification of these prohibited practices is not meant 
to be all-inclusive.
    \8\ PCX Rule 4.6 states that ``[n]o member, member firm or any 
participant therein shall effect or induce the purchase or sale or 
otherwise effect transactions in any security for the purpose of 
creating or inducing a false, misleading or artificial appearance of 
activity in such security, or for the purpose of unduly or 
improperly influencing the market price of such security, or for the 
purpose of making a price which does not reflect the true state of 
the market in such security.''
    \9\ 17 CFR 240.10b-5.
---------------------------------------------------------------------------

    First, with regard to the type of orders eligible for execution on 
Auto-Ex, the Exchange proposes that all orders not eligible under 
subsection (b) or proposed Rule 6.87 be deemed ineligible orders. The 
Exchange proposes this rule change to clarify what orders are eligible 
for execution on Auto-Ex.
    Second, the Exchange proposes to replace PCX Rule 6.87(d) with 
proposed Rule 6.87(d)(2). Specifically, the Exchange proposes to delete 
language that currently states that ``firms entering orders for 
execution on Auto-Ex may not divide them up in order to make their 
parts eligible for entry into Auto-Ex.'' The Exchange proposes to 
replace Rule 6.87(d) with new Rule 6.87(d)(2), which prohibits dividing 
an order involving a single investment decision into multiple smaller 
lots for the purposes of meeting the order size requirements of Auto-Ex 
eligibility. The Exchange also proposes that multiple orders to trade 
the same series entered within any fifteen-second period for the 
account of the same beneficial owner will be presumed to be based on a 
single investment decision. The Exchange proposes this change to 
clarify its rules on unbundling.

[[Page 45813]]

    Third, with regard to entering multiple orders in the same call 
class or put class for the account of the same beneficial owner within 
the same 15-second period, the Exchange proposes that only the first of 
such orders that equals or adds up to less than the firm Auto-Ex size 
requirement will be entitled to execution. The Exchange proposes this 
change in order to specifically prohibit conduct that is in conflict 
with the purpose of Auto-Ex and would otherwise circumvent the 
prohibitions against unbundling.
    Fourth, the Exchange proposes to codify language to prohibit Users 
from using Auto-Ex to perform Market Maker functions. PCX Rule 6.32 
defines a Market Maker as an individual who is registered with the 
Exchange for the purpose of making transactions as dealer-specialist on 
the Floor of the Exchange. With regard to entering orders via Auto-Ex 
to perform a market making function, the Exchange proposes that no 
member or associated person of a member may use Auto-Ex on a regular 
and continuous basis to simultaneously execute orders to buy and sell 
series for the account of the same beneficial holder. In making the 
determination of whether a member or person is using the Auto-Ex system 
to perform a market making function, the Exchange will consider the 
following factors: the simultaneous or near-simultaneous entry of limit 
orders to buy and sell the same option; and the entry of multiple limit 
orders at different prices in the same option series. The Exchange 
proposes this change to prohibit Users from acting as Market Makers 
through the use of Auto-Ex.\10\
---------------------------------------------------------------------------

    \10\ See PCX Rules 6.88 (b) and 6.89(d)(3). PCX Rule 6.88(b) 
states that ``[n]o Floor Broker may knowingly use a Floor Broker 
Hand-Held Terminal, on a regular and continuous basis, to 
simultaneously represent orders to buy and sell option contracts in 
the same series for the account of the same beneficial holder. If 
the Exchange determines that a person or entity has been sending, on 
a regular and continuous basis, orders to simultaneously buy and 
sell option contracts in the same series for the account of the same 
beneficial holder, the Exchange may prohibit orders for the account 
of such person or entity from being sent through the Exchange's 
member Firm Interface for such period of time as the Exchange deems 
appropriate.''
    PCX Rule 6.89(d)(3) states that ``[t]erminals may be used to 
receive brokerage orders only. Terminals may not be used to perform 
a market making function. No Member may knowingly use a Terminal on 
a regular and continuous basis to simultaneously represent orders to 
buy and sell option contracts in the same series for the account of 
the same beneficial holder. If the Exchange determines that a person 
or entity has been sending, on a regular and continuous basis, 
orders to simultaneously buy and sell option contracts in the same 
series for the account of the same beneficial holder, the Exchange 
may prohibit orders for the account of such person or entity from 
being sent through the Exchange's Member Firm Interface for such 
period of time as the Exchange deems appropriate. Any system used by 
a Member to operate a Terminal must be separate and distinct from 
any system that may be used by a Member or any person associated 
with a Member in connection with market making functions.''
---------------------------------------------------------------------------

    Fifth, the Exchange proposes to codify, as a prohibited practice, 
effecting transactions that constitute manipulation as provided in Rule 
4.6(a) and Rule 10b-5 under the Act. The Exchange proposes this change 
to prevent members or Users from using Auto-Ex to violate PCX and SEC 
rules and to protect investors and the public. Finally, the Exchange 
proposes to renumber rules 6.87(d) through (j) as Rules 6.87(e) through 
(k).
    e. Nullification of Orders. The Exchange proposes to add subsection 
(g) to Rule 6.77, Commentary .01. Currently, Rule 6.77, Commentary .01 
allows two Options Floor Officials to nullify a transaction or adjust 
its terms if they determine the transaction to have been in violation 
of certain PCX rules.\11\ The Exchange proposes that if a transaction 
is in violation of Rule 6.87 regarding Automatic Execution, then two 
Floor Officials may nullify or adjust such transaction. The Exchange 
proposes this change to remain consistent in its applicaiton of PCX 
Rules and procedures.
---------------------------------------------------------------------------

    \11\ PCX Rule 6.77, Commentary .01 states that ``[t]wo Options 
Floor Officials may nullify a transaction or adjust its terms if 
they determine the transaction to have been in violation of any of 
the following: (a) Rule 6.73 (Manner of Bidding and Offering); (b) 
Rule 6.75 (Priority of Bids and Offers); (c) Rule 6.56 (Transactions 
Outside Order Book Official's Last Quoted Range); (d) Rule 6.76 
(Priority on Split Price Transactions); (e) Rule 6.86 (Trading Crowd 
Firm Disseminated Market Quotes); (f) Rule 6.66(c) (Order 
Identification: Broker-Dealer Orders: Failure to identify a broker-
dealer order, provided that the transaction may be nullified or its 
terms may be adjusted only if the transaction is for 20 contracts or 
less).''
---------------------------------------------------------------------------

2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) \12\ of the Act, in general, and furthers the 
objectives of Section 6(b)(5),\13\ in that it is designed to promote 
just and equitable principles of trade, to enhance competition and to 
protect investors and the public interest.
---------------------------------------------------------------------------

    \12\ 15 U.S.C. 78f.
    \13\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments on the proposed rule change were neither solicited 
nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
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-00-05 and should be 
submitted by August 15, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
---------------------------------------------------------------------------

    \14\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Jonathan G. Katz,
Secretary.
[FR Doc. 00-18742 Filed 7-24-00; 8:45 am]
BILLING CODE 8010-01-M