[Federal Register Volume 66, Number 88 (Monday, May 7, 2001)]
[Notices]
[Pages 23059-23061]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-11337]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44234; File No. SR-PCX-00-03]


Self-Regulatory Organizations Notice of Filing of Proposed Rule 
Change by the Pacific Exchange, Inc. Implementing a One-Year Pilot 
Program Relating to Its Automatic Executive System

April 30, 2001.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on February 15, 2000, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') the proposed rule change as described in 
Items I, II and III below, which Items have been

[[Page 23060]]

prepared by the Exchange. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78S(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange proposes to amend its rules to allow automatic 
executions of orders in its Limit Order Book (``Limit Order Book'' or 
``Book'') when those orders become marketable. Below is the text of the 
proposed rule change. Proposed new language is italicized.
* * * * *
para.5231  Automatic Execution System
    Rule 6.87(a)-(k)--No change.
    (1) Auto-Ex Book Function
    (A) The Auto-Ex Book function of POETS will permit orders in the 
Limit Order Book to be executed via the Auto-Ex system when those 
orders become marketable, subject to the following procedures:
    (i) When one or more orders in the Limit Order Book become 
marketable, as indicated by a locked or crossed market being displayed 
on the trading floor, the LMM may direct the OBO to initiate the Auto-
Ex Book function, which will cause marketable orders in the Limit Order 
Book to be automatically executed against the accounts of market makers 
who are participating on the Auto-Ex system at the time.
    (B) The Auto-Ex Book function is subject to a one-year pilot 
program which is set to expire [insert date one year from date of SEC 
approval].
* * * * *

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 Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments its received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange 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
    At the PCX, limit orders of public customers may be placed in the 
Exchange's Options Limit Order Book \3\ either electronically (via 
POETS \4\) or manually, by an options floor broker. At this time, only 
limit orders of ``public customers'' are eligible to be placed in the 
Limit Order Book.\5\ Orders not eligible to be placed in the Limit 
Order Book must be manually represented by a floor broker at the 
trading post.
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    \3\ The rules applicable to the Limit Order Book are set forth 
in PCX Rules 6.51-6.58.
    \4\ Pacific Options Exchange Trading System. See Securities 
Exchange Act Release No. 28633 (January 18, 2990), 55 FR 2466 
(January 24, 1990).
    \5\ See PCX Rule 6.87.
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    Currently, orders in the Limit Order Book can be executed in two 
ways. First, they can be executed electronically against incoming 
market or limit orders that a member firm has entered through POETS. 
For example, if a customer order to buy 20 option contracts at $5 is 
being represented in the Book, an incoming market order to sell 20 
contracts (or limit order to sell 20 contracts at $5) entered 
electronically will execute against that order in the Book.\6\
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    \6\ If there were no orders in the Book to buy at $5, and a bid 
of $5 was being disseminated by the PCX, then an incoming market 
order to sell (or a limit order to sell at $5) would be 
automatically executed by the Auto-Ex feature of POETS, with PCX 
market makers as the contra side to the trade. See note 14, infra.
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    Second, orders in the Book can be executed manually. To execute an 
order in the Book manually, a floor member \7\ must vocalize a bid or 
offer for the option contracts being represented in the Book. This 
requires that the floor member gain the attention of the Order Book 
Official (``OBO'' \8\) and make an appropriate vocalization, e.g., 
``sell 20 XYZ calls to the Book at $5.'' \9\ To consummate the trade, 
the OBO must perform the following actions: (1) call up the appropriate 
page for that particular option on the class display; (2) highlight the 
appropriate series (e.g., March 30 calls); (3) enter either the buy key 
or the sell key; (4) enter either the put key or the call key; (5) type 
in the number of contracts to be purchased or sold; (6) enter the floor 
member's acronym (e.g., MO1) and; (7) press the ``enter'' key to 
execute at the limit price or, alternatively, to improve the limit 
price, enter the better price (e.g., 4\7/8\) and press the ``enter'' 
key.
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    \7\ Floor members include market makers and floor brokers. Only 
members and Exchange employees who have been approved to perform a 
floor function may consummate transactions on the trading floor. See 
PCX Rule 6.2, Commentary .01.
    \8\ See generally PCX Rules 6.51-6.58 (rules relating to Order 
Book Officials (``OBOs'')). The Exchange notes that currently, all 
OBOs are employed by the PCX. However, the Commission recently 
approved an Exchange proposal to permit LMMs to use their own 
employees to operate the Book, which would include performing the 
function of the OBO. See Securities Exchange Act Release No. 41595 
(July 2, 1999), 64 FR 38064 (July 14, 1999) (order approving SR-PCX-
98-02). Therefore, the term ``OBO'' as used in this proposal 
includes OBOs currently employed by the Exchange and any employees 
of LMMs who are performing the function of the OBO.
    \9\ Floor members must trade against orders in the Book ahead of 
orders then being manually represented in the trading crowd at the 
same price, because orders in the Book have priority over orders in 
the trading crowd. See PCX Rule 6.75(a)-(b).
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    The current manual process for executing orders in the Book is used 
when an order in the Book becomes marketable and a trade occurs.\10\ 
For example, assume that the PCX market is 5 bid, 5\1/8\ asked, with 20 
contracts in the Book to buy at 5. Next, assume that the underlying 
stock ticks down \1/8\ of a point, and the new market in the option 
becomes 4\7/8\ bid, 5 asked. As long as the order to buy at 5 remains 
in the Book, the market will be locked at 5 bid, 5 asked.\11\ To unlock 
the market, the order in the Book, which is now marketable, must be 
traded--but to do so will require a member of the trading crowd to 
obtain the OBO's attention, vocalize an offer for some or all of the 
contracts available at 5, and wait for the OBO to type in the 
information on the trade.
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    \10\ A limit order to buy is marketable when the order's limit 
price is equal to or greater than the current offering price and a 
limit order to sell is marketable when the order's limit price is 
equal to or less than the current bid price. At the PCX, when the 
market on the screen on the trading floor is locked or crossed, the 
prices in the affected series are displayed in the purple, which 
alerts the members on the floor that there are buyers and sellers 
who are ready and willing to trade.
    \11\ A similar result would occur if a market maker in the 
trading crowd offered to sell options at 5, or a floor broker in the 
crowd representing an order made an offer to sell at 5, while 
concurrently there was an existing bid in the Book at the same 
price, i.e., in theory, there would be a locked market. In practice, 
however, the market maker or floor broker willing to sell at 5 would 
vocalize an acceptance of the bid in the Book to trade at 5. If the 
size of the market maker's or floor broker's offer was greater than 
the size of the order in the Book, the offer at 5 would continue in 
effect until it was satisfied or withdrawn.
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    The Exchange believes that the current manual process for executing 
orders in the Book is inefficient. During times of heavy trading, it 
can be difficult for the OBO to type in specific trade details when 
that OBO may be involved in trades in other option series or other 
option issues. The inefficiencies of the current process have also 
become exacerbated due to rapid swings in prices that have been 
occurring recently in the marketplace, particularly in options 
overlying so-called ``internet stocks.''
    Accordingly, the Exchange is proposing to effect a system change 
that will cause orders in the Book to be executed more efficiently when 
they become marketable. Specifically,

[[Page 23061]]

marketable orders in the Book will be executed via the Auto-Ex system 
when the Lead Market Maker (``LMM'') directs the OBO to operate the 
Auto-Ex Book Function. For example, if there are 30 contracts in the 
Book to buy at $5 and the trading crowd's offer to sell changes to a 
price of $5,\12\ rather than locking the market (5 bid, 5 asked), the 
system will, upon the instruction of the LMM, execute the orders in the 
Book via the Auto-Ex System.\13\ The 30 contracts to buy in the Book at 
$5 will then be executed against the accounts of market makers who are 
logged on to Auto-Ex at that time.
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    \12\ As noted above, this offer may be generated automatically 
by Auto-Quote, as a result of a change in the market in the 
underlying stock, or it may be generated manually by a member of the 
crowd vocalizing an offer, which is entered into POETS by the Market 
Quote Terminal Operator and subsequently disseminated.
    \13\ The Auto-Ex feature of POETS permit 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. Auto-Ex preserves book priority 
in all options. See PCX Rule 6.87; see also Securities Exchange Act 
Release No. 41823 (September 1, 1999), 64 FR 49265 (September 10, 
1999) (order approving PXC proposal to increase the size of orders 
that may be automatically executed via Auto-Ex). The Auto-Ex system 
is also used to execute any imbalance of orders that there may be at 
the opening via the Automated Opening Rotation System. See Note 14, 
infra.
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    The function will also permit orders in the Book at various prices 
to be executed almost simultaneously. For example, assume that there 
are multiple orders in the Book, including orders to buy 50 contracts 
at $5, 50 contracts to buy at 4\3/4\ and 50 contracts to buy at 4\1/2\. 
If the underlying stock price moves significantly, resulting in the PCX 
offering price of the overlying option price moving from 5\1/4\ down to 
4;\1/2\, the LMM may direct the OBO to initiate the Auto-Ex Book 
feature so that all of the buy orders in the Book referred to above 
will be automatically executed at their limit prices. This result 
simply speeds up the process for what currently may occur manually, 
with individual members of the trading crowd selling options against 
the buy orders in the book at their limit prices. Alternatively, 
however, the LMM or members of the trading crowd may determine to 
provide price improvement to the customer orders in the book, and may 
direct that all of those buy orders in the example (including those 
with limit prices of $5, 4\3/4\ and 4\1/2\) be filled at 4\1/2\. In 
this instance, of course, the Auto-Ex Book feature would not be used.
    The Exchange is proposing to implement the use of the Auto-Ex Book 
function on a one-year pilot program basis. This will allow the 
Exchange to study the operation of the system and to report back to the 
Commission at least sixty days prior to seeking permanent approval of 
the system change.
    The Exchange notes that the proposed Auto-Ex Book feature will 
operate in a manner that is similar to the Exchange's Automated Opening 
Rotation (``AOR'') system, which automates the execution of orders in 
the Book at the opening of trading.\14\ Specifically, the AOR system 
permits the OBO to establish a single price opening for executing 
market and marketable limit orders in the POETS system. It executes any 
imbalance of orders that existed at the opening at a single price, 
against the accounts of market makers who are participating on the 
Auto-Ex System at the time. The Exchange believes that approval of the 
Auto-Ex Book proposal, like the Commission's approval of the AOR 
system, will facilitate execution of orders in POETS, eliminate 
problems and inefficiencies associated with manual trading, eliminate 
backlogs of unexecuted orders, promote fair participation in trading 
against orders in the Book by all participants, and in general, improve 
market efficiency on the PCX.
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    \14\ See Securities Exchange Act Release No. 43187 (August 21, 
2000), 65 FR 54264 (August 29, 2000) (order approving one year 
extension of pilot program).
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    In conclusion, the Exchange believes that use of the proposed 
feature will help to assure that customers' orders in the Book are 
filled more promptly. It will also help to prevent delays in trading 
and prompt resolution of problems in the crowd, because OBO's will not 
have to take as much time to respond to requests to execute marketable 
orders in the Book.
2. Basis
    The Exchange believes that this proposal is consistent with Section 
6(b) of the Act,\15\ in general, and furthers the objectives of Section 
6(b)(5)\16\ in particular, in that it is designed to facilitate 
transactions in securities, promote just and equitable principles of 
trade, and to protect investors and the public interest.
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    \15\ 15 U.S.C. 78f(b).
    \16\ 15 U.S.C. 78f(b)(5).
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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 Exchange 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 proposal is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 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-00-03 and should 
be submitted by [May 29, 2001.]

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-11337 Filed 5-4-01; 8:45 am]
BILLING CODE 8010-01-M