[Federal Register Volume 66, Number 191 (Tuesday, October 2, 2001)]
[Notices]
[Pages 50237-50240]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-24577]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44847; File No. SR-PCX-2001-05]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change and Amendments 
No. 1 and No. 2 Thereto by the Pacific Exchange, Inc. Relating to Its 
Auto-Ex Incentive Program for Market Makers

September 25, 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 January 11, 2001, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by the Exchange. 
On March 20, 2001, the PCX submitted Amendment No. 1 to the proposed 
rule change.\3\ On May 17, 2001, the PCX

[[Page 50238]]

submitted Amendment No. 2 to the proposed rule change.\4\ 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.
    \3\ See letter from Cindy Sink, Senior Attorney, Regulatory 
Policy, PCX, to Nancy Sanow, Assistant Director, Division of Market 
Regulation, Commission, dated March 19, 2001. In Amendment No. 1, 
the PCX deleted from its proposed rule text the provision permitting 
guaranteed participation by Lead Market Makers (``LMMs''). In 
addition, in Amendment No. 1, PCX renumbered certain sections of its 
proposed rule text. Finally, PCX corrected certain typographical 
errors contained in its original filing.
    \4\ See letter from Cindy Sink, Senior Attorney, Regulatory 
Policy, PCX, to Nancy Sanow, Assistant Director, Division of Market 
Regulation, Commission, dated May 16, 2001. In Amendment No. 2, the 
PCX made a technical change to its filing. Specifically, the PCX 
redesignated paragraph (1) of Rule 6.87, as set forth in Amendment 
No. 1, as paragraph (k).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The PCX proposed to provide assignment of Auto-Ex orders to logged-
on Market Makers according to the percentage of their in-person agency 
contracts by adopting a new Auto-Ex Incentive Program. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *
    Rule 6.87(a)-(j)--No change.
    6.87(k) Allocation of Auto-Ex Trades to Individual Market Makers. 
The OFTC will determine the manner in which orders entered through the 
Auto-Ex system will be assigned to individual Market Makers for 
execution, on an issue-by-issue basis, [subject to the following 
restrictions:] as follows:
    [(1) Each Market Maker who is participating on the Auto-Ex system 
will be to execute a maximum of ten option contracts per Auto-Ex trade, 
except that:
    (A) The OFTC may permit individual Market Makers and Lead Market 
Makers (``LMMs'') to be allocated a number of contracts greater then 
ten and no more than fifty, but may do so only upon the request of the 
individual Market Maker or LMM.
    (B) In accordance with the provision on LMMs' guaranteed 
participation in Rule 6.82(d)(2), the LMM in an issue will be required 
either (i) to participate in every other trade executed on Auto-Ex in 
that issue or (ii) to participate in a percentage of every trade 
consistent with the amount of the LMM's amount of guaranteed 
participation.
    (C) The OFTC may require Market Makers or an LMM who is 
participating on Auto-Ex in a particular option issue to execute a 
number of contracts greater than ten, but before doing so, the OFTC 
must take into account whether doing so would place a Market Maker at 
undue risk based on that Market Maker's capitalization.
    (2) The OFTC will ordinarily seek to assure that each Market Maker 
participating on Auto-Ex in a particular option 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.]

Auto-Ex Incentive Program

    (1) Auto-Ex orders are assigned to Market Makers who are logged-on 
Auto-Ex according to the percentage of their in-person agency contracts 
traded in that issue (excluding Auto-Ex contracts traded) compared to 
all of the Market Maker in-person agency contracts traded (excluding 
Auto-Ex contracts) during the review period. The review period will be 
determined by the Options Floor Trading Committee (``OFTC'') and may be 
for any period of time not in excess of two weeks. The percentage 
distribution determined for a review period will be effective for the 
succeeding review period.
    (A) Participation Percentage Calculation. Each Auto-Ex order in an 
issue will be allocated to Market Makers on Auto-Ex on a rotating 
basis. On each rotation (subject to the exceptions described below) 
each participating Market Maker logged onto Auto-Ex will be assigned 
the number of Auto-Ex contracts that reflects the percentage of agency 
contracts that the Market Maker traded in-person in that issue during 
the review period. A participation percentage will be calculated for 
each Market Maker for each issue that the Market Maker trades. For this 
purpose, all transactions on behalf of the same LMM will be aggregated 
into a single percentage for the LMM.
    (B) Assignment of Contracts. Once a Market Maker has logged onto 
Auto-Ex, the Market Maker will be assigned contracts during the Auto-Ex 
rotation until that Market Maker's participation percentage has been 
met. This may mean that multiple orders (or an order and a part of the 
succeeding order) will be assigned to the same Market Maker during the 
rotation.
    (C) Joint Accounts. A joint account participant may substitute on 
the Auto-Ex wheel for another participant who is registered to trade 
the same joint account and may receive the same participation 
percentage that has been established for the participant for which the 
replacement is substituting, provided that the following conditions are 
met:
    (i) The substitute must notify the OBO of the substitution;
    (ii) The substitute must log on to the same option issues that the 
original trader was logged-on to; and
    (iii) The agency trades of the substitute will count toward the 
calculation of the participation percentage of the original participant 
for the subsequent review period.
    (D) Minimum Participation. The Exchange will determine the number 
of contracts that make up one percent of the rotation. Market Makers 
logged onto Auto-Ex in an issue, regardless of their participation 
percentage, will be entitled to at least one percentage of the rotation 
on every rotation.
    (E) Rotation. Generally, one rotation consists of the number of 
contracts replicating the cumulative percentage of all Market Makers 
logged onto Auto-Ex who have a participation percentage plus one 
percentage for each Market Maker that does not have a specific 
participation percentage.
    (F) Maximum assignment. The maximum number of contracts that a 
Market Maker may be consecutively assigned at any one time during a 
rotation will be variable and may be different for different issues or 
the same for all issues. Because the maximum number of contracts 
permitted may be smaller than the number of contracts to which a 
particular Market Maker is entitled during one rotation, that Market 
Maker will receive more than one turn during one rotation.
* * * * *

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 it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item III 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
    The Exchange proposes a rule change that will allow the Exchange to 
assign Auto-Ex orders to Market Makers logged-on to Auto-Ex according 
to their percentage of in-person agency

[[Page 50239]]

contracts \5\ traded in an issue during the review period.\6\ The 
Exchange proposes to delete the current method of assigning Auto-Ex 
contracts, which consists of assigning a minimum of ten contracts and a 
maximum of one hundred \7\ contracts to each participating Market Maker 
per Auto-Ex trade, and adopt a new Auto-Ex Incentive Program. Currently 
the LMM receives its guaranteed participation percentage under Rule 
6.82(d)(2) and the remaining contracts are allocated according to a 
rotation system to the remaining Market Makers in the crowd. The 
proposed Auto-Ex Incentive Program will replace the current system of 
Auto-Ex contract assignment in its entirety and will be implemented on 
a floor-wide basis.\8\
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    \5\ Agency contracts are those contracts that are represented by 
an agent and do not include contracts traded between market makers 
in-person in the trading crowd.
    \6\ The proposed rule changes were based in part on Chicago 
Board Options Exchange, Inc. (``CBOE'') Rule 6.8 Interpretations and 
Policies .06(c) ``100 Spoke RAES Wheel.'' In addition, the Exchange 
notes that the Commission has directed that the options markets 
adopt new, or amend existing, rules concerning its automated 
quotation and execution systems which substantially enhance 
incentives to quote competitively and reduce disincentives for 
market participants for market participants to act competitively. 
See Section IV.B.h.(i), Order Instituting Public Administrative 
Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange 
Act of 1934, Making Findings and Imposing Remedial Sanctions, 
Securities Exchange Act Release No. 43268 (September 11, 2000) and 
Administrative Proceeding File 3-10282 (the ``Order''). Telephone 
conversation between Cindy Sink, Senior Attorney, Regulatory Policy, 
PCX and Gordon Fuller, Counsel to the Assistant Director, Division 
of Market Regulation, Commission (September 24, 2001).
    \7\ The maximum order size for execution through Auto-Ex is now 
one hundred contracts pursuant to Rule 6.87(b)(1). See Securities 
Exchange Act Release No. 43887 (January 25, 2001), 66 FR 8831 
(February 2, 2001). The PCX has confirmed that some of the options 
traded on its floor currently are subject to the one hundred 
contract maximum order size. Telephone conversation between Cindy 
Sink, Senior Attorney, Regulatory Policy, PCX and Geoffrey Pemble, 
Attorney, Division of Market Regulation, Commission (September 25, 
2001).
    \8\ Telephone conversation among Cindy Sink, Senior Attorney, 
Regulatory Policy, PCX, Gordon Fuller, Counsel to the Assistant 
Director, Division of Market Regulation, Commission, and Geoffrey 
Pemble, Attorney, Division of Market Regulation, Commission 
(September 7, 2001).
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    The proposed rule provides for Auto-Ex orders to be assigned to 
Market Makers who are logged-on to Auto-Ex according to the percentage 
of their in-person agency contracts traded in that issue (excluding 
Auto-Ex contracts traded) compared to all of the Market Maker in-person 
agency contracts traded (excluding Auto-Ex contracts) during the review 
period. The review period will be determined by the Options Floor 
Trading Committee (``OFTC'') and may be for any period of time not in 
excess of two weeks.\9\ The percentage distribution determined for a 
review period will be effective for the succeeding review period.
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    \9\ The Exchange represents that the review period will be set 
at two weeks for all options classes and that the Options Floor 
Trading Committee (``OFTC'') will not vary the term of the review 
period except in the case of exigent circumstances. Telephone 
conversation between Cindy Sink, Senior Attorney, Regulatory Policy, 
PCX and Gordon Fuller, Counsel to the Assistant Director, Division 
of Market Regulation, Commission (September 24, 2001).
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    The proposed rule provides the following:
    (A) Participation Percentage Calculation.
    Each Auto-Ex order in an issue will be allocated to Market Makers 
on Auto-Ex on a rotating basis. On each rotation (subject to the 
exceptions described below) each participating Market Maker logged-on 
to Auto-Ex will be assigned the number of Auto-Ex contracts that 
reflects the percentage of agency contracts that the Market Maker 
traded in-person in that issue during the review period. A 
participation percentage will be calculated for each Market Maker for 
each issue that the Market Maker trades. For this purpose, all 
transactions on behalf of the same LMM will be aggregated into a single 
percentage for the LMM.
    (B) Assignment of Contracts.
    Once a Market Maker has logged-on to Auto-Ex, the Market Maker will 
be assigned contracts during the Auto-Ex rotation until that Market 
Maker's participation percentage has been met. This may mean that 
multiple orders (or an order and a part of the succeeding order) will 
be assigned to the same Market Maker during the rotation.
    (C) Joint Accounts.
    A joint account participant may substitute on the Auto-Ex wheel for 
another participant who is registered to trade the same joint account 
and may receive the same participation percentage that has been 
established for the participant for which the replacement is 
substituting, provided that the following conditions are met:
    (i) the substitute must notify the Order Book Official of the 
substitution;
    (ii) the substitute must log-on to Auto-Ex for the same option 
issues for which the original trader was logged-on; and
    (iii) the agency trades of the substitute will count toward the 
calculation of the participation percentage of the original participant 
for the subsequent review period.
    (D) Minimum Participation.
    The Exchange will determine the number of contracts that make up 
one percent of the rotation. Market Makers logged onto Auto-Ex in an 
issue, regardless of their participation percentage, will be entitled 
to at least one percent of the rotation on every rotation.
    (E) Rotation.
    Generally, one rotation consists of the number of contracts 
replicating the cumulative percentage of all Market Makers logged onto 
Auto-Ex who have a participation percentage plus one percentage for 
each Market Maker that does not have a specific participation 
percentage.
    (F) Maximum assignment.
    The maximum number of contracts that a Market Maker may be 
consecutively assigned at any one time during a rotation will be 
variable and may be different for different issues or the same for all 
issues. Because the maximum number of contracts permitted may be 
smaller than the number of contracts to which a particular Market Maker 
is entitled during one rotation, that Market Maker will receive more 
than one turn during one rotation.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) \10\ of the Act, in general, and furthers the 
objectives of Section 6(b)(5),\11\ in particular, in that it is 
designed to facilitate transactions in securities, to promote just and 
equitable principles of trade, to enhance competition and to protect 
investors and the public interest.
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    \10\ 15 U.S.C. 78f(b).
    \11\ 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 inappropriate burden on competition.

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

    Written comments were neither solicited nor received.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change 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

[[Page 50240]]

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 at the Commission's Pubic 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the Exchange. All 
submissions should refer to File No. SR-PCX-2001-05 and should be 
submitted by October 23, 2001.

IV. Commission's Findings and Order Granting Accelerated Approval 
of Proposed Rule Change

    After careful review, the Commission finds that implementation of 
the proposed rule change on a pilot basis is consistent with the 
requirements of Section 6 of the Act \12\ and the rules and regulations 
thereunder applicable to a national securities exchange.\13\ 
Specifically, the Commission believes that the proposal is consistent 
with Sections 6(b)(5) and 6(b)(8) of the Act.\14\ Section 6(b)(5) 
requires, among other things, that the rules of an exchange be designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, to facilitate transactions in 
securities, to remove impediments to and perfect the mechanisms of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest.\15\ Section 6(b)(5) also 
requires that those rules not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers. Section 
6(b)(8) of the Act requires that the rules of an exchange not impose 
any burden on competition not necessary or appropriate in furtherance 
of the purposes of the Act.
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    \12\ 15 U.S.C. 78f.
    \13\ 15 U.S.C. 78f(b)(5).
    \14\ 15 U.S.C. 78f(b)(5) and (b)(8).
    \15\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    The proposed rule would provide for the assignment of Auto-Ex 
orders to Market Makers who are logged-on Auto-Ex according to the 
percentage of their in-person agency contracts traded in that issue 
(excluding Auto-Ex contracts traded) compared to all of the Market 
Maker in-person agency contracts traded (excluding Auto-Ex contracts) 
during the review period. Although the PCX's proposal does not reward a 
Market Maker for improving the Exchange's displayed quotation, it does 
reward a Market Maker for providing liquidity to orders in the trading 
crowd by linking the Market Maker's percentage of Auto-Ex contracts to 
the percentage of agency contracts it executed in the trading crowd. 
The Commission finds that it is consistent with the purposes of Section 
6(b)(5) of the Act for PCX to revise its Auto-Ex contract assignment 
method in this way. The Commission believes that, because the PCX's 
proposed Auto-Ex incentive system for Market Makers will more closely 
allocate the percentage of contracts that a particular Market Maker can 
receive on a single revolution of the wheel to the percentage of in-
person agency contracts traded on the floor by that Market Maker, 
Market Makers will have a greater incentive to compete effectively for 
orders in the crowd. This result, in turn, should benefit investors and 
promote the public interest.
    The Commission further finds that the proposed Auto-Ex Incentive 
Program, in general, does not impose any unnecessary burden on 
competition, consistent with Section 6(b)(8) \16\ of the Act. In fact, 
the proposed rule change should help foster competition because Auto-Ex 
allocations to Market Makers will be based on the number of in-person 
agency contracts that they execute on the floor, rather than on the 
same number of Auto-Ex contracts being allocated to each logged-on 
Market Maker during each wheel rotation. In addition, the Commission 
finds that the maximum assignment provision set forth in the proposed 
rule change, which limits the number of contracts each Market Maker can 
be assigned consecutively at any one time during a rotation, does not 
impose any unnecessary burden on competition, consistent with Section 
6(b)(8) \17\ of the Act. This maximum assignment provision will not 
affect the number of contracts that each Market Maker is entitled to 
receive during each revolution of the Auto-Ex wheel, but only the 
timing of the allocation of contracts to each Market Maker. This 
provision ensures that each Market Maker logged-on to Auto-Ex will 
receive at least some contracts before Market Makers with a greater 
participation percentage are assigned all of their contracts in a given 
revolution. This provision also reduces the exposure of Market Makers 
to market risk by breaking up the distribution of contracts into 
smaller groupings.
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    \16\ 15 U.S.C. 78f(b)(8).
    \17\ 15 U.S.C. 78f(b)(8).
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    The Commission is approving this proposal on a nine-month pilot 
basis, through June 25, 2002. As indicated above, the Commission 
anticipates that the proposed Auto-Ex Incentive Program for Market 
Makers will encourage Market Makers to compete effectively for order 
flow in the trading crowds, thus benefiting investors and promoting the 
public interest. The Commission, however, intends to review the 
Exchange's experience with its new allocation system during the course 
of the pilot program.
    The Exchange has requested that the Commission approve this 
proposed rule change on an accelerated basis. The Commission notes that 
PCX's proposal is virtually identical to a proposed rule change by CBOE 
(SR-CBOE-99-40) that was approved on a nine-month pilot basis by the 
Commission,\18\ and was extended by the Commission for an additional 
six months and four months, respectively, in two subsequent orders.\19\ 
Thus, the proposed rule change concerns issues that previously have 
been the subject of a full comment period pursuant to Section 19(b) of 
the Act.\20\ Accordingly, the Commission finds good cause for approving 
the proposed rule change (SR-PCX-2001-05) prior to the thirtieth day 
after the date of publication of notice thereof in the Federal 
Register.
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    \18\ See Securities Exchange Act Release No. 42824 (May 25, 
2000), 65 FR 37442 (June 14, 2000).
    \19\ See Securities Exchange Act Release No. 44020 (February 28, 
2001), 66 FR 13985 (March 8, 2001); Securities Exchange Act Release 
No. 44749 (August 28, 2001); 66 FR 46487 (September 5, 2001).
    \20\ 15 U.S.C. 78s(b).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\21\ that the proposed rule change (SR-PCX-2001-05) is hereby 
approved on an accelerated basis, as a pilot program through June 25, 
2002.
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    \21\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-24577 Filed 10-1-01; 8:45 am]
BILLING CODE 8010-01-M