[Federal Register Volume 67, Number 100 (Thursday, May 23, 2002)]
[Notices]
[Pages 36281-36283]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12895]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45930; File No. SR-PCX-2001-13]


Self-Regulatory Organizations; Order Granting Approval to 
Proposed Rule Change and Amendment No. 1 Thereto by the Pacific 
Exchange, Inc. Relating to its Auto-Ex System

May 15, 2002.

I. Introduction

    On January 30, 2002, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change \3\ relating to disengagement of 
the Exchange's Automatic Execution System for Options (``Auto-Ex''), 
increasing or decreasing Auto-Ex order size, and declaring quotes from 
away markets unreliable. PCX submitted Amendment No. 1 to the proposed 
rule change on April 9, 2002.\4\ The proposed rule change, as amended 
by Amendment No. 1, was published for comment in the Federal Register 
on April 15, 2002.\5\ The Commission received no comments on the 
amended proposal. This order approves the proposed rule change, as 
amended by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The Exchange filed this proposed rule change pursuant to the 
requirements of Section IV.B.h.(i)(bb) of the Commission's September 
11, 2000 Order Instituting Public Administrative Proceedings 
Pursuant to Section 19(h)(1) of the Act, which required the PCX (as 
well as the other floor-based options exchanges) to adopt new, or 
amend existing rules concerning automatic quotation and execution 
systems which specify the circumstances, if any, by which automated 
execution systems would be disengaged or operated in any manner 
other than the normal manner set forth in the exchange's rules; and, 
requires the documentation of the reasons for each decision to 
disengage an automatic execution system or operate it in any manner 
other than the normal manner. See Securities Exchange Act Release 
No. 43268 (September 11, 2000), Administrative Proceeding File No. 
3-10282.
    \4\ See letter from Cindy Sink, Senior Attorney, Regulatory 
Policy, PCX, to Deborah L. Flynn, Assistant Director, Division of 
Market Regulation, Commission, dated April 8, 2002 (``Amendment No. 
1'').
    \5\ See Securities Exchange Act Release No. 45712 (April 9, 
2002), 67 FR 18285 (April 15, 2002).
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II. Description of the Proposal

    The Exchange proposes to modify PCX's Automatic Execution System 
Rule (Rule 6.87) to include provisions regarding: (1) Disengaging Auto-
Ex and increasing or decreasing the Auto-Ex eligible order size, (2) 
declaring quotes from away markets unreliable, and (3) documenting 
these actions. The Exchange also proposes to clarify PCX Rule 6.28.

Disengaging Auto-Ex and Increasing or Decreasing the Auto-Ex Eligible 
Order Size

    The Exchange proposes to define the unusual market conditions that 
may permit suspending Auto-Ex or increasing or decreasing the size of 
orders that may be automatically executed over the Auto-Ex as follows: 
(1) High volatility (when a stock or the entire market is experiencing 
rapid and extreme price fluctuations usually accompanied by doublewide 
spreads); (2) large influx of orders (when volume is two or more times 
the average daily volume in an issue, or when an extraordinarily large 
options order is executed on the PCX and reported); or (3) unreliable 
quote feed (when the Exchange is unable to accurately collect, process 
and/or disseminate quotation data). Such unusual market conditions may 
be caused by news announcements (e.g., announcements relating to 
earnings speculation, economic news, reports of mergers or takeovers, 
or disasters).
    The Exchange's current Rules 6.87(h)(1) and (2) permit suspension 
of Auto-Ex in the event of floor-wide and non-floor wide Pacific 
Options Exchange Trading System (``POETS'') \6\

[[Page 36282]]

malfunction. Current PCX Rule 6.87(h)(3) permits the suspension of 
Auto-Ex in other unusual situations not involving POETS malfunction. 
For consistency and clarity, the Exchange proposes to move current PCX 
Rule 6.28(c)(6) concerning suspension of Auto-Ex and place it in PCX 
Rule 6.87(h)(3)(B). PCX Rule 6.28(c)(6) provides that if there are 
unusual market conditions not involving a POETS System malfunction, two 
Floor Officials may suspend Auto-Ex for a period of time not to exceed 
five minutes if, because of unusual market conditions or circumstances, 
the Floor Officials determine that such action is appropriate in 
maintaining a fair and orderly market. Whenever such action is taken, 
Floor Officials or senior Exchange Staff must immediately notify a 
Floor Governor. Thereafter, the suspension of Auto-Ex may be ended, or 
may be continued for more than five minutes, based on a determination 
of two Floor Officials and one Floor Governor (or a senior operations 
officer if no Floor Governor is available).
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    \6\ POETS is the Exchange's automated trading system comprised 
of an options order routing system, an automatic execution system, 
an on-line limit order book system, and an automatic market quote 
update system.
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    For consistency and clarity, the Exchange proposes to move and 
revise current PCX Rule 6.28(c)(8) (concerning the procedure for 
increasing the permissible size of orders that may be automatically 
executed over Auto-Ex up to 100 contracts) and place it in PCX Rule 
6.87(h)(3)(C). The Exchange also proposes new PCX Rule 6.87(h)(3)(C) 
which addresses the procedure for decreasing the size of orders that 
may be automatically executed over Auto-Ex. The proposed procedure 
provides that two Floor Officials would be permitted to: (1) Increase 
the size of orders that may be automatically executed over the Auto-Ex 
system up to 100 contracts; or (2) decrease the size of orders eligible 
for automatic execution. Such an increase or decrease would be 
permitted to be approved by two Floor Officials in one or more option 
issues when they believe that unusual market conditions exist, provided 
that the decision is made for no more than one trading day. To the 
extent the conditions exist on the following trading day, two Floor 
Officials would be required to review the situation again and make an 
independent decision of whether to increase or decrease the Auto-Ex 
eligible order size for that subsequent day. Any decisions made by two 
Floor Officials to increase or decrease the Auto-Ex eligible order size 
for a particular option issue for two or more consecutive days would be 
reviewed by the Options Floor Trading Committee at its next regularly 
scheduled meeting. Whenever two Floor Officials decrease the size of 
orders eligible for automatic execution, the lowest number of contracts 
that would be permitted to be established would be five.
    Additionally, the Exchange proposes to amend PCX Rule 6.87(h)(2) to 
provide for decreasing the guaranteed Auto-Ex size in one or more 
option issues when a non floor-wide POETS malfunction occurs but the 
Exchange is able to process and disseminate quotes accurately. In such 
circumstances, two Floor Officials would be permitted to decrease the 
guaranteed Auto-Ex size in one or more option issues pursuant to the 
procedures set forth in PCX Rule 6.87(h)(3)(C).

Declaring Away Markets Unreliable

    The Exchange proposes PCX Rule 6.87(h)(4), which would provide a 
Floor Official discretion to determine that quotes in one or more 
particular options classes in a market are not reliable only when: (1) 
A market's quotes in a particular options class are not firm based upon 
direct communication to the Exchange from the market or the 
dissemination through OPRA of a message indicating that disseminated 
quotes are not firm; or (2) a market has directly communicated to the 
Exchange or otherwise confirmed that the market is experiencing systems 
or other problems affecting the reliability of its disseminated quotes.
    If one or more of these factors occurs, then the following 
procedures would be required to be followed. First, an LMM would 
contact an Order Book Official (``OBO'') and request that the away 
market be declared unreliable. Second, the OBO would contact the 
control room and request a declaration that the away market is 
unreliable. Third, if the control room confirmed that an away market is 
unreliable, then the OBO would contact a Floor Official and request a 
declaration that the away market is unreliable. Fourth, the Floor 
Official would review and verify the circumstances and determine 
whether the away market should be declared unreliable. The OBO would 
notify the control room that the away market is unreliable and should 
be removed from the NBBO calculation. Fifth, the Floor Surveillance 
Unit would contact the away exchange, and notify the away market that 
one or more of its quotes have been removed from the NBBO calculation. 
Sixth, the Floor Official would continue to monitor the away market 
that has been declared unreliable and notify the control room to return 
to firm mode when appropriate.
    Any determination to exclude a market or any of its quotes from the 
Auto-Ex determination of the NBBO pursuant to the proposed rule would 
expire at the end of the trading day, or at the time that the quotes 
are confirmed by the market to be reliable again, whichever occurs 
first. Exclusion of a market or its quotes from the Auto-Ex 
determination of the NBBO would be reported to Exchange member firms.

Documentation

    The Exchange proposes to require documentation of any action taken 
to suspend Auto-Ex, increase or decrease the size of Auto-Ex eligible 
orders or to operate Auto-Ex in a manner other than the usual manner 
with an Unusual Activity Report (``UAR''). The UAR would be required to 
be signed by two Floor Officials and would be required to state the 
system problem or market activity that led to the Floor Officials' 
ruling. The UAR information would be recorded in the Floor Surveillance 
log, which would document the option issues affected by the action, the 
time the action was taken, the Exchange officials who undertook the 
action, and the reasons why the action was taken.
    Specifically, the following documentation would be required when an 
away market is declared unreliable: (1) The OBO would be required to 
log the issues(s) and time of the LMM's request for a declaration that 
the away market was unreliable; (2) the OBO would be required to 
prepare a UAR documenting the facts giving rise to the LMM's request, 
the date, time, and duration of the exclusion and the reasons for 
placing the away market back into the NBBO calculation; (3) the Floor 
Official would be required to sign the UAR; and (4) the control room 
would maintain a log of the time the away market was taken out of the 
NBBO calculation and the time that the away market was placed back into 
the NBBO calculation.

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended by Amendment No. 1, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange\7\ and, in particular, the 
requirements of Section 6 of the Act\8\ and the rules and regulations 
thereunder. The Commission finds specifically that the proposed rule

[[Page 36283]]

change is consistent with Section 6(b)(5) of the Act\9\ because it 
provides objective criteria and well-defined procedures for: (1) 
Disengaging and reengaging AUTO-X, which should increase the likelihood 
that AUTO-X will not be disengaged in a discriminatory manner; and (2) 
excluding another market's quote from the PCX's NBBO, which should 
increase the likelihood that PCX's NBBO will more accurately reflect 
the actual state of the market at a given time. Specifically, the 
Commission notes that the determination of a Floor Official to exclude 
unreliable quotes is limited to circumstances in which the away market 
has either directly communicated or confirmed that its quotes are 
unreliable. In this way, the discretion afforded to PCX officials to 
determine that another market's options quotes are unreliable is 
appropriately limited. Moreover, the record keeping requirements and 
other proposed procedures are not unreasonable.
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    \7\ In approving this proposed rule change, the Commission notes 
that it has considered its impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \8\ 15 U.S.C. 78f.
    \9\ 15 U.S.C. 78f(b)(5).
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IV. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\10\ that the proposed rule change (SR-PCX-2001-13), as amended by 
Amendment No. 1, is approved.
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    \10\ Id.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-12895 Filed 5-22-02; 8:45 am]
BILLING CODE 8010-01-P