[Federal Register Volume 67, Number 100 (Thursday, May 23, 2002)]
[Notices]
[Pages 36283-36286]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12985]


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SECURITIES AND EXCHANGE COMMISSION

(Release No. 34-45937; File No. SR-PCX-2002-13)


Self-Regulatory Organization; Order Approving Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to the Priority of Bids 
and Offers on the Options Floor and the Manner in Which Orders Must Be 
Allocated in Connection With Options Transactions

May 15, 2002.

I. Introduction

    On February 15, 2002, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission''), 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 relating to priority of bids and offers on the 
options floor and the manner in which orders must be allocated in 
connection with options transactions. On March 12, 2002, the PCX 
submitted Amendment No. 1 to the proposed rule change. The proposed 
rule change, as amended, was published for comment in the Federal 
Register on April 2, 2002.\3\ The Commission received no comments on 
the proposed rule change. This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 45634 (March 22, 
2002), 67 FR 15649 (April 2, 2002) (``Notice''). Although the Notice 
stated that the date of filing of the proposed rule change was 
February 19, 2002, the proposal was deemed filed on February 15, 
2002.
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II. Description of Proposal

    The PCX is proposing to adopt new rules, and to amend existing 
rules, to include practices and procedures whereby option orders are 
allocated on the Exchange's Options Trading Floor to address situations 
where the rules are currently silent. This rule filing is being 
submitted to the Commission pursuant to subparagraph IV.B.j. of the 
Commission's Order of September 11, 2000.\4\
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    \4\ See 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).
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    The proposed rule change includes provisions that concern several 
areas, as described below:

a. Obligations of Market Makers

    The Exchange is proposing to adopt new PCX Rule 6.37(e)(2), which 
would prohibit any practice or procedure whereby Market Makers trading 
any particular option issue determine by agreement the allocation of 
orders that may be executed in that issue.

b. Simultaneous Bids and Offers

    Currently, PCX Rule 6.75(a) provides that the highest bid has 
priority, but where two or more bids for the same option contract 
represent the highest price and one is displayed by the Order Book 
Official, that bid receives priority over any other bid at the post. If 
two or more bids represent the highest price and a bid displayed by an 
Order Book Official is not involved, the rule provides that priority is 
afforded to those bids in the sequence in which they are made. PCX Rule 
6.75(b) applies the same priority principles to offers.
    The Exchange is now proposing to adopt new PCX Rule 6.75(c), 
entitled ``Simultaneous Bids an Offers.'' This proposed provision 
states that, except as otherwise provided, if the bids (or offers) of 
two or more members are made simultaneously, or if it is impossible to 
determine clearly the order of time in which they were made, such bids 
(or offers) will be deemed to be on parity and priority will be 
afforded to them, insofar as practicable, on an equal basis.

c. Order Allocation Procedures

1. In General: Determination of Priority Sequence
    Proposed PCX Rule 6.75(f)(1) states that a Floor Broker is 
responsible for determining the sequence in which bids or offers are 
vocalized on the Trading Floor in response to the Floor Broker's bid, 
offer, or call for a market. It further states that my disputes 
regarding a Floor Broker's bid, offer, or call for a market. It further 
states that any disputes regarding a Floor Broker's determination of 
time priority sequence will be resolved by the Order Book Official, 
provided that such determinations of the Order Book Official are 
subject to further review by two Floor Officials, pursuant to PCX Rule 
6.77.
    Proposed PCX Rule 6.75(f)(2) provides that when a Floor Broker's 
bid or offer has been accepted by more than one member, that Floor 
Broker must designate the members who were first, second, third, and so 
forth. It further states that, except as otherwise provided, the member 
with first priority is entitled to buy or sell as many contracts as the 
Floor Broker may have available to trade. if there are any contracts 
remaining, the member with second priority will be entitled to buy or 
sell as many contracts as there are remaining in the Floor Broker's 
order, and so on, until the Floor Broker's order has been filled 
entirely.
    Proposed PCX Rule 6.75(f)(3) provides that a Market Maker is 
responsible for determining the sequence in which bids and offers are 
vocalized on the Trading Floor in response to that Market Maker's bid, 
offer, or call for a market. Likewise, an Order Book Official is 
responsible for determining the sequence in which bids and offers are 
vocalized on the Trading Floor in response to the Order Book Official's 
bid, offer, or call for a market. The proposed rule further provides 
that the order allocation procedures for Market Makers and Order Book 
Officials, including the determination of time priority sequence, are 
the same as those for Floor Brokers as set forth in proposed PCX Rule 
6.75(f)(1) as described above.

[[Page 36284]]

2. LMM Guaranteed Participation
    Proposed PCX Rule 6.75(f)(4)(A) provides that if a Lead Market 
Maker (``LMM'') establishes first priority during the vocalization 
process, the LMM will be entitled to buy or sell as many contracts as 
the Floor Broker may have available to trade. However, if the LMM does 
not establish first priority during the vocalization process, but does 
establish second, third, or some other time priority sequence, the LMM 
will be entitled to buy or sell the number of contracts equal to the 
LMM's guaranteed participation level (pursuant to PCX Rule 6.82(d)(2)) 
plus any contracts the Floor Broker has remaining after the bids or 
offers of other members with higher time priority than the LMM have 
been satisfied.
    Proposed PCX Rule 6.75(f)(4)(B) provides that if one or more orders 
in the limit order book have priority over an LMM's bid or offer, then 
the LMM's guaranteed participation level will apply only to the number 
of contracts remaining after all contracts in the limit order book that 
are at, or better than, the LMM's bid or offer have first been 
satisfied.
    Proposed PCX Rule 6.75(f)(4)(C) provides that LMMs may waive some 
or all of their guaranteed participation on particular trades, but only 
to the extent that doing so is permissible under PCX Rule 6.86 (``Firm 
Quotes''). In such circumstances, if the LMM has waived the right to 
trade a certain number of option contracts, those option contracts will 
then become available for execution by the member (or members) who are 
next in priority sequence.
    Proposed PCX Rule 6.75(f)(4)(D) provides that LMMs may direct some 
or all of their guaranteed participation to competing public orders in 
the trading crowd pursuant to PCX Rule 6.82(d).
    Proposed PCX Rule 6.75(f)(4)(E) provides that bid and offering 
prices that are disseminated by an automatic quotation system are 
presumed to be the bid and offering prices of the LMM for purposes of 
PCX Rule 6.86 (``Firm Quotes'') and PCX Rule 6.82(d)(2) (``Guaranteed 
Participation''). Nevertheless, LMMs must vocalize all of their bids 
and offers in response to a call for a market and in acceptance of 
another member's bid or offer. If a Floor Broker enters the trading 
crowd and vocalizes acceptance of a bid or offer that is then being 
disseminated, the LMM will be entitled to guaranteed participation on 
that transaction.
3. Parity Due to Simultaneous Bidding or Offering
    Proposed PCX Rule 6.75(f)(5)(A) states that if the bids or offers 
of more than one member are made simultaneously, such bids or offers 
will be deemed to be on parity and priority will be afforded to them, 
insofar as practicable, on an equal basis, pursuant to PCX Rule 
6.75(c). Accordingly, the proposed rule change states that efforts will 
be made to assure that each member on parity receives an equal number 
of contracts, to the extent mathematically possible. One or more 
members on parity may waive their rights to some of their share (or 
shares) of contracts, but only to the extent that doing so is 
permissible under PCX Rule 6.86 (``Firm Quotes''). In such 
circumstances, the remaining number of contracts will be allocated, to 
the extent practicable, on an equal basis. However, an LMM who has 
received guaranteed participation on a transaction may not participate 
in the waived portion of the order unless there are contracts remaining 
to be allocated after all other members have been satisfied.
    Proposed PCX Rule 6.75(f)(5)(B) provides that if the bids and 
offers of more than one member, including the LMM, are on parity, then 
the LMM's guaranteed participation will first be applied to the entire 
order and the remainder of the order will be allocated, to the extent 
practicable, on an equal basis among the members other than the LMM who 
are on parity. The LMM may participate in such remainder of the order 
only if there are contracts remaining after all members other than the 
LMM have first been satisfied.
    Proposed PCX Rule 6.75(f)(5)(C) states that if the LMM waives 
priority or guaranteed participation when the LMM and one or more other 
members are on parity, then the portion of the order that the LMM has 
waived will be made available to the other members who are on parity.
4. Size Pro Rata Allocations (Collective Response Situations)
    Proposed Rule 6.75(f)(6) states that if the members of the trading 
crowd provide a collective response to a member's request for a market 
in order to fill a large order, pursuant to PCX Rule 6.37(f)(2), then 
if the size of the trading crowd's market, in the aggregate, is less 
than or equal to the size of the order to be filled, the members of the 
trading crowd will each receive a share of the order that is equal to 
the size of their respective bids or offers. However, if the size of 
the trading crowd's market exceeds the size of the order to be filled, 
that order will be allocated on a size rata basis, with the members of 
the trading crowd each receiving, to the extent practicable, the 
percentage of the order that is the ratio of the size of their 
respective bids or offers to the total size of all bids or offers.

d. Procedures of Lead Market Makers

    PCX Rule 6.82(d)(2) currently provides, in part, that LMMs at their 
own discretion may direct their guaranteed participation to competing 
public orders in the crowd. The Exchange is proposing to modify this 
provision to provide that LMMs may direct ``some or all'' of their 
guaranteed participation to competing public orders (i.e., competing 
orders for the accounts of non-broker-dealers) in the crowd.
    PCX Rule 6.82(d)(2) currently provides, in part, that LMMs ``shall 
be allocated 50% participation in transactions occurring at their 
disseminated bids and/or offers in their allocated issue(s).'' The 
Exchange is proposing to amend this rule so that it provides that LMMs 
``shall be allocated 50% participation (or such lesser percentage as 
the Options Allocation Committee may establish in allocating an issue 
to an LMM) in transactions occurring at their disseminated bids and/or 
offers in their allocated issues.''
    Finally, PCX Rule 6.82(e)(2)(a) currently provides, in part, that 
LMMs ``shall have a right to participate pro rata with the trading 
crowd in trades that take place at the LMM's principal bid or offer.'' 
The Exchange is proposing to modify this provision to state that LMMs 
``have a right to participate with the trading crowd in trades that 
take place at the LMM's principal bid or offer, pursuant to the 
priority rule set forth in PCX Rule 6.75.''

III. Discussion

    After careful consideration, the Commission has determined to 
approve the proposed rule change.\5\ For the reasons discussed below, 
the Commission finds that the proposed rule change is consistent with 
the requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange. Specifically, the 
Commission finds that the proposed rule change is consistent with the 
requirements of Section 6(b)(5) of the Act.\6\
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    \5\ In approving the proposal, the Commission has considered its 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
    \6\ 15 U.S.C. 78f(b)(5). Section 6(b)(5) of the Act requires 
that the rules of an exchange, among other things, be designed to 
prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, 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; and not be designed to permit unfair discrimination 
between customers, issuers, brokers, or dealers.

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[[Page 36285]]

    The Commission believes that the proposed provision concerning 
``Obligations of Market Makers,'' which prohibits agreements among 
Market Makers with respect to the allocation of trades, should help to 
preclude anti-competitive conduct and prevent fraudulent and 
manipulative acts and practices.
    The Commission believes further that the proposed provision 
concerning ``Simultaneous Bids and Offers'' fills a significant gap in 
the Exchange's current rules by setting forth the method for allocating 
an order among market participants in situations when their competing 
bids or offers are made simultaneously, or when the sequence in which 
their bids or offers were made cannot be clearly determined. In the 
Commission's view, the proposed rule change establishes a fair and 
equitable manner of apportioning an order in these situations by 
providing that the bids or offers will be deemed to be an parity, so 
that each maker receives, as far as practicable, an equal share of the 
order.
    With respect to ``Order Allocation Procedures,'' the Commission 
believes that the proposed rule change provides an important 
clarification by specifying the market participant with responsibility 
for determining the time priority sequence of bids and offers vocalized 
on the Trading Floor in response to a bid, offer, or call for a market. 
As discussed above, the proposed rule change assigns this duty to the 
Floor Broker, the Order Book Official, or Market Maker to whose bid, 
offer, or call for a market the participants responded. The Commissions 
believes that this is a reasonable method of assigning responsibility 
for allocating a trade, particularly because the market participant who 
initiated the bid, offer, or call for a market is the best position to 
determine the identity and sequence of who responded.
    The Commission notes that the proposal also provides for the 
resolution of disputes regarding the determination of time priority 
sequence, which should contribute to fair allocation of orders. The PCX 
also has represented that is has the ability to determine the identity 
of the individual who allocated a particular trade,\7\ and the 
Commission believes that the ability to identify such individuals is 
important to the Exchange's ability to monitor for violation of 
Exchange allocation rules.
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    \7\ See Notice, supra note 3, at n.6.
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    The Commission notes that the provisions of the proposed rule 
change concerning the ``LMM Guaranteed Participation'' provide a more 
specific description of how this guaranteed participation is to be 
applied than that provided in the PCX's current rules. Among other 
things, the proposal specifies that the LMM Guaranteed Participation 
applies only to the number of contracts remaining after all customer 
orders in the limit order book have first been satisfied. Although PCX 
Rule 6.82(d)(2) already provides that public order placed in the book 
take priority over the LMM guarantee, the Commission believes that the 
new provision is an important clarification of the Exchange's rules 
regarding application of the LMM guarantee.
    Existing PCX Rule 6.82(d)(2) provides that the LMM Guaranteed 
Participation applies in ``transaction occurring at the [LMMs'] 
disseminated bids and/or offers.'' The proposal fills in a significant 
gap in the Exchange's current rules, in the Commission's view, by 
clarifying that prices disseminated by an automatic quotation system 
are presumed to be the prices of the LMM so as to qualify the LMM for 
the Guaranteed Participation. The proposed rule change also establishes 
that the prices disseminated by an automatic quotation system are 
presumed to be the bid and offer of the LMM for purposes of PCX Rule 
6.86 on ``Firm Quotes.'' \8\ The proposal further states that LMMs must 
nevertheless vocalize all their bids or offers in response to a call 
for a market or in acceptance of a bid or offer that is being 
disseminated. In the Commission's view, this requirement is appropriate 
to harmonize the proposed rule change with the PCX's other rules on 
vocalization.
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    \8\ The Commission notes that PCX Rule 6.86 provides that ``with 
respect to any bid or offer for any listed option made available by 
the Exchange to quotation vendors, the Lead Market Maker and any 
registered Market Makers constituting the trading crowd in such 
option series will collectively be the Responsible Broker or Dealer 
to the extent of the aggregate quotation size specified.'' 
Accordingly, if the Exchange's quotation is established by an 
automatic quotation system, such quotation is the quotation of all 
members of the crowd.
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    The Commission also believes that it is reasonable to permit 
members and LMMs to waive all or some of their share of contracts, as 
provided in the proposed provisions concerning ``Parity Due to 
Simultaneous Bidding or Offering,'' consistent with the PCX's rule on 
firm quote obligations. THe Commission further believes that it is fair 
and equitable to allocate such waived contracts among the other members 
on parity on an equal basis, to the extent practicable, as the proposed 
rule change provides.\9\
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    \9\ The Commission notes that the proposed rules on the LMM 
Guaranteed Participation provide that if the LMM waives some of that 
participation, the contracts will become available to the members 
who are next in the priority sequence. The Commission believes this, 
too, is a reasonable allocation method that conforms with the time 
priority principles reflected elsewhere in the PCX's rules.
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    The Commission notes that, as made clear by the proposal, an LMM 
who has received a guaranteed participation may not participate in the 
waived portion of an order unless there are remaining contracts to be 
allocated after all other members have been satisfied. Similarly, the 
proposed rule change clarifies generally that when one or more members 
are on parity with the LMM, after the LMM receives its Guaranteed 
Participation, the LMM is not entitled to a share in the remainder of 
the order with the other members unless all such other members have 
been satisfied. The Commission believes that these provisions will help 
assure fair allocation of orders and maintain a competitive environment 
on the Exchange.
    As detailed above, the proposed rule change also clarifies how 
orders are allocated in the situation where members of the trading 
crowd provide a collective response to a member's request for a market 
in order to fill a large order pursuant to PCX Rule 6.37(f)(2).\10\ In 
the Commission's view, allocating participating members their 
respective sizes when their aggregate size is less than or equal to the 
size of the order, and allocating them their shares on a pro rata basis 
when their aggregate size exceeds the size of the order, is a 
reasonable way to apportion participation in such trades.
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    \10\ See Securities Exchange Act Release No. 45578 (March 15, 
2002), 67 FR 13393 (March 22, 2002) (SR-PCX-2001-50).
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    With respect to ``Procedures of Lead Market Makers,'' the 
Commission believes that it is reasonable to amend PCX Rule 6.82(d)(2) 
to give the Options Allocation Committee the ability to reduce the LMM 
Guaranteed Participation percentage from the maximum permitted under 
PCX Rule 6.82(d) when it allocates an issue to an LMM. The Commission 
notes that subparagraphs (A) and (B) of Rule 6.82(d)(2) already permit 
the Committee to reduce the LMM guarantee under certain conditions.
    The additional amendment clarifying that an LMM may direct some of 
its participation to a public order in the crowd--not just all of it, 
as the current rules implies--is reasonable, in the

[[Page 36286]]

Commission's view, as it conforms with the original purpose of this 
provision.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\11\ that proposed rule change (SR-PCX-2002-13) be, and hereby is, 
approved.
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    \11\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-12985 Filed 5-22-02; 8:45 am]
BILLING CODE 8010-01-M