[Federal Register Volume 67, Number 124 (Thursday, June 27, 2002)]
[Notices]
[Pages 43367-43372]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-16200]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46096; File No. SR-PCX-2001-17]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Pacific Exchange, Inc. 
Relating to Auto-Ex Price Improvement Incentive for Market Makers

June 20, 2002.
    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 16, 2002, 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 May 
3, 2002, the Exchange filed Amendment No. 1 to the proposed rule 
change.\3\ On June 14, 2002, the Exchange filed Amendment No. 2 to the 
proposed rule change.\4\ The Commission is publishing this notice to 
solicit comments on the proposed rule change, as amended, 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 L. Sink, Senior Attorney, Regulatory 
Policy, PCX, to Deborah L. Flynn, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated May 2, 2002 
(``Amendment No. 1''). Amendment No. 1 replaced in its entirety the 
proposed rule text and the Exchange's statement regarding the 
proposed rule change.
    \4\ See letter from Michael D. Pierson, Vice President, 
Regulatory Policy, PCX, to Steven G. Johnston, Special Counsel, 
Division, Commission, dated June 13, 2002 (``Amendment No. 2''). 
Amendment No. 2 deleted language from Rule 6.87(k)(2)(c)(ii) and 
Commentary .04 to Rule 6.87 to reflect changes to PCX's Rules 
approved by the Commission.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The PCX proposes a rule change that is intended to encourage 
competition among Market Makers for trades on its automatic execution 
system for options (``Auto-Ex'') by rewarding individual

[[Page 43368]]

Market Makers who improve the disseminated market.
    The text of the proposed rule change is set forth below. New text 
is italicized. Rule 6.87
* * * * *
    (k)
* * * * *

(2) Auto-Ex Price Improvement Incentive Program

    (A) A Market Maker who improves the disseminated quote will be 
given Priority Status on the Auto-Ex System as provided below.
    (i) To receive priority, a Market Maker must improve the 
disseminated market by inputting the improved quote into a Market Maker 
Hand Held Terminal and simultaneously by vocalizing the improved bid or 
offer. The improved market will be disseminated via the Options Price 
Reporting Authority (``OPRA'').
    (ii) The improved quote must be in a size that is at least the 
lesser of ten contracts or the disseminated size.
    (iii) The Market Maker who improved the disseminated market must 
remain in the crowd and will be responsible for filling orders in the 
crowd until that Market Maker no longer has priority.
    (iv) If orders are re-routed to Floor Broker Hand-Held Terminals 
for execution pursuant to Commentary .07, Floor Brokers will identify 
the improved quote by an alert in the system and will use their best 
efforts to assure that Market Makers with Priority Status receive 
allocations of contracts as provided in subsection (E), below.
    (B) The Market Maker's priority for both automatic and manual 
executions will continue until one of the following occurs:
    (i) the Market Maker's commitment size is filled;
    (ii) the Market Maker's better price is improved; or
    (iii) the Market Maker removes the bid or offer that improved the 
disseminated quote.
    (C) The following provisions apply if the improved quote is 
matched:
    (i) Market Makers who match the improved quote immediately (i.e., 
within one second) will be deemed to have Priority Status and will be 
allocated contracts as provided in subsection (E), below.
    (ii) Market Makers who match the improved market, but who do not 
match it immediately, will not be given Priority Status.
    (iii) An incoming order in a size greater than the size of the 
market improvement, including any matching quotes, will receive split 
price execution.
    (iv) If the LMM matches the improved quote via Auto-Quote or QTX 
after one second, then inbound orders will be assigned pursuant to Rule 
6.87(k)(1), but only after Market Makers with Priority Status have 
first been satisfied.
    (D) The following provisions apply if the improved quote is further 
improved:
    (i) If the improved quote is improved by Auto-Quote or QTX, then 
inbound orders will be assigned pursuant to Rule 6.87(k)(1).
    (ii) If a Market Maker improves the improved quote, the Market 
Maker who subsequently improved the quote will be given Priority 
Status.
    (E) Order Allocation Process.
    (i) A Market Maker with Priority Status who quotes alone at the 
best price will be allocated 100% of the incoming orders up to the size 
of the Market Maker's quote.
    (ii) If more than one Market Maker improves the quote, then such 
Market Makers will be allocated contracts as follows:
    (a) Market Makers with Priority Status will be on parity and will 
be allocated 40% of the next incoming order or orders on an equal 
distribution basis, up to their quoted sizes. The 40% allocation will 
be effected only after all public customer orders at the same price 
have first been executed. Orders will continue to be allocated in this 
manner until the total number of contracts allocated pursuant to this 
subsection equals or exceeds 20 contracts, at which time Priority 
Status will no longer apply. For example, Priority Status will no 
longer apply once a Market Maker has been allocated 40 contracts based 
on an allocation of 40% of a single 100-contract order, pursuant to 
this subsection. Likewise, Priority Status will no longer apply once a 
Market Maker has been allocated a total of 24 contracts based on three 
subsequent allocations of 8 contracts, each of which are based on 
allocations of 40% of 20 contracts.
    (b) All other outstanding bids and offers at the improved price, as 
well as any bids and offers representing the remaining sizes of Market 
Maker quotes with Priority Status, will then receive allocations on a 
size pro rata basis.
    (c) LMMs quoting at the improved price will be eligible to receive 
guaranteed participation in connection with allocations made pursuant 
to subsection (b), above, but not for allocations made pursuant to 
subsection (a), above.

(3) Interim Price Improvement Incentive Program

    (A) A Market Maker who improves the disseminated quote will receive 
Priority Status as provided below.
    (i) To receive Priority Status, a Market Maker must improve the 
disseminated quote via open outcry by a size that is at least the 
lesser of ten contracts or the disseminated size.
    (ii) The improved quote will be keyed into POETS by the Order Book 
Official (``OBO'') and will be disseminated via OPRA.
    (iii) When a Market Maker improves the quote in a particular 
series, orders in that series will be routed to Floor Broker Hand Held 
Terminals for execution. However, if the LMM has set Auto-Ex to execute 
incoming orders at the NBBO pursuant to Rule 6.87(i), and a Market 
Maker has improved the PCX BBO but not the NBBO, then incoming orders 
may be executed automatically at the NBBO pursuant to Rule 6.87(k)(1). 
If incoming orders are not automatically executed at the NBBO in such 
circumstances (e.g., because they exceed a size parameter), then they 
will be re-routed to a Floor Broker Hand-Held Terminal for execution. 
When that occurs, the Market Maker who improved the PCX BBO (but not 
the NBBO) will have Priority Status at the PCX BBO price. If the PCX 
BBO becomes the NBBO, that Market Maker will have Priority Status.
    (iv) Floor Brokers will identify the improved quote by an alert in 
the system and must use their best efforts to identify the Market 
Makers with Priority Status and assure that such Market Makers receive 
allocations of contracts as provided in this subsection (E), below.
    (v) The Market Maker who improved the disseminated market must 
remain in the trading crowd and will be responsible for filling orders 
in the crowd until that Market Maker no longer has priority.
    (B) The Market Maker's Priority Status will continue until one of 
the following occurs:
    (i) the Market Maker's commitment size is filled;
    (ii) the Market Maker's better price is improved; or
    (iii) the Market Maker removes the bid or offer that improved the 
disseminated quote;
    (C) The following provisions apply if the improved quote is 
matched:
    (i) Market Makers who match the improved quote immediately (i.e., 
within one second) will be deemed to have Priority Status and will be 
allocated contracts as provided in subsection (E) below.

[[Page 43369]]

    (ii) Market Makers who match the improved market, but who do not 
match it immediately, will not be given Priority Status.
    (iii) An incoming order in a size greater than the size of the 
market improvement, including any matching quotes, will receive split 
price execution in the trading crowd.
    (iv) If the LMM matches the improved quote via Auto-Quote or QTX 
after one second, then inbound orders will be assigned pursuant to 
6.87(k)(1), but only after Market Makers with Priority Status have 
first been satisfied.
    (D) The following provisions apply if the improved quote is further 
improved:
    (i) If a Market Maker improves the improved quote, the Market Maker 
who subsequently improved the quote will be given Priority Status.
    (ii) If the improved quote is improved by Auto-Quote or QTX, then 
inbound orders will be assigned pursuant to 6.87(k)(1).
    (E) Order Allocation Process
    (i) A Market Maker with Priority Status who quotes alone at the 
best price will be allocated 100% of the incoming orders up to the size 
of that Market Maker's quote.
    (ii) If more than one Market Maker improves the quote, then such 
Market Makers will be allocated contracts as follows:
    (a) Market Makers with Priority Status will be on parity and will 
be allocated 40% of the next incoming order or orders on an equal 
distribution basis, up to their quoted sizes. The 40% allocation will 
be effected only after all public customer orders at the same price 
have first been executed. Orders will continue to be allocated in this 
manner until the total number of contracts allocated pursuant to this 
subsection equals or exceeds 20 contracts, at which time Priority 
Status will no longer apply. For example, Priority Status will no 
longer apply once a Marker Maker has been allocated 40 contracts based 
on an allocation of 40% of a single 100-contract order, pursuant to 
this subsection. Likewise, Priority Status will no longer apply once a 
Market Maker has been allocated a total of 24 contracts based on three 
subsequent allocations of 8 contracts, each of which are based on 
allocations of 40% of 20 contracts.
    (b) All other outstanding bids and offers at the improved price, as 
well as any bids and offers representing the remaining sizes of Market 
Maker quotes with Priority Status, will then receive allocations on a 
size pro rata basis.
    (c) LMMs quoting at the improved price will be eligible to receive 
guaranteed participation in connection with allocations made pursuant 
to subsection (b), above, but not for allocations made pursuant to 
subsection (a), above.

Commentary

* * * * *
    .02  For purposes of Rules 6.87(k)(2) and 6.87(k)(3), references to 
Market Makers include Lead Market Makers.
    .03  Rules 6.87(k)(2) and 6.87(k)(3) apply to all classes and 
series of option contracts traded on the Exchange.
    .04  The Auto-Ex guaranteed size is the size the LMM has guaranteed 
to the Options Allocation Committee.
    .05  Split price execution refers to an execution of a trade where 
some of the contracts in the order will receive an execution at the 
best available price, and the remainder of the contracts in the order 
will be executed at the next best available price. Under Rule 
6.87(k)(2), an incoming order will be filled at the improved price 
until the improved quote and quotes matching the improved quote have 
been satisfied. The balance of the incoming order will be executed at 
the next best price. In the interim program, the balance of the order 
will be executed in the trading crowd. In the permanent program, split 
price execution will be automated.
    .06  Rule 6.87(k)(3), the Interim Price Improvement Incentive 
Program, will become operative on or before July 15, 2002 and will 
continue to apply until Rule 6.87(k)(2) becomes operative. Rule 
6.87(k)(2) will be rolled out gradually until such time that it is 
implemented floor wide. The PCX estimates that Rule 6.87(k)(2) will 
commence operation in December 2002 and will become completely 
operative by the third quarter of 2003. At that time, Rule 6.87(k)(2) 
will supercede Rule 6.87(k)(3).
    .07  POETS re-routes orders to Floor-Broker Hand-Held terminals if: 
(i) the inbound order exceeds the established size parameter for 
automatic execution; (ii) the order is for the account of a broker-
dealer and the Exchange has not designated broker-dealer orders as 
eligible for automatic execution in the issue; (iii) the Auto-Ex system 
has been suspended pursuant to Rule 6.87(i); (iv) the NBBO is crossed 
or locked and the Auto-Ex system has been set to re-route orders 
pursuant to Rule 6.87(j); or (v) the order would otherwise receive an 
execution at a price that is inferior to the NBBO.

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 self-regulatory organization 
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 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
    Background. The proposed rule change is intended to substantially 
enhance incentives for PCX Market Makers to quote competitively and 
substantially reduce disincentives for market participants to act 
competitively.\5\ Currently, changes to the PCX's disseminated quote 
are effected either by Auto-Quote, by the proprietary quote feed 
(``QTX'') of an Lead Market Maker (``LLM''), or by manual input. First, 
in Pacific Options Exchange Trading System (``POETS'') \6\ or QTX 
processing, Auto-Quote parameters are established and maintained by the 
LMM. As the price of the underlying security changes, the system 
recalculates the bid/ask prices of each option series. This 
recalculated bid/ask price establishes the published price for inbound 
orders and defines the execution price for trades effected through the 
automatic execution system.

[[Page 43370]]

Second, the bid and ask prices for options of a particular series may 
also be changed manually by an exchange or LMM employee, who enters new 
quotes of floor members that are vocalized in the trading crowd by 
public outcry.
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    \5\ The PCX's settlement with the Commission requires the PCX, 
among other things, to adopt rules concerning its automated 
quotation and execution systems which substantially enhance 
incentives to quote competitively and substantially reduce 
disincentives for market participants to act competitively. See 
Securities Exchange Act Release No. 43268 (September 11, 2000), 
Administrative Proceeding File No. 3-10282. The Exchange notes that 
the Commission previously has approved a PCX rule change proposal 
that the Exchange believes serves to encourage its Market Makers to 
quote more competitively and to be rewarded with trades executed on 
Auto-Ex. See Securities Exchange Act Release No. 44847 (September 
25, 2001), 66 FR 50237 (October 2, 2001) (File No. SR -PCX-2001-05) 
(Accelerated approval of proposal to assign orders to Market Makers 
who are logged-on Auto-Ex, based on the percentage of their in-
person agency contracts traded in a particular issue.). Pursuant to 
the approved rule change, Auto-Ex orders are assigned to Market 
Makers according to the number of in-person agency contracts they 
have traded (excluding Auto-Ex contracts traded) in a particular 
issue compared to all of the Market Maker in-person contracts 
(excluding Auto-Ex contracts) during a review period. The review 
period is determined by the Options Floor Trading Committee and may 
be no longer than two weeks.
    \6\ POETS is the Exchange's automated trading system comprised 
of an options order routing system, an automatic execution system 
(``Auto-Ex''), an on-line limit order book system and an automatic 
market quote update system (``Auto-Quote'').
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    Currently, inbound electronic orders that are executed on Auto-Ex 
are assigned to the Market Makers who are logged on to Auto-Ex by 
rotation.\7\ The number of contracts assigned to Market Makers on Auto-
Ex is based upon the number of their in-person agency contracts traded 
in an issue (excluding Auto-Ex contracts traded) compared to all of the 
Market Maker in-person agency contracts traded in the issue (excluding 
Auto-Ex contracts traded) during a review period.\8\
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    \7\ PCX Rule 6.87(k)(1) governs the rotational assignment of 
Auto-Ex orders. See supra note 5.
    \8\ See supra note 5.
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    Auto-Ex Price Improvement Incentive Program. The proposed rule 
change provides an incentive for Market Makers \9\ to improve the 
disseminated prices on the PCX by assigning priority on Auto-Ex to the 
Market Maker who improved the disseminated quote.\10\ A Market Maker 
who improves the disseminated quote would be given Priority Status on 
the Auto-Ex System as follows.
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    \9\ For purposes of this proposal, references to Market Makers 
include Lead Market Makers. See proposed Commentary .02.
    \10\ The proposed rule changes set forth in this filing cover 
all classes and series of option contracts traded on the Exchange. 
See proposed Commentary .03.
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    To receive priority, a Market Maker would be required to improve 
the disseminated market by inputting the improved quote into a Market 
Maker Hand Held Terminal and simultaneously by vocalizing the improved 
bid or offer. The improved market would be disseminated via the Options 
Price Reporting Authority (``OPRA''). The improved quote would be 
required to be in a size that is at least the lesser of ten contracts 
or the disseminated size.\11\ The Market Maker who improved the 
disseminated market would be required to remain in the crowd and would 
be responsible for filling orders in the crowd until that Market Maker 
no longer has priority.
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    \11\ Under PCX Rule 6.86(c)(1)(A), the Exchange may, under 
certain circumstances, disseminate a size less than the guaranteed 
size (the guaranteed size is the minimum firm quote size for which 
the LLM has, during the allocation process, pledged to make 
markets). See Securities Exchange Act Release No. 46029, June 4, 
2002 (Federal Register publication pending). Assume, for example, 
that the LLM is disseminating a market of 2 bid, 2.20 asked, in a 
particular option series for which the guaranteed size is twenty 
contracts. Then assume that a customer order to buy one contract for 
2.10 is entered on the Exchange, making the new best bid and offer 
on the Exchange 2.10 bid, 2.20 asked. In this situation, the 
Exchange disseminates the true size of the customer order for one 
contract. Under the instant proposed rule change, under the 
circumstances above, one contract would become the minimum amount by 
which a Market Maker could improve the disseminated quote. Telephone 
conversation between Michael D. Pierson, Vice President, PCX, and 
Steven G. Johnston, Special Counsel, Division, Commission, on June 
6, 2002.
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    If orders are re-routed to Floor Broker Hand-Held Terminals for 
execution,\12\ Floor Brokers would identify the improved quote by an 
alert in the system and would use their best efforts to assure that 
Market Makers with Priority Status receive allocations of contracts as 
provided in proposed PCX Rule 6.87(k)(2)(E), setting forth the order 
allocation process.
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    \12\ As noted in proposed Commentary .07, POETS will re-route 
orders to Floor-Broker Hand-Held terminals if: (i) the inbound order 
exceeds the established size parameter for automatic execution; (ii) 
the order is for the account of a broker-dealer and the Exchange has 
not designated broker-dealer orders as eligible for automatic 
execution in the issue; (iii) the Auto-Ex system has been suspended 
pursuant to PCX Rule 6.87(i), which permits the Options Floor 
Trading Committee to designate orders in certain option issues for 
default manual representation in the trading crowd if an order would 
be executed at a price more than one trading increment away from the 
PCX market; (iv) the NBBO is crossed or locked and the Auto-Ex 
system has been set to re-route orders pursuant to PCX Rule 6.87(j); 
or (v) the order would otherwise receive an execution at a price 
that is inferior to the NBBO.
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    The Market Maker's priority for both automatic and manual 
executions would continue until one of the following occurs: the Market 
Maker's commitment size is filled; the Market Maker's better price is 
improved; or the Market Maker removes the bid or offer that improved 
the disseminated quote.
    The following provisions would apply if the improved quote is 
matched: Market Makers who match the improved quote immediately (i.e., 
within one second) would be deemed to have Priority Status and would be 
allocated contracts as provided in proposed PCX Rule 6.87(k)(2)(E). 
Market Makers who match the improved market, but who do not match it 
immediately, would not be given Priority Status. An incoming order in a 
size greater than the size of the market improvement, including any 
matching quotes, would receive split price execution.\13\ If the LMM 
matches the improved quote via Auto-Quote or QTX after one second, then 
inbound orders would be assigned pursuant to PCX Rule 6.87(k)(1),\14\ 
but only after Market Makers with Priority Status have first been 
satisfied.\15\
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    \13\ Split price execution refers to an execution of a trade 
where some of the contracts in the order will receive an execution 
at the best available price, and the remainder of the contracts in 
the order will be executed at the next best available price. Under 
Proposed PCX Rule 6.87(k)(2), an incoming order would be filled at 
the improved price until the improved quote and quotes matching the 
improved quote have been satisfied. The balance of the incoming 
order would be executed at the next best price. In the interim 
program, the balance of the order would be executed in the trading 
crowd. In the permanent program, split price execution would be 
automated.
    \14\ See supra note 7. An exception would be made in the case 
where incoming orders would be assigned to Floor-Broker Hand-Held 
Terminals pursuant to proposed Commentary .07 (See supra note 12). 
In that situation, Market Makers with Priority Status would retain 
priority at the improved price until filled, but additional incoming 
orders would be allocated to crowd members consistent with current 
PCX rules, including rules governing open outcry trading. Telephone 
conversation between Michael D. Pierson, Vice President, PCX, and 
Steven G. Johnston, Special Counsel, Division, Commission, on May 9, 
2002.
    \15\ If the LMM matches the improved quote via Auto-Quote or QTX 
within one second, then no Market Makers would have priority status 
and inbound orders would be assigned pursuant to PCX Rule 
6.87(k)(1). Telephone conversation among Michael D. Pierson, Vice 
President, and Cindy L. Sink, Senior Attorney, Regulatory Policy, 
PCX; and Elizabeth K. King, Associate Director, Division, 
Commission, and Steven G. Johnston, Special Counsel, Division, 
Commission, on May 28, 2002.
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    The following provisions would apply if the improved quote is 
further improved: If the improved quote is improved by Auto-Quote or 
QTX, then inbound orders would be assigned pursuant to PCX Rule 
6.87(k)(1).\16\ If a Market Maker improves the improved quote, the 
Market Maker who subsequently improved the quote would be given 
Priority Status.
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    \16\ See supra note 7.
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    Order Allocation Process. Proposed PCX Rule 6.87(k)(2)(E) provides 
that a Market Maker with Priority Status who quotes alone at the best 
price would be allocated 100% of the incoming orders up to the size of 
the Market Maker's quote. However, if more than one Market Maker 
improves the quote, then such Market Makers would be allocated 
contracts as follows: First, under subsection (E)(ii)(a) to proposed 
PCX Rule 6.87(k)(2), Market Makers with Priority Status would be on 
parity and would be allocated 40% of the next incoming order or orders 
on an equal distribution basis, up to their quoted sizes. The 40% 
allocation would be effected only after all public customer orders at 
the same price have first been executed. Orders would continue to be 
allocated in this manner until the total number of contracts allocated 
pursuant to this subsection equals or exceeds 20 contracts, at which 
time Priority Status would no longer apply.\17\
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    \17\ For example, Priority Status would no longer apply once a 
Market Maker has been allocated 40 contracts based on an allocation 
of 40% of a single 100-contract order, pursuant to this subsection. 
Likewise, Priority Status would no longer apply once a Market Maker 
has been allocated a total of 24 contracts based on three subsequent 
allocations of 8 contracts, each of which are based on allocations 
of 40% of 20 contracts.

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[[Page 43371]]

    Second, under proposed subsection (E)(ii)(b) to proposed PCX Rule 
6.87(k)(2), all other outstanding bids and offers at the improved 
price, as well as any bids and offers representing the remaining sizes 
of Market Maker quotes with Priority Status, would then receive 
allocations on a size pro rata basis.
    With regard to LMM guaranteed participation under PCX Rule 6.82(d), 
LMMs quoting at the improved price would be eligible to receive 
guaranteed participation in connection with allocations made under 
subsection (E)(ii)(b) to proposed PCX Rule 6.87(k)(2), but not under 
subsection (E)(ii)(a) of the proposed rule.
    The PCX estimates that the technology changes necessary to begin 
implementing the proposed rule and make its provisions operative would 
take approximately 10 months. The proposed rule would be implemented 
gradually until such time that it is implemented floor wide. The PCX 
estimates that the proposed rule would commence operation in December 
2002 and would become completely operative by the third quarter of 
2003. However, the Exchange is proposing to adopt an interim program, 
described below, to reward Market Makers who improve the disseminated 
market until this program is available. Once the permanent program set 
forth above is operative, it would supersede the interim program.
    Interim Price Improvement Incentive Program. The Exchange proposes 
to adopt an interim rule change to become operative on or before July 
15, 2002 and to remain operative until the above-described rule change 
becomes operative. Under the interim program, a Market Maker who 
improves the disseminated quote would receive Priority Status as 
follows.
    To receive Priority Status, a Market Maker would be required to 
improve the disseminated quote via open outcry by a size of ten 
contracts or the disseminated size, whichever is less.\18\ The improved 
quote would be keyed into POETS by the Order Book Official (``OBO'') 
and would be disseminated via OPRA. When a Market Maker improves the 
quote in a particular series, orders in that series would be routed to 
Floor Broker Hand Held Terminals for execution. However, if the LMM has 
set Auto-Ex to execute incoming orders at the NBBO pursuant to PCX Rule 
6.87(i), and a Market Maker has improved the PCX BBO but not the NBBO, 
then incoming orders would be permitted to execute automatically at the 
NBBO. However, in circumstances where incoming orders are not 
automatically executed at the NBBO (e.g., because they exceed a size 
parameter), orders would be re-routed to a Floor Broker Hand-Held 
Terminal for execution.\19\ When that occurs, the Market Maker who 
improved the PCX BBO (but not the NBBO) would have Priority Status at 
the PCX BBO price. If the PCX BBO becomes the NBBO, that Market Maker 
would have Priority Status.
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    \18\ See supra note 11.
    \19\ See supra note 12. Telephone conversation between Cindy L. 
Sink, Senior Attorney, Regulatory Policy, PCX and Steven G. 
Johnston, Special Counsel, Division, Commission, on May 29, 2002.
---------------------------------------------------------------------------

    Floor Brokers would identify the improved quote by an alert in the 
system and would be required to use their best efforts to identify the 
Market Makers with Priority Status and assure that such Market Makers 
receive allocations of contracts as provided in proposed PCX Rule 
6.87(k)(3)(E), the order allocation process. The Market Maker who 
improved the disseminated market would be required to remain in the 
trading crowd and would be responsible for filling orders in the crowd 
until that Market Maker no longer has priority.
    The Market Maker's Priority Status would continue until one of the 
following occurs: the Market Maker's commitment size is filled; the 
Market Maker's better price is improved; or the Market Maker removes 
the bid or offer that improved the disseminated quote.
    The following provisions would apply if the improved quote is 
matched: Market Makers who match the improved quote immediately (i.e., 
within one second) would be deemed to have Priority Status and would be 
allocated contracts as provided in proposed PCX Rule 6.87(k)(3)(E). 
Market Makers who match the improved market, but who do not match it 
immediately, would not be given Priority Status. An incoming order in a 
size greater than the size of the market improvement, including any 
matching quotes, would receive split price execution in the trading 
crowd.\20\ If the LMM matches the improved quote via Auto-Quote or QTX 
after one second, then inbound orders would be assigned pursuant to PCX 
Rule 6.87(k)(1),\21\ but only after Market Makers with Priority Status 
have first been satisfied.\22\
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    \20\ See supra note 13.
    \21\ See supra note 14.
    \22\ See supra note 15.
---------------------------------------------------------------------------

    The following provisions would apply if the improved quote were 
further improved: If a Market Maker improves the improved quote, the 
Market Maker who subsequently improved the quote would be given 
Priority Status. If the improved quote were improved by Auto-Quote or 
QTX, then inbound orders would be assigned pursuant to PCX Rule 
6.87(k)(1).
    Order Allocation Process for the Interim Program. Under proposed 
PCX Rule 6.87(k)(3), a Market Maker with Priority Status who quotes 
alone at the best price would be allocated 100% of the incoming orders 
up to the size of the Market Maker's quote. However, if more than one 
Market Maker improves the quote, then such Market Makers would be 
allocated contracts as follows: First, under proposed subsection 
(E)(ii)(a) to proposed PCX Rule 6.87(k)(3), Market Makers with Priority 
Status would be on parity and would be allocated 40% of the next 
incoming order or orders on an equal distribution basis, up to their 
quoted sizes. The 40% allocation would be effected only after all 
public customer orders at the same price have first been executed. 
Orders would continue to be allocated in this manner until the total 
number of contracts allocated pursuant to this subsection equals or 
exceeds 20 contracts, at which time Priority Status would no longer 
apply.\23\ Second, under subsection (E)(ii)(b) to proposed PCX Rule 
6.87(k)(3), all other outstanding bids and offers at the improved 
price, as well as any bids and offers representing the remaining sizes 
of Market Maker quotes with Priority Status, would then receive 
allocations on a size pro rata basis.
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    \23\ See supra note 17.
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    With regard to LMM guaranteed participation under PCX Rule 6.82(d), 
LMMs quoting at the improved price would be eligible to receive 
guaranteed participation in connection with allocations made under 
subsection (E)(ii)(b) to proposed PCX Rule 6.87(k)(3), but not under 
subsection (E)(ii)(a) to proposed PCX Rule 6.87(k)(3).
2. Statutory Basis
    The Exchange believes that this proposal is consistent with section 
6(b) of the Act \24\ in general, and furthers the objectives of section 
6(b)(5),\25\ in particular, in that it is designed to facilitate 
transactions in securities, to promote just and equitable principles of 
trade, to foster cooperation and coordination with persons engaged in 
facilitation transactions in securities, and to remove impediments to 
and perfect the mechanism of a free and open market and a national 
market system.
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    \24\ 15 U.S.C. 78f(b).
    \25\ 15 U.S.C. 78f(b)(5).

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[[Page 43372]]

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

    The PCX 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

    No written comments were either solicited or 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 or 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 proposed rule change and Amendment No. 1 
thereto, 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 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, 450 Fifth Street, NW., Washington, DC 20549-0609. 
Copies of the proposed rule change and amendments will also be 
available for inspection and copying at the principal office of the 
PCX. All submissions should refer to File No. SR-PCX-2001-17 and should 
be submitted by July 18, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-16200 Filed 6-26-02; 8:45 am]
BILLING CODE 8010-01-P