[Federal Register Volume 67, Number 187 (Thursday, September 26, 2002)]
[Notices]
[Pages 60709-60711]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-24411]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46515; File No. SR-PCX-2002-53]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to New Order Types Called 
``Midpoint Cross Order'' and ``Midpoint Directed Fill'' and a New 
Interpretation Under PCXE Rule 7.6(a)

September 19, 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 August 5, 2002, 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, II, 
and III below, which Items have been prepared by the PCX. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    PCX, through its wholly-owned subsidiary PCX Equities, Inc. 
(``PCXE''), proposes to amend its rules governing the Archipelago 
Exchange, the equities trading facility of PCXE, by: (1) Adopting two 
new order types--a Midpoint Crossing Order and a Midpoint Directed 
Fill; and (2) adding interpretive language to the Trading Differentials 
under PCXE Rule 7.6 to provide for separate minimum trading 
differentials for these new order types. The Exchange's proposed rule 
change would permit the aforementioned order types to receive an 
execution under specified circumstances at price increments finer than 
the minimum trading differential permitted under the

[[Page 60710]]

Exchange's current rules for other transactions on the Archipelago 
Exchange. The text of the rule change is available at the Office of the 
Secretary of the Exchange and at the Commission.

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 PCX 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 PCX 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 Archipelago Exchange trading facility (``ArcaEx'') commenced 
operations on March 22, 2002, replacing the PCXE's traditional trading 
floor facilities.\3\ As part of its continuing effort to enhance 
participation in its electronic auction market, the Exchange proposes 
to adopt two new order types called a ``Midpoint Cross Order'' and a 
``Midpoint Directed Fill,'' which would permit Equity Trading Permit 
(``ETP'') Holders \4\ and Sponsored Participants \5\ (collectively 
``Users'') to receive executions priced between the NBBO at price 
increments finer than the minimum trading differential permitted under 
the Exchange's current rules.
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    \3\ See Securities Exchange Act Release No. 44983 (October 25, 
2001), 66 FR 55225 (November 1, 2001), File No. SR-PCX-00-25 (ArcaEx 
Approval Order).
    \4\ See PCXE Rule 1.1(n).
    \5\ A ``Sponsored Participant'' means ``a person which has 
entered into a sponsorship arrangement with a Sponsoring ETP Holder 
pursuant to [PCXE] Rule 7.29.'' See PCXE Rule 1.1(tt).
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    The Exchange proposes to add PCXE Rule 7.31(y) to define a Midpoint 
Cross Order. A Midpoint Cross Order is a Cross Order \6\ that is priced 
at the midpoint of the NBBO. If at the time of order entry a locked or 
crossed market exists in the security, the ArcaEx trading system would 
reject the Midpoint Cross Order. The Exchange also proposes to add PCXE 
Rule 7.31(z) to define a Midpoint Directed Fill. A Midpoint Directed 
Fill is a Directed Fill \7\ that is priced at the midpoint of the NBBO. 
When a locked or crossed market exists in the security, the inbound 
Directed Order would bypass the Directed Order Process \8\ and 
immediately enter the Display Order Process for execution.\9\ In the 
Directed Order Process, the User's Directed Order would be executed 
against a Directed Fill, which is the order of the User's designated 
market maker. Specifically, for a market maker to interact with 
incoming Directed Orders, the market maker must submit a standing 
instruction to ArcaEx for the parameters of a Directed Fill, including, 
but not limited to, the size of the order, the Users who may send such 
market maker a Directed Order, the price improvement algorithm and the 
period of time the instruction is effective. The proposed Midpoint 
Directed Fill would be an additional feature of the ArcaEx system's 
price improvement algorithm, which would enable market makers to match 
automatically against incoming Directed Orders at the midpoint price 
between the NBBO.
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    \6\ A Cross Order is defined as a two-sided order with 
instructions to match the identified buy-side with the identified 
sell-side at a specified price (the cross price), subject to price 
improvement requirements. See PCXE Rule 7.31(s).
    \7\ See PCXE Rule 7.31(j) (definition of ``Directed Fill'').
    \8\ The Directed Order Process is the first step in the ArcaEx 
execution algorithm. Through this Process, Users may direct an order 
to a Market Maker with whom that they have a relationship and the 
Market Maker may execute the order. To access this process, the User 
must submit a Directed Order, which is a market or limit order to 
buy or sell that has been directed to a particular market maker by 
the User. See PCXE Rule 7.37(a) (description of ``Directed Order 
Process'').
    \9\ The Display Order Process is the second step in the ArcaEx 
execution algorithm. In this process, the ArcaEx system matches an 
incoming marketable order against orders in the Display Order 
Process at the display price of the resident order for the total 
size available at that price or for the size of the incoming order. 
See PCXE Rule 7.37(b) (description of ``Display Order Process'').
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    The Exchange's current rules governing minimum price variations and 
minimum price improvement increments (``MPII'') \10\ for securities 
traded on the ArcaEx are set forth in PCXE Rule 7.6. The PCXE's current 
minimum price variation and MPII is $0.01. The proposed rule change 
provides an exception to PCXE Rule 7.6 that would permit Midpoint Cross 
Orders and Midpoint Directed Fills to receive executions at price 
increments finer than the minimum trading differential permitted under 
the Exchange's rules. In order to implement these new order types, the 
Exchange is proposing to add interpretive language to address 
situations where the midpoint of the NBBO bid/ask differential is a 
subpenny price (e.g., the midpoint of an NBBO of $20-$20.03 is 
$20.015). In such circumstances, the proposed rule would permit 
Midpoint Cross Orders and Midpoint Directed Fills to be executed and 
reported in increments as small as one-half of the minimum price 
variation (i.e., as $0.005).\11\ Furthermore, in situations where the 
NBBO bid/ask differential is one minimum price variation (i.e., $0.01), 
Midpoint Cross Orders and Midpoint Directed Fills may be executed in 
increments of one-half of the minimum price variation (i.e., as 
$0.005), as an exception to the MPII as prescribed in current PCXE Rule 
7.6(a), Commentary .06.
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    \10\ The minimum price improvement increment (``MPII'') on 
ArcaEx is equal to $0.01 or 10% of the NBBO spread, whichever is 
greater. See PCXE Rule 7.6(a), Commentary .06. Under current PCXE 
rules, the MPII requirements must be satisfied in the execution of 
Cross Orders and Directed Orders. See PCXE Rules 7.31(j) and (s).
    \11\ See proposed PCXE Rule 7.6(a), Commentary .07.
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    The Exchange is also making minor technical changes to Rule 7.6(a), 
Commentary .05 by eliminating obsolete references and making changes to 
the text so that the rule will conform to a parallel rule as set forth 
in Rule 7.6(a), Commentary .03. Users of ArcaEx have requested a 
midpoint-pricing mechanism for Cross Orders and Directed Fills so that 
a midpoint trade can take place in odd-spread markets and $0.01 
markets, as described above.\12\ To achieve this, the PCX proposes to 
allow such order types designated for midpoint pricing to be executed 
at finer trading differentials than $0.01. The PCX believes that a 
finer trading differential for executions of Midpoint Cross Orders and 
Midpoint Directed Fills will facilitate enhanced order interaction and 
foster price competition. Accordingly, the Exchange believes that the 
proposal promotes a more efficient and effective market operation, and 
enhances the investment choices available to investors over a broad 
range of trading scenarios.
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    \12\ Users that use indexation strategies are particularly 
interested in using the midpoint-pricing feature. Also, the Exchange 
believes that the quotation spreads (the difference between the 
highest bid quotation and the lowest offer quotation) in the most 
liquid Nasdaq securities are $0.01 for a substantial majority of the 
trading day.
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    The Exchange notes that the proposal to trade at finer price 
increments applies only to Midpoint Cross Orders and Midpoint Directed 
Orders. The rule change is not intended to permit Users to generally 
display quotes, enter orders, or execute trades in price increments 
less than $0.01. In other words, trades resulting from the midpoint-
pricing mechanism may be executed on the basis of $0.005 increments; 
however, it will still not be possible to enter orders, bids, or offers 
in $0.005 increments.

[[Page 60711]]

2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b)\13\ of the Act, in general, and further the 
objectives of Section 6(b)(5),\14\ in particular, because it is 
designed to promote just and equitable principles of trade, to foster 
cooperation and coordination with persons engaged in facilitating 
transactions in securities, and to remove impediments and perfect the 
mechanisms of a free and open market and to protect investors and the 
public interest. In addition, the Exchange believes that the proposed 
rule change is consistent with provisions of Section 11A(a)(1)(B) of 
the Act, which states that new data processing and communications 
techniques create the opportunity for more efficient and effective 
market operations.
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    \13\ 15 U.S.C. 78f(b).
    \14\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The PCX believes that the proposed rule change does not 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 solicited or received with respect to the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the 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. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
PCX. All submissions should refer to File No. SR-PCX-2002-53 and should 
be submitted by October 17, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-24411 Filed 9-25-02; 8:45 am]
BILLING CODE 8010-01-P