[Federal Register Volume 69, Number 47 (Wednesday, March 10, 2004)]
[Notices]
[Pages 11472-11475]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-5376]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49347; File No. SR-PCX-2002-66]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Pacific Exchange, Inc. 
Relating to Marking Orders and Affirmative Determinations

March 1, 2004.
    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 September 30, 2002, the Pacific Exchange, Inc. (``PCX'') filed with 
the Securities and Exchange Commission a proposed rule change relating 
to marking orders and affirmative determinations. On January 2, 2004, 
the PCX filed Amendment No. 1 to the proposed rule change, which 
replaced the original filing in its entirety. Amendment No. 1 is 
described in Items I, II and III below, which the PCX has prepared. 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

    The PCX, through its wholly owned subsidiary PCX Equities, Inc. 
(``PCXE''), proposes to amend PCXE Rule 7.16(c) regarding an ETP 
Holder's obligation to make affirmative determinations. The text of the 
proposed rule change is below. New text is italicized and deleted text 
is in brackets.
* * * * *
    Rule 7.16(c) Marking Orders and Affirmative Determinations [No ETP 
Holder of the Corporation shall mark a sell order ``long'' unless (1) 
the security to be delivered after sale is carried in the account for 
which the sale is to be effected or (2) such ETP Holder is informed 
that the seller owns the security ordered to be sold, and as soon as is 
possible without undue inconvenience or expense, will deliver the 
security owned to the account for which the sale is to be effected.]
    (1) Long Sales--No ETP Holder or associated person for whom the 
Exchange serves as the Designated Examining Authority may accept a long 
sale order from any customer in any security (except exempt securities 
other than municipals) unless:
    (A) The ETP Holder has possession of the security;
    (B) The security is long in the customer's account with the ETP 
Holder;
    (C) The ETP Holder or associated person makes an affirmative 
determination that the customer owns the security and will deliver it 
in good deliverable form within three (3) business days of the 
execution of the order; or
    (D) The security is on deposit in good deliverable form with an ETP 
Holder of the Exchange, a member of a national securities exchange, a 
broker/dealer registered with the SEC, or any organization subject to 
state or federal banking regulations and that instructions have been 
forwarded to that depository to deliver the securities against payment.

(2) Short Sales

    (A) Customer short sales--No ETP Holder or associated person for 
whom the Exchange serves as the Designated Examining Authority shall 
accept a ``short'' sale order for any customer in any security unless 
the ETP Holder or associated person makes an affirmative determination 
that the ETP Holder will receive delivery of the security from the 
customer or that the ETP Holder can borrow the security on behalf of 
the customer for delivery by settlement date. This requirement does not 
apply, however, to transactions in corporate debt securities.
    (B) Proprietary short sales--No ETP Holder may effect a ``short'' 
sale for its own account in any security unless the ETP Holder or 
associated person makes an affirmative determination that the ETP 
Holder can borrow the securities or otherwise provide for delivery of 
the securities by the settlement date. This requirement will not apply 
to transactions in corporate debt securities, to bona fide market 
making transactions by an ETP Holder in securities in which it is 
registered as an exchange market maker, or to transactions that result 
in fully hedged or arbitraged positions. For the purposes of this 
paragraph, transactions unrelated to normal market making activity, 
such as index arbitrage and risk arbitrage that are independent from an 
ETP Holder's market making functions, will not be considered bona fide 
market making activity. Similarly, bona fide market making would 
exclude activity that is related to speculative selling strategies of 
the ETP Holder or investment decisions of the firm and is 
disproportionate to the usual market making patterns or practices of 
the ETP Holder in that security.

(3) Affirmative Determination

    (A) To satisfy the requirements for an ``affirmative 
determination'' contained in subsection (c)(1)(C) above for long sales, 
the ETP Holder or associated person must make a notation on the order 
ticket at the time the order is taken that reflects the conversation 
with the customer as to the present location of the securities in 
question, whether they are in good deliverable form and the customer's 
ability to deliver them to the ETP Holder within three (3) business 
days.
    (B) To satisfy the requirement for an ``affirmative determination'' 
contained in subsection (c)(2)(B) above for customer and proprietary 
short sales, the ETP Holder or associated person must keep a written 
record that includes: (i) If a customer assures delivery, the present 
location of the securities in question, whether they are in good 
deliverable form and the customer's ability to deliver them to the ETP 
Holder within three (3) business days; or (ii) if the ETP Holder or 
associated person locates the stock, the identity of the individual and 
firm contacted who offered assurance that the shares would be delivered 
or that were available for borrowing by settlement date and the number 
of shares needed to cover the short sale.
    (C) The manner by which an ETP Holder or associated person 
annotates compliance with the ``affirmative determination'' requirement 
contained above (e.g., marking the order ticket, recording inquiries in 
a log, etc.) is not specified by this Rule and, therefore, will be 
decided by each ETP Holder. ETP Holders may rely on ``blanket'' or 
standing assurances (i.e., ``Easy to Borrow'' lists) that 
securities will be

[[Page 11473]]

available for borrowing on settlement date to satisfy their affirmative 
determination requirements under this Rule. For any short sales 
executed in Nasdaq National Market (``NNM'') or national securities 
exchange-listed (``listed'') securities, ETP Holders also may rely on 
``Hard to Borrow'' lists indicating NNM or listed securities that are 
difficult to borrow or unavailable for borrowing on settlement date to 
satisfy their affirmative determination requirements under this Rule, 
provided that: (i) any security restricted i.e., subject to NASD UPC 
Rule 11830, must be included on such a list; and (ii) the creator of 
the list attests in writing on the document or otherwise that any NNM 
or listed securities not included on the list are easy to borrow or are 
available for borrowing. ETP Holders are permitted to use Easy to 
Borrow or Hard to Borrow lists provided: (i) The information used to 
generate the list is less than 24-hours old; and (ii) the ETP Holder 
delivers the security on settlement date. Should an ETP Holder relying 
on an Easy to Borrow or Hard to Borrow list fail to deliver the 
security on settlement date, the Exchange will deem such conduct 
inconsistent with the terms of this Rule, absent mitigating 
circumstances such as a verifiable disruption or malfunction of an 
execution or communication system or such intervening act that may be 
demonstrated and adequately documented by the ETP Holder.
    (4) Bona Fide Fully Hedged and Bona Fide Fully Arbitraged--In 
determining the availability of the exemption provided in paragraph 
(2)(b) above for ``bona fide fully hedged'' and ``bona fide fully 
arbitraged'' transactions, the Exchange may apply the following 
guidelines:
    (A) Bona Fide Fully Hedged--The following transactions will be 
considered bona fide fully hedged: (i) Short a security and long a 
convertible debenture, preferred or other security which has a 
conversion price at or in the money and is convertible within ninety 
days into the short security; (ii) short a security and long a call 
which has a strike price at or in the money and which is exercisable 
within 90 calendar days into the underlying short security; (iii) short 
a security and long a position in warrants or rights which are 
exercisable within 90 days into the short security. To the extent that 
the long warrants or rights are ``out of the money,'' then the short 
position will be exempt up to the market value of the long warrants or 
rights.
    (B) Bona Fide Fully Arbitraged--The following transactions shall be 
considered bona fide fully arbitraged: (i) Long a security purchased in 
one market together with a short position from an offsetting sale of 
the same security in a different market at as nearly the same time as 
practicable for the purpose of taking advantage of a difference in 
price in the two markets; (ii) long a security which is without 
restriction other than the payment of money exchangeable or convertible 
within 90 calendar days of the purchase into a second security together 
with a short position from an off-setting sale of the second security 
at or about the same time for the purpose of taking advantage of a 
concurrent disparity in the prices of the securities.
    (C) The transaction date of the short sale will govern when a fully 
hedged or fully arbitraged position exists.
    (d)-(f)--No change.
* * * * *
    Rule 7.18(a)-(c)--No change.
    (d) Applicability. The following Rules of the Corporation will not 
be applicable to transactions on the Corporation in Nasdaq Securities. 
7.16 (a, d and e), 7.55-7.57.

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 that it had received. The text of the 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 the statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Proposed PCXE Rule 7.16(c)(1) (``Long Sales'') states that no ETP 
Holder or associated person for whom the PCX serves as the Designated 
Examining Authority (``DEA'') may accept a long sale order from any 
customer in any security (except exempt securities other than 
municipals) unless: (A) The ETP Holder has possession of the security; 
(B) the security is long in the customer's account with the ETP Holder; 
(C) the ETP Holder or associated person makes an affirmative 
determination that the customer owns the security and will deliver it 
in good deliverable form within three business days of the execution of 
the order; or (D) the security is on deposit in good deliverable form 
with an ETP Holder of the PCX, a member of a national securities 
exchange, a broker-dealer registered with the Commission, or any 
organization subject to state or federal banking regulations, and that 
instructions have been forwarded to that depository to deliver the 
securities against payment.
    Proposed PCXE Rule 7.16(c)(2) (``Short Sales'') provides that, with 
respect to customer short sales, no ETP Holder or associated person for 
whom the PCX serves as the DEA shall accept a ``short'' sale order for 
any customer in any security unless the ETP Holder or associated person 
makes an affirmative determination that the ETP Holder will receive 
delivery of the security from the customer or that the ETP Holder can 
borrow the security on behalf of the customer for delivery by 
settlement date. As proposed, the rule provides that this requirement 
does not apply to transactions in corporate debt securities.
    The proposed rule further provides that no ETP Holder may effect a 
``short'' sale for its own account in any security unless the ETP 
Holder or associated person makes an affirmative determination that the 
ETP Holder can borrow the securities or otherwise provide for delivery 
of the securities by the settlement date. The proposed rule provides 
that this requirement will not apply to transactions in corporate debt 
securities, to bona fide market making transactions by an ETP Holder in 
securities in which it is registered as a PCX market maker, or to 
transactions that result in fully hedged or arbitraged positions. The 
proposed rule further clarifies that transactions unrelated to normal 
market making activity, such as index arbitrage and risk arbitrage that 
are independent from an ETP Holder's market making functions, will not 
be considered bona fide market making activity. Similarly, bona fide 
market making would exclude activity that is related to speculative 
selling strategies of the ETP Holder or investment decisions of the 
firm and is disproportionate to the usual market making patterns or 
practices of the ETP Holder in that security.
    Proposed PCXE Rule 7.16(c)(3) (``Affirmative Determination'') 
provides that in order to satisfy the requirements for an ``affirmative 
determination'' for long sales, the ETP Holder or associated person 
must make a notation on the order ticket at the time the order is taken 
that reflects the conversation with the customer as to the present 
location of the securities in question, whether they are in good 
deliverable form, and the customer's ability to deliver them to the ETP 
Holder within three business

[[Page 11474]]

days. The proposed rule further provides that in order to satisfy the 
requirement for an ``affirmative determination'' for customer and 
proprietary short sales, the ETP Holder or associated person must keep 
a written record that includes: (i) If a customer assures delivery, the 
present location of the securities in question, whether they are in 
good deliverable form, and the customer's ability to deliver them to 
the ETP Holder within three business days; or (ii) if the ETP Holder or 
associated person locates the stock, the identity of the individual and 
firm contacted who offered assurance that the shares would be delivered 
or that were available for borrowing by settlement date and the number 
of shares needed to cover the short sale.
    The proposed rule further provides that the manner by which an ETP 
Holder or associated person annotates compliance with the ``affirmative 
determination'' requirement discussed above (e.g., marking the order 
ticket, recording inquiries in a log, etc.) is not specified by the 
Rule and, therefore, will be decided by each ETP Holder. As proposed, 
ETP Holders may rely on ``blanket'' or standing assurances (i.e., 
``Easy to Borrow'' lists) that securities will be available for 
borrowing on settlement date to satisfy their affirmative determination 
requirements under this Rule. For any short sales executed in NASDAQ 
National Market (``NNM'') or national securities exchange listed 
(``listed'') securities, the proposed rule provides that ETP Holders 
also may rely on ``Hard to Borrow'' lists indicating the NNM or listed 
securities that are difficult to borrow or unavailable for borrowing on 
settlement date to satisfy their affirmative determination requirements 
under this Rule, provided that (i) Any securities that are subject to 
NASD Uniform Practice Code Rule 11830 (i.e., any Nasdaq securities that 
have a clearing short position of 10,000 shares or more and that are 
equal to at least one-half of one percent of the issue's total shares 
outstanding) must be included on such a list; and (ii) the creator of 
the list attests in writing on the document or otherwise that any NNM 
or listed securities not included on the list are easy to borrow or are 
available for borrowing. The proposed rule further provides that ETP 
Holders are permitted to use Easy to Borrow or Hard to Borrow lists 
provided that: (i) The information used to generate the list is less 
than 24-hours old; and (ii) the ETP Holder delivers the security on 
settlement date. Should an ETP Holder relying on an Easy to Borrow or 
Hard to Borrow list fail to deliver the security on settlement date, 
the PCX will deem such conduct inconsistent with the terms of this 
Rule, absent mitigating circumstances such as a verifiable disruption 
or malfunction of an execution or communication system or such 
intervening act that may be demonstrated and adequately documented by 
the ETP Holder.
    Proposed Rule 7.16(c)(4) (``Bona Fide Fully Hedged and Bona Fide 
Fully Arbitraged'') provides that the PCX may apply certain guidelines 
in determining the availability of the exemption provided for ``bona 
fide fully hedged'' and ``bona fide fully arbitraged'' transactions. 
Under the proposed rule, the following transactions would be considered 
bona fide fully hedged: (i) Short a security and long a convertible 
debenture, preferred, or other security that has a conversion price at 
or in the money and is convertible within ninety days into the short 
security; (ii) short a security and long a call that has a strike price 
at or in the money and which is exercisable within 90 calendar days 
into the underlying short security; (iii) short a security and long a 
position in warrants or rights that are exercisable within 90 days into 
the short security. To the extent that the long warrants or rights are 
``out of the money,'' then the short position will be exempt up to the 
market value of the long warrants or rights.
    The proposed rule further provides that the following transactions 
shall be considered bona fide fully arbitraged: (i) Long a security 
purchased in one market together with a short position from an 
offsetting sale of the same security in a different market at as nearly 
the same time as practicable for the purpose of taking advantage of a 
difference in price in the two markets; (ii) long a security which is 
without restriction other than the payment of money exchangeable or 
convertible within 90 calendar days of the purchase into a second 
security together with a short position from an off-setting sale of the 
second security at or about the same time for the purpose of taking 
advantage of a concurrent disparity in the prices of the securities. 
The proposed rule provides that the transaction date of the short sale 
will govern when a fully hedged or fully arbitraged position exists.
    The Commission notes that proposed Regulation SHO under the Act,\3\ 
which the Commission recently published for public comment, would 
require short sellers in all equity securities to locate securities to 
borrow before selling and would impose strict delivery requirements on 
securities where many sellers have failed to deliver the securities.
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    \3\ See Securities Exchange Act Release No. 48709 (Oct. 28, 
2003), 68 FR 62972 (Nov. 6, 2003).
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2. Basis
    The PCX believes that the proposal is consistent with Section 6(b) 
of the Act \4\ and furthers the objectives of Section 6(b)(5) \5\ of 
the Act in that it is designed to promote just and equitable principles 
of trade, prevent fraudulent and manipulative acts and practices, and 
protect investors and the public interest.
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    \4\ 15 U.S.C. 78f(b).
    \5\ 15 U.S.C. 78f(b)(5).
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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

    The PCX neither solicited nor received written comments on the 
proposed rule change.

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

    Within 35 days after 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 that date if it finds the longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the PCX 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 amended 
proposal 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. 
Comments may also be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to 
File No. SR-PCX-2002-66, and this file number should be included on the 
subject line

[[Page 11475]]

if e-mail is used. To help the Commission process and review your 
comments more efficiently, comments may be sent in hard copy or by e-
mail, but not by both methods. 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 the filing will also be available for 
inspection and copying at the principal office of the PCX. All 
submissions should be submitted by March 31, 2004.
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    \6\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\6\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-5376 Filed 3-9-04; 8:45 am]
BILLING CODE 8010-01-P