[Federal Register Volume 70, Number 47 (Friday, March 11, 2005)]
[Notices]
[Pages 12257-12260]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-1020]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51318; File No. SR-PCX-2005-25]


Self-Regulatory Organizations; Pacific Exchange, Inc.; Notice of 
Filing and Immediate Effectiveness of Proposed Rule Change Relating to 
Split Price Priority

March 4, 2005.
    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 March 1, 2005, the Pacific Exchange, Inc. (``PCX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II below, which Items 
have been prepared by PCX. The Exchange filed the proposal pursuant to 
Section 19(b)(3)(A) of the Act,\3\ and Rule 19b-4(f)(6) thereunder,\4\ 
which renders the proposal effective upon filing with the Commission. 
The Commission is publishing this notice to solicit

[[Page 12258]]

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.
    \3\ 15 U.S.C. 78s(b)(3)(A).
    \4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    PCX proposes to amend PCX Rule 6.75 relating to split price 
transactions. The text of the proposed rule change is set forth 
below.\5\ Proposed new language is in italics; proposed deletions are 
in [brackets].
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    \5\ Based on a conversation with PCX, the Commission staff made 
two grammatical corrections to the proposed rule text. Telephone 
conference on March 3, 2005 between Steven Matlin, Senior Counsel, 
PCX and Ann Leddy, Special Counsel, Division of Market Regulation, 
Commission.
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* * * * *
    Rule 6.75(h) Priority on Split Price Transactions Occurring in Open 
Outcry.
    (1) Purchase or sale priority. If an OTP Holder or OTP Firm 
purchases (sells) one or more option contracts of a particular series 
at a particular price or prices, the OTP Holder or OTP Firm must, at 
the next lower (higher) price at which another OTP Holder or OTP Firm 
bids (offers), have priority in purchasing (selling) up to the 
equivalent number of option contracts of the same series that the OTP 
Holder or OTP Firm purchased (sold) at the higher (lower) price or 
prices, provided that the OTP Holder or OTP Firm's bid (offer) is made 
promptly and continuously and that the purchase (sale) so effected 
represents the opposite side of a transaction with the same order or 
offer (bid) as the earlier purchase or purchases (sale or sales). This 
paragraph only applies to transactions effected in open outcry.
    (2) [Sale priority. If an OTP Holder or OTP Firm sells one or more 
option contracts of a particular series at a particular price or 
prices, he shall, at the next higher price at which another OTP Holder 
or OTP Firm offers, have priority in selling up to the equivalent 
number of option contracts of the same series that he sold at the lower 
price or prices, provided that his offer is made promptly and that the 
sale so effected represents the opposite side of a transaction with the 
same order or bid as the earlier sale or sales.] If an OTP Holder or 
OTP Firm purchases (sells) fifty or more option contracts of a 
particular series at a particular price or prices, he/she shall, at the 
next lower (higher) price have priority in purchasing (selling) up to 
the equivalent number of option contracts of the same series that he/
she purchased (sold) at the higher (lower) price or prices, but only if 
his/her bid (offer) is made promptly and the purchase (sale) so 
effected represents the opposite side of the transaction with the same 
order or offer (bid) as the earlier purchase or purchases (sale or 
sales). The Exchange may increase the ``minimum qualifying order size'' 
above 100 contracts for all products. Announcements regarding changes 
to the minimum qualifying order size shall be made via an Exchange 
Bulletin. This paragraph only applies to transactions effected in open 
outcry.
    (3) No Change.
    (4) Except for the provisions set forth in Rule 6.75(h)(2), [T]the 
priority afforded by this rule is effective only insofar as it does not 
conflict with orders on the book of the Order Book Official as provided 
in Rule 6.75. Such orders on the book of the Order Book Official have 
precedence over OTP Holders and OTP Firms' orders at a particular 
price; orders on the book also have precedence over OTP Holder or OTP 
Firms' orders that are not superior in price by at least the MPV.
    (5) Floor Brokers are able to achieve split price priority in 
accordance with paragraphs (1) and (2) above. Provided however, that a 
floor broker who bids (offers) on behalf of a non-market-maker PCX 
broker-dealer (``PCX BD'') must ensure that the PCX BD qualifies for an 
exemption from Section 11(a)(1) of the Exchange Act or that the 
transaction satisfies the requirements of Exchange Act Rule 11a2-2(T), 
otherwise the floor broker must yield priority to orders for the 
accounts of non-OTP Holders or non-OTP Firms.
* * * * *

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 Exchange 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
    PCX Rule 6.75(h) establishes priority for split-price transactions. 
Generally, an OTP Holder or OTP Firm buying (selling) at a particular 
price shall have priority over other OTP Holders or OTP Firms 
purchasing (selling) up to an equivalent number of contracts of the 
same order at the next lower (higher) price. Awarding split price 
priority serves as an inducement to OTP Holders and OTP Firms to bid 
(offer) more aggressively for an order that may require a split-price 
execution by giving them priority at the next lower (higher) price 
point. For example, assume the market is $1.00-$1.20, 300 up when a 
floor broker (``FB'') receives instructions from a customer that it 
would like to buy 500 options at a price or prices no higher than 
$1.20. The FB could attempt to execute the order in open outcry at a 
price better than the displayed market of $1.20. Assume a market maker 
(``MM'') in the crowd is willing to sell 250 contracts at $1.15 
provided he can also sell the remaining 250 contracts at $1.20. Under 
current PCX rules, that MM could offer $1.15 for 250 contracts and 
then, by virtue of the split price priority rule, he/she would have 
priority for the balance of the order (up to 250 contracts) over other 
crowd members. If executed, the resulting net price of $1.175 is better 
than the current displayed market of $1.20, which results in a better 
fill for the customer.\6\
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    \6\ If successful, two trades will be reported at $1.15 and 
$1.20 and the net price result to the customer will be $1.175.
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    One limitation on the ability of crowd participants to use the 
split price priority rule is the rule's requirement that orders in the 
limit order book (``Book'') have priority over the OTP Holder or OTP 
Firm attempting to fill the balance of the order at the split price. 
Using the example above, if the $1.20 price represented orders in the 
Book, those orders would have priority over the MM at $1.20. This means 
that a MM who is willing to trade at $1.15 and $1.20 may be completely 
unwilling to trade at the better price of $1.15 if he/she cannot trade 
the balance of the order at $1.20 because of the requirement to yield 
to existing customer interest in the Book. This jeopardizes the FB's 
ability to execute the first part of the order at a price of $1.15, 
thereby potentially making it difficult to achieve price improvement 
for the customer at the PCX. Instead, the order may trade at another 
exchange that has no impediments, i.e., no customer interest at those 
price levels. Accordingly, the purpose of this proposal is to adopt a 
limited exception to the existing priority requirement.
    Under newly proposed paragraph (2) of Rule 6.75, an OTP Holder or 
OTP Firm with an order for at least 100 contracts who buys (sells) at 
least 50 contracts at a particular price would have price priority over 
all others in

[[Page 12259]]

purchasing (selling) up to an equivalent number of contracts of the 
same order at the next lower (higher) price.\7\ Using the above 
example, the MM trading at $1.15 would have priority over OTP Holders 
and OTP Firms and orders in the Book at $1.20 to trade at $1.20 with 
the balance of the order in the trading crowd. The Exchange believes 
the proposal will lead to more aggressive quoting by MMs, which in turn 
could lead to better executions. As indicated above, a MM may be 
willing to trade at a better price for a portion of an order if he/she 
is assured of trading with the balance of the order at the next pricing 
increment. As a result, FBs representing orders in the trading crowd 
may receive better-priced executions. As proposed, the Exchange will 
have the ability to increase the minimum qualifying order size to a 
number larger than 100 contracts. Any changes, which would have to 
apply to all products, would be announced to the OTP Holders and OTP 
Firms via an Exchange Bulletin.
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    \7\ Orders for less than 100 contracts would be unaffected by 
this proposal. The Exchange also takes the opportunity to 
consolidate current paragraphs (1) and (2) of Rule 6.75(h) into one 
paragraph (paragraph (1)). This consolidation would not effect the 
operation of the rule in any way; it simply would make the rule 
shorter.
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    The Exchange believes that it is reasonable to make a limited 
exception to the customer priority rule to allow split price trading. 
In this regard, the proposed exception would be similar in operation to 
the limited priority exception that exists for Combination, Spread, 
Ratio and Straddle orders (contained in Rule 6.75, Commentary .04). 
This priority exception generally provides that a crowd member 
affecting a qualifying order may trade ahead of the Book on one side of 
the order provided the other side of the order betters the Book. This 
exception was intended to facilitate the trading of Combination, 
Spread, Ratio and Straddle orders, which by virtue of their multi-
legged composition could be more difficult to trade without a limited 
exception to the priority rule for one of the legs. The purpose behind 
the proposed split-price priority exception is the same--to facilitate 
the execution of large orders, which by virtue of their size and the 
need to execute them at multiple prices may be difficult to execute 
without a limited exception to the priority rules. The proposed 
exception would operate in the same manner as the Combination, Spread, 
Ratio and Straddle order exception by allowing an OTP Holder or OTP 
Firm affecting a trade that betters the market to have priority on the 
balance of that trade at the next pricing increment even if there are 
orders in the Book at the same price.
    To address potential concerns regarding Section 11(a) of the 
Act,\8\ the Exchange proposes to adopt Rule 6.75(h)(5). Section 11(a) 
generally prohibits members of national securities exchanges from 
effecting transactions for the member's own account, absent an 
exemption. With respect to the proposal, there could be situations 
where because of the limited exception to customer priority, orders on 
behalf of members could trade ahead of orders of nonmembers in 
violation of Section 11(a).\9\ The proposed Commentary makes clear that 
FBs may avail themselves of the split-price priority rule but that they 
will be obligated to ensure compliance with Section 11(a). In this 
regard, a FB that bids (offers) on behalf of a non-market maker PCX OTP 
Holder or OTP Firm (``PCX BD'') must ensure that the PCX BD qualifies 
for an exemption from Section 11(a)(1) of the Act or that the 
transaction satisfies the requirements of Rule 11a2-2(T). Otherwise, 
the FB would be required to yield priority to orders for the accounts 
of non-OTP Holders or non-OTP Firms.
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    \8\ 15 U.S.C. 78k(a).
    \9\ For example, assume FB A walks into the trading crowd 
attempting to find a crowd member willing to effect a split-price 
transaction. FB B, who is representing either a proprietary or 
member BD order, expresses interest. In this instance, Section 11(a) 
could be implicated, absent an exemption.
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2. Statutory Basis
    For the above reasons, the Exchange believes that the proposed rule 
change would enhance competition. The Exchange believes that the 
proposed rule change is consistent with Section 6(b) \10\ of the Act, 
in general, and furthers the objectives of Section 6(b)(5),\11\ in 
particular, in that it is designed to facilitate transactions in 
securities, to promote just and equitable principles of trade, to 
foster competition and to protect investors and the public interest.
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    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange 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

    Written comments on the proposed rule change were neither solicited 
nor received.

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

    Because the foregoing proposed rule change does not:
    (i) Significantly affect the protection of investors or the public 
interest;
    (ii) Impose any significant burden on competition; and
    (iii) Become operative for 30 days from the date on which it was 
filed, or such shorter time as the Commission may designate if 
consistent with the protection of investors and the public interest, it 
has become effective pursuant to Section 19(b)(3)(A) of the Act,\12\ 
and Rule 19b-4(f)(6) thereunder.\13\ At any time within 60 days of the 
filing of the proposed rule change the Commission may summarily 
abrogate such rule change if it appears to the Commission that such 
action is necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Act.
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    \12\ 15 U.S.C. 78s(b)(3)(A).
    \13\ 17 CFR 240.19b-4(f)(6). The Commission notes that the 
Exchange provided written notice of its intent to file the proposed 
rule change, along with a brief description and text of the proposed 
rule change, at least five business days prior to the date of filing 
of the proposed rule change.
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    A proposed rule change filed under Rule 19b-4(f)(6) \14\ normally 
does not become operative prior to 30 days after the date of filing. 
However, pursuant to Rule 19b-4(f)(6)(iii), the Commission may 
designate a shorter time if such action is consistent with the 
protection of investors and the public interest. PCX has requested that 
the Commission waive the thirty-day operative date specified in Rule 
19b-4(f)(6)(iii) \15\ in order to conform its rules pertaining to split 
price priority with those of other options exchanges.
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    \14\ 17 CFR 240.19b-4(f)(6).
    \15\ 17 CFR 240.19b-4(f)(6)(iii).
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    The Commission believes that waiving the thirty-day operative delay 
is consistent with the protection of investors and the public interest 
\16\ because it will allow PCX to implement immediately rules similar 
to ones already in place at another options exchange and should 
encourage more

[[Page 12260]]

aggressive quoting by market makers in competition for large-sized 
orders, and, in turn, better-priced executions. For these reasons, the 
Commission waives the 30-day pre-operative period.
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    \16\ For purposes only of accelerating the operative date of 
this proposal, the Commission has considered the proposed rule's 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
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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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-PCX-2005-25 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609. All submissions should refer to File Number 
SR-PCX-2005-25. This file number should be included on the subject line 
if e-mail is used. To help the Commission process and review your 
comments more efficiently, please use only one method. The Commission 
will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section. Copies of such filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-PCX-2005-25 and should be 
submitted on or before April 1, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-1020 Filed 3-10-05; 8:45 am]
BILLING CODE 8010-01-P