[Federal Register Volume 67, Number 100 (Thursday, May 23, 2002)]
[Notices]
[Pages 36283-36286]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 02-12985]
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SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-45937; File No. SR-PCX-2002-13)
Self-Regulatory Organization; Order Approving Proposed Rule
Change by the Pacific Exchange, Inc. Relating to the Priority of Bids
and Offers on the Options Floor and the Manner in Which Orders Must Be
Allocated in Connection With Options Transactions
May 15, 2002.
I. Introduction
On February 15, 2002, the Pacific Exchange, Inc. (``PCX'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``Commission''), pursuant to section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change relating to priority of bids and offers on the
options floor and the manner in which orders must be allocated in
connection with options transactions. On March 12, 2002, the PCX
submitted Amendment No. 1 to the proposed rule change. The proposed
rule change, as amended, was published for comment in the Federal
Register on April 2, 2002.\3\ The Commission received no comments on
the proposed rule change. This order approves the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 45634 (March 22,
2002), 67 FR 15649 (April 2, 2002) (``Notice''). Although the Notice
stated that the date of filing of the proposed rule change was
February 19, 2002, the proposal was deemed filed on February 15,
2002.
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II. Description of Proposal
The PCX is proposing to adopt new rules, and to amend existing
rules, to include practices and procedures whereby option orders are
allocated on the Exchange's Options Trading Floor to address situations
where the rules are currently silent. This rule filing is being
submitted to the Commission pursuant to subparagraph IV.B.j. of the
Commission's Order of September 11, 2000.\4\
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\4\ See Order Instituting Public Administrative Proceedings
Pursuant to section 19(h)(1) of the Securities Exchange Act of 1934,
Making Findings and Imposing Remedial Sanctions, Securities Exchange
Act Release No. 43268 (September 11, 2000).
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The proposed rule change includes provisions that concern several
areas, as described below:
a. Obligations of Market Makers
The Exchange is proposing to adopt new PCX Rule 6.37(e)(2), which
would prohibit any practice or procedure whereby Market Makers trading
any particular option issue determine by agreement the allocation of
orders that may be executed in that issue.
b. Simultaneous Bids and Offers
Currently, PCX Rule 6.75(a) provides that the highest bid has
priority, but where two or more bids for the same option contract
represent the highest price and one is displayed by the Order Book
Official, that bid receives priority over any other bid at the post. If
two or more bids represent the highest price and a bid displayed by an
Order Book Official is not involved, the rule provides that priority is
afforded to those bids in the sequence in which they are made. PCX Rule
6.75(b) applies the same priority principles to offers.
The Exchange is now proposing to adopt new PCX Rule 6.75(c),
entitled ``Simultaneous Bids an Offers.'' This proposed provision
states that, except as otherwise provided, if the bids (or offers) of
two or more members are made simultaneously, or if it is impossible to
determine clearly the order of time in which they were made, such bids
(or offers) will be deemed to be on parity and priority will be
afforded to them, insofar as practicable, on an equal basis.
c. Order Allocation Procedures
1. In General: Determination of Priority Sequence
Proposed PCX Rule 6.75(f)(1) states that a Floor Broker is
responsible for determining the sequence in which bids or offers are
vocalized on the Trading Floor in response to the Floor Broker's bid,
offer, or call for a market. It further states that my disputes
regarding a Floor Broker's bid, offer, or call for a market. It further
states that any disputes regarding a Floor Broker's determination of
time priority sequence will be resolved by the Order Book Official,
provided that such determinations of the Order Book Official are
subject to further review by two Floor Officials, pursuant to PCX Rule
6.77.
Proposed PCX Rule 6.75(f)(2) provides that when a Floor Broker's
bid or offer has been accepted by more than one member, that Floor
Broker must designate the members who were first, second, third, and so
forth. It further states that, except as otherwise provided, the member
with first priority is entitled to buy or sell as many contracts as the
Floor Broker may have available to trade. if there are any contracts
remaining, the member with second priority will be entitled to buy or
sell as many contracts as there are remaining in the Floor Broker's
order, and so on, until the Floor Broker's order has been filled
entirely.
Proposed PCX Rule 6.75(f)(3) provides that a Market Maker is
responsible for determining the sequence in which bids and offers are
vocalized on the Trading Floor in response to that Market Maker's bid,
offer, or call for a market. Likewise, an Order Book Official is
responsible for determining the sequence in which bids and offers are
vocalized on the Trading Floor in response to the Order Book Official's
bid, offer, or call for a market. The proposed rule further provides
that the order allocation procedures for Market Makers and Order Book
Officials, including the determination of time priority sequence, are
the same as those for Floor Brokers as set forth in proposed PCX Rule
6.75(f)(1) as described above.
[[Page 36284]]
2. LMM Guaranteed Participation
Proposed PCX Rule 6.75(f)(4)(A) provides that if a Lead Market
Maker (``LMM'') establishes first priority during the vocalization
process, the LMM will be entitled to buy or sell as many contracts as
the Floor Broker may have available to trade. However, if the LMM does
not establish first priority during the vocalization process, but does
establish second, third, or some other time priority sequence, the LMM
will be entitled to buy or sell the number of contracts equal to the
LMM's guaranteed participation level (pursuant to PCX Rule 6.82(d)(2))
plus any contracts the Floor Broker has remaining after the bids or
offers of other members with higher time priority than the LMM have
been satisfied.
Proposed PCX Rule 6.75(f)(4)(B) provides that if one or more orders
in the limit order book have priority over an LMM's bid or offer, then
the LMM's guaranteed participation level will apply only to the number
of contracts remaining after all contracts in the limit order book that
are at, or better than, the LMM's bid or offer have first been
satisfied.
Proposed PCX Rule 6.75(f)(4)(C) provides that LMMs may waive some
or all of their guaranteed participation on particular trades, but only
to the extent that doing so is permissible under PCX Rule 6.86 (``Firm
Quotes''). In such circumstances, if the LMM has waived the right to
trade a certain number of option contracts, those option contracts will
then become available for execution by the member (or members) who are
next in priority sequence.
Proposed PCX Rule 6.75(f)(4)(D) provides that LMMs may direct some
or all of their guaranteed participation to competing public orders in
the trading crowd pursuant to PCX Rule 6.82(d).
Proposed PCX Rule 6.75(f)(4)(E) provides that bid and offering
prices that are disseminated by an automatic quotation system are
presumed to be the bid and offering prices of the LMM for purposes of
PCX Rule 6.86 (``Firm Quotes'') and PCX Rule 6.82(d)(2) (``Guaranteed
Participation''). Nevertheless, LMMs must vocalize all of their bids
and offers in response to a call for a market and in acceptance of
another member's bid or offer. If a Floor Broker enters the trading
crowd and vocalizes acceptance of a bid or offer that is then being
disseminated, the LMM will be entitled to guaranteed participation on
that transaction.
3. Parity Due to Simultaneous Bidding or Offering
Proposed PCX Rule 6.75(f)(5)(A) states that if the bids or offers
of more than one member are made simultaneously, such bids or offers
will be deemed to be on parity and priority will be afforded to them,
insofar as practicable, on an equal basis, pursuant to PCX Rule
6.75(c). Accordingly, the proposed rule change states that efforts will
be made to assure that each member on parity receives an equal number
of contracts, to the extent mathematically possible. One or more
members on parity may waive their rights to some of their share (or
shares) of contracts, but only to the extent that doing so is
permissible under PCX Rule 6.86 (``Firm Quotes''). In such
circumstances, the remaining number of contracts will be allocated, to
the extent practicable, on an equal basis. However, an LMM who has
received guaranteed participation on a transaction may not participate
in the waived portion of the order unless there are contracts remaining
to be allocated after all other members have been satisfied.
Proposed PCX Rule 6.75(f)(5)(B) provides that if the bids and
offers of more than one member, including the LMM, are on parity, then
the LMM's guaranteed participation will first be applied to the entire
order and the remainder of the order will be allocated, to the extent
practicable, on an equal basis among the members other than the LMM who
are on parity. The LMM may participate in such remainder of the order
only if there are contracts remaining after all members other than the
LMM have first been satisfied.
Proposed PCX Rule 6.75(f)(5)(C) states that if the LMM waives
priority or guaranteed participation when the LMM and one or more other
members are on parity, then the portion of the order that the LMM has
waived will be made available to the other members who are on parity.
4. Size Pro Rata Allocations (Collective Response Situations)
Proposed Rule 6.75(f)(6) states that if the members of the trading
crowd provide a collective response to a member's request for a market
in order to fill a large order, pursuant to PCX Rule 6.37(f)(2), then
if the size of the trading crowd's market, in the aggregate, is less
than or equal to the size of the order to be filled, the members of the
trading crowd will each receive a share of the order that is equal to
the size of their respective bids or offers. However, if the size of
the trading crowd's market exceeds the size of the order to be filled,
that order will be allocated on a size rata basis, with the members of
the trading crowd each receiving, to the extent practicable, the
percentage of the order that is the ratio of the size of their
respective bids or offers to the total size of all bids or offers.
d. Procedures of Lead Market Makers
PCX Rule 6.82(d)(2) currently provides, in part, that LMMs at their
own discretion may direct their guaranteed participation to competing
public orders in the crowd. The Exchange is proposing to modify this
provision to provide that LMMs may direct ``some or all'' of their
guaranteed participation to competing public orders (i.e., competing
orders for the accounts of non-broker-dealers) in the crowd.
PCX Rule 6.82(d)(2) currently provides, in part, that LMMs ``shall
be allocated 50% participation in transactions occurring at their
disseminated bids and/or offers in their allocated issue(s).'' The
Exchange is proposing to amend this rule so that it provides that LMMs
``shall be allocated 50% participation (or such lesser percentage as
the Options Allocation Committee may establish in allocating an issue
to an LMM) in transactions occurring at their disseminated bids and/or
offers in their allocated issues.''
Finally, PCX Rule 6.82(e)(2)(a) currently provides, in part, that
LMMs ``shall have a right to participate pro rata with the trading
crowd in trades that take place at the LMM's principal bid or offer.''
The Exchange is proposing to modify this provision to state that LMMs
``have a right to participate with the trading crowd in trades that
take place at the LMM's principal bid or offer, pursuant to the
priority rule set forth in PCX Rule 6.75.''
III. Discussion
After careful consideration, the Commission has determined to
approve the proposed rule change.\5\ For the reasons discussed below,
the Commission finds that the proposed rule change is consistent with
the requirements of the Act and the rules and regulations thereunder
applicable to a national securities exchange. Specifically, the
Commission finds that the proposed rule change is consistent with the
requirements of Section 6(b)(5) of the Act.\6\
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\5\ In approving the proposal, the Commission has considered its
impact on efficiency, competition, and capital formation. 15 U.S.C.
78c(f).
\6\ 15 U.S.C. 78f(b)(5). Section 6(b)(5) of the Act requires
that the rules of an exchange, among other things, be designed to
prevent fraudulent and manipulative acts and practices, to promote
just and equitable principles of trade, to remove impediments to and
perfect the mechanisms of a free and open market and a national
market system, and, in general, to protect investors and the public
interest; and not be designed to permit unfair discrimination
between customers, issuers, brokers, or dealers.
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[[Page 36285]]
The Commission believes that the proposed provision concerning
``Obligations of Market Makers,'' which prohibits agreements among
Market Makers with respect to the allocation of trades, should help to
preclude anti-competitive conduct and prevent fraudulent and
manipulative acts and practices.
The Commission believes further that the proposed provision
concerning ``Simultaneous Bids and Offers'' fills a significant gap in
the Exchange's current rules by setting forth the method for allocating
an order among market participants in situations when their competing
bids or offers are made simultaneously, or when the sequence in which
their bids or offers were made cannot be clearly determined. In the
Commission's view, the proposed rule change establishes a fair and
equitable manner of apportioning an order in these situations by
providing that the bids or offers will be deemed to be an parity, so
that each maker receives, as far as practicable, an equal share of the
order.
With respect to ``Order Allocation Procedures,'' the Commission
believes that the proposed rule change provides an important
clarification by specifying the market participant with responsibility
for determining the time priority sequence of bids and offers vocalized
on the Trading Floor in response to a bid, offer, or call for a market.
As discussed above, the proposed rule change assigns this duty to the
Floor Broker, the Order Book Official, or Market Maker to whose bid,
offer, or call for a market the participants responded. The Commissions
believes that this is a reasonable method of assigning responsibility
for allocating a trade, particularly because the market participant who
initiated the bid, offer, or call for a market is the best position to
determine the identity and sequence of who responded.
The Commission notes that the proposal also provides for the
resolution of disputes regarding the determination of time priority
sequence, which should contribute to fair allocation of orders. The PCX
also has represented that is has the ability to determine the identity
of the individual who allocated a particular trade,\7\ and the
Commission believes that the ability to identify such individuals is
important to the Exchange's ability to monitor for violation of
Exchange allocation rules.
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\7\ See Notice, supra note 3, at n.6.
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The Commission notes that the provisions of the proposed rule
change concerning the ``LMM Guaranteed Participation'' provide a more
specific description of how this guaranteed participation is to be
applied than that provided in the PCX's current rules. Among other
things, the proposal specifies that the LMM Guaranteed Participation
applies only to the number of contracts remaining after all customer
orders in the limit order book have first been satisfied. Although PCX
Rule 6.82(d)(2) already provides that public order placed in the book
take priority over the LMM guarantee, the Commission believes that the
new provision is an important clarification of the Exchange's rules
regarding application of the LMM guarantee.
Existing PCX Rule 6.82(d)(2) provides that the LMM Guaranteed
Participation applies in ``transaction occurring at the [LMMs']
disseminated bids and/or offers.'' The proposal fills in a significant
gap in the Exchange's current rules, in the Commission's view, by
clarifying that prices disseminated by an automatic quotation system
are presumed to be the prices of the LMM so as to qualify the LMM for
the Guaranteed Participation. The proposed rule change also establishes
that the prices disseminated by an automatic quotation system are
presumed to be the bid and offer of the LMM for purposes of PCX Rule
6.86 on ``Firm Quotes.'' \8\ The proposal further states that LMMs must
nevertheless vocalize all their bids or offers in response to a call
for a market or in acceptance of a bid or offer that is being
disseminated. In the Commission's view, this requirement is appropriate
to harmonize the proposed rule change with the PCX's other rules on
vocalization.
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\8\ The Commission notes that PCX Rule 6.86 provides that ``with
respect to any bid or offer for any listed option made available by
the Exchange to quotation vendors, the Lead Market Maker and any
registered Market Makers constituting the trading crowd in such
option series will collectively be the Responsible Broker or Dealer
to the extent of the aggregate quotation size specified.''
Accordingly, if the Exchange's quotation is established by an
automatic quotation system, such quotation is the quotation of all
members of the crowd.
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The Commission also believes that it is reasonable to permit
members and LMMs to waive all or some of their share of contracts, as
provided in the proposed provisions concerning ``Parity Due to
Simultaneous Bidding or Offering,'' consistent with the PCX's rule on
firm quote obligations. THe Commission further believes that it is fair
and equitable to allocate such waived contracts among the other members
on parity on an equal basis, to the extent practicable, as the proposed
rule change provides.\9\
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\9\ The Commission notes that the proposed rules on the LMM
Guaranteed Participation provide that if the LMM waives some of that
participation, the contracts will become available to the members
who are next in the priority sequence. The Commission believes this,
too, is a reasonable allocation method that conforms with the time
priority principles reflected elsewhere in the PCX's rules.
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The Commission notes that, as made clear by the proposal, an LMM
who has received a guaranteed participation may not participate in the
waived portion of an order unless there are remaining contracts to be
allocated after all other members have been satisfied. Similarly, the
proposed rule change clarifies generally that when one or more members
are on parity with the LMM, after the LMM receives its Guaranteed
Participation, the LMM is not entitled to a share in the remainder of
the order with the other members unless all such other members have
been satisfied. The Commission believes that these provisions will help
assure fair allocation of orders and maintain a competitive environment
on the Exchange.
As detailed above, the proposed rule change also clarifies how
orders are allocated in the situation where members of the trading
crowd provide a collective response to a member's request for a market
in order to fill a large order pursuant to PCX Rule 6.37(f)(2).\10\ In
the Commission's view, allocating participating members their
respective sizes when their aggregate size is less than or equal to the
size of the order, and allocating them their shares on a pro rata basis
when their aggregate size exceeds the size of the order, is a
reasonable way to apportion participation in such trades.
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\10\ See Securities Exchange Act Release No. 45578 (March 15,
2002), 67 FR 13393 (March 22, 2002) (SR-PCX-2001-50).
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With respect to ``Procedures of Lead Market Makers,'' the
Commission believes that it is reasonable to amend PCX Rule 6.82(d)(2)
to give the Options Allocation Committee the ability to reduce the LMM
Guaranteed Participation percentage from the maximum permitted under
PCX Rule 6.82(d) when it allocates an issue to an LMM. The Commission
notes that subparagraphs (A) and (B) of Rule 6.82(d)(2) already permit
the Committee to reduce the LMM guarantee under certain conditions.
The additional amendment clarifying that an LMM may direct some of
its participation to a public order in the crowd--not just all of it,
as the current rules implies--is reasonable, in the
[[Page 36286]]
Commission's view, as it conforms with the original purpose of this
provision.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\11\ that proposed rule change (SR-PCX-2002-13) be, and hereby is,
approved.
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\11\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-12985 Filed 5-22-02; 8:45 am]
BILLING CODE 8010-01-M