[Federal Register Volume 59, Number 149 (Thursday, August 4, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-18960] [[Page Unknown]] [Federal Register: August 4, 1994] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-34463; File No. SR-Phlx-92-12] Self-Regulatory Organizations; Order Approving a Proposed Rule Change by the Philadelphia Stock Exchange, Inc., Relating to Restrictions on Orders in Multiply Traded Options Entered by Specialists and Registered Options Traders for Execution on Other Exchanges July 29, 1994. On December 14, 1992, the Philadelphia Stock Exchange, Inc. (``Phlx'' or ``Exchange'') filed with 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 restrictions on entering orders in multiply traded options. Notice of the proposal appeared in the Federal Register on March 12, 1993.\3\ One comment letter was received opposing the proposed rule change,\4\ to which the Phlx responded.\5\ This order approves the Exchange's proposal. --------------------------------------------------------------------------- \1\15 U.S.C. 78s(b)(1) (1988). \2\17 CFR 240.19b-4 (1992). \3\See Securities Exchange Act Release No. 31961 (March 8, 1993), 58 FR 13662 (March 12, 1993). \4\See Letter from Alger Chapman, Chairman and Chief Executive Officer, CBOE, to Jonathan Katz, Secretary, Commission, dated April 13, 1993 (``CBOE Comment Letter''). \5\See Letter from Gerald O'Connell, Vice President, Market Regulation, Phlx, to Jonathan Katz, Secretary, Commission, dated June 25, 1993 (``Phlx Response Letter''). --------------------------------------------------------------------------- Description of Proposal The Phlx proposes to adopt Advice B-12, which would extend the prohibitions contained in Phlx Rule 1014 and Phlx Advice B-4, regarding off-floor opening orders for options traded on multiple exchanges. Currently, Commentary .14 to Phlx Rule 1014 and Phlx Advice B-4 prohibit a Registered Options Trader (``ROT'') from placing an opening order for their market functions account from off-floor. The Phlx now seeks to restrict Phlx ROTs and specialists from sending orders which would establish or increase a position in registered options to other exchanges from off of the Phlx options trading floor. Before an opening order initiated from the Phlx equity options floor may be sent to another market for execution, it must first clear the crowd at the Phlx when the bid or offer of the order is on or between the Phlx disseminated market.\6\ Pursuant to the proposal, ROTs and specialists would be required to place their off-floor opening positions in their customer accounts, regardless of whether the execution of such orders occurs on the Phlx or on another exchange.\7\ The fine schedule for proposed Advice B-12 would run on a three year cycle, such that repeat violations within a three-year period would result in escalating fines.\8\ --------------------------------------------------------------------------- \6\Clearing the crowd on the Phlx would require that the order be loudly and audibly voiced in the crowd and, if not then executed, the order may be sent away. \7\Proposed Advice B-12 would only be applicable to transactions in equity option. \8\The fine schedule for Advice B-12 provides that a fine of $500 will be imposed for the first violation and a fine of $1,000 will be imposed for the second violation. The sanction for the third violation is discretionary with the Phlx Business Conduct Committee. In addition, under a rolling three-year cycle, if three years elapse between the first and second violation, the second violation would be treated as a first violation. If there is a violation within the three years after the most recent violation, the next highest fine will be issued. Thus, a third violation less than three years after a fine was issued for a second violation would be treated as a ``third violation,'' even though more than three years may have elapsed after the first violation. --------------------------------------------------------------------------- Comment Letter The CBOE believes that the Phlx proposal raises implications regarding the multiple listing of options which should be dealt with on a uniform basis by the options exchanges.\9\ Specifically, the CBOE believes that the proposal would allow Phlx specialists and ROTs, who enter transactions from the Phlx options floor, to obtain ``good faith'' margin treatment for options transactions executed on other exchanges even if there is little or no activity in those options on the Phlx and the transactions have no relationship to the specialists' and ROTs' performance at the Phlx. As a result, the CBOE believes that multiple listing could be used as a means of giving the floor members of options exchanges preferred access to options traded on other exchanges without regard to whether there is any meaningful competition in those options between the exchanges.\10\ The CBOE suggests that specialists and ROTs should be required to effect a certain percentage (e.g., 75%) of their contract volume in a class of options on the exchange on which they act as a specialist or ROT before being entitled to effect transactions on other exchanges in that options class through their market functions accounts.\11\ --------------------------------------------------------------------------- \9\The CBOE acknowledges, however, that the proposal is a logical extension of the Phlx's existing rules because it accords the same treatment to all transactions initiated from off the Phlx floor without regard to whether the transactions are executed on the Phlx or another exchange. See CBOE Comment Letter, supra note 4. \10\Id. \11\Id. --------------------------------------------------------------------------- Phlx Response The Phlx refutes the arguments raised by the CBOE.\12\ The Phlx states that by seeking to ensure that Phlx floor traders conduct their market making functions from the Phlx equity options floor where they can best meet their affirmative and negative market making obligations, the proposal merely brings the Phlx's rules into line with the existing rules of the other options exchanges, including the CBOE's. As a result, the Phlx contends that the proposal does not raise the implications contemplated by the CBOE of ``disparate, competitive treatment by the different options exchanges.''\13\ --------------------------------------------------------------------------- \12\See Phlx Response Letter, supra note 5. \13\Id. --------------------------------------------------------------------------- Additionally, the Phlx argues that it has rules in place addressing the competitive concerns raised by the CBOE. Pursuant to Phlx Advice B- 3, ROTs are required to trade in person, and not through the use of orders, the greater of 1,000 contracts or 50% of their contract volume on the Exchange in each quarter.\14\ Additionally, at least 50% of a ROT's trading activity in each quarter must be in assigned options classes. Proposed Advice B-12 does not alter the application of Advice B-3. As a result, the Phlx argues that specialists and ROTs would not be able to obtain good faith margin treatment for a significant number of transactions executed on other markets relative to the number of trades that they must execute on the Phlx equity options floor, regardless of the level of trading activity in their assigned options classes at the Phlx.\15\ --------------------------------------------------------------------------- \14\These trades must actually be executed on the Exchange. Trades that are announced on the Exchange floor, clear the crowd, and are subsequently executed on another market, are not counted as Exchange trades for purposes of this requirement. Telephone conversation between Gerald O'Connell, Vice President, Market Regulation, Phlx, and Sharon Lawson, Assistant Director, Office of Market Supervision, Division of Market Regulation, Commission, on July 18, 1994. \15\Id. --------------------------------------------------------------------------- Discussion 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, and, in particular, the requirements of Section 6(b)(5)\16\ in that the proposal is designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, and to protect investors and the public interest. Specifically, the Commission finds that the proposal is a reasonable extension of the Phlx's existing rules by according the same treatment to all transactions initiated from off the Phlx floor, without regard to whether the transactions are executed on the Phlx or another exchange. The Commission agrees with the Exchange that this restriction should serve to ensure that Phlx floor traders are conducting their market making activities from on the floor where they can best meet their affirmative and negative market making obligations. --------------------------------------------------------------------------- \16\15 U.S.C. 78f(b)(5) (1988). --------------------------------------------------------------------------- The Commission appreciates the concerns raised by the CBOE; however, the Commission believes that the Phlx has adequate rules and procedures to ensure that Exchange ROTs and specialists can obtain market-maker treatment for options trades executed on other exchanges only where they perform a real market-making function for such options on the Phlx floor. First, under Section 11(b) of the Act,\17\ Rule 11b- 1 thereunder\18\ and Phlx Rule 1014, specialists and ROTs are required to engage in a course of dealings in a manner reasonably calculated to contribute to the maintenance of a fair and orderly market. This ensures that trades by such persons are for the purposes of fulfilling market-making obligations under the Act. Secondly, Exchange Advice B-3 minimizes the opportunity for ROTs to obtain good faith margin for a significant number of trades executed on other exchanges. By requiring that the greater of 1,000 contracts or 50% of their contract volume be executed on the Exchange in each quarter\19\ and that at least 50% of their contract volume be in assigned classes in each quarter. Advice B- 3 effectively ensures that market-makers will not be able to use the Phlx floor simply to send orders to other markets but instead will have substantive obligations that ensure they are acting as a bona fide market-maker.\20\ --------------------------------------------------------------------------- \17\15 U.S.C. 78k(b) (1988). \18\17 CFR 240.11b-1 (1981). \19\See supra note 14. \20\CBOE Rule 8.7, Interpretation and Policy .03, is quite similar to Phlx Advice B-3. This CBOE rule requires that (1) ``at least 75 percent of a Market-Maker's total contract volume must be in option classes to which he has been appointed pursuant to [CBOE] Rule 8.3;'' and (2) ``a Market-Maker must execute in person, and not through the use of orders, at least 25 percent of his total transactions.'' --------------------------------------------------------------------------- In summary, the Commission notes that only market makers who are conducting bona fide market making activity on the Phlx floor are entitled to good faith margin treatment for their options transactions. As a result of the above, the Commission does not believe that the current proposal would result in disparate, competitive treatment by the options exchange, as envisioned by the CBOE.\21\ --------------------------------------------------------------------------- \21\Indeed, the Commission believes that approval of the proposed rule change makes the situation envisioned by the CBOE less likely by removing the ambiguity that currently exists in the Phlx's rules and clarifying that off-floor orders, whether executed on the Phlx floor or at another exchange, are not entitled to good faith margin treatment. --------------------------------------------------------------------------- It is therefore ordered, pursuant to Section 19(b)(2) of the Act,\22\ that the proposed rule change (SR-PHlx-92-12) is hereby approved. \22\15 U.S.C. 78s(b)(2) (1988). --------------------------------------------------------------------------- For the Commission, by the Division of Market Regulation, pursuant to delegated authority.\23\ --------------------------------------------------------------------------- \23\17 CFR 200.30-3(a)(12) (1993). --------------------------------------------------------------------------- Margaret H. McFarland, Deputy Secretary. [FR Doc. 94-18960 Filed 8-3-94; 8:45 am] BILLING CODE 8010-01-M