[Federal Register Volume 61, Number 203 (Friday, October 18, 1996)]
[Notices]
[Pages 54481-54483]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-26783]
[[Page 54481]]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37810; File No. SR-PSE-96-09]
Self-Regulatory Organizations; Pacific Stock Exchange, Inc.;
Order Approving Proposed Rule Change by the Pacific Stock Exchange
Incorporated and Notice of Filing and Order Granting Accelerated
Approval of Amendment No. 2 to Proposed Rule Change Relating to the
Options Book Pilot Program
October 11, 1996.
I. Introduction
On April 1, 1996, the Pacific Stock Exchange, Inc. (``PSE'' 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
proposal to establish a pilot program under which a limited number of
lead market makers (``LMMs'') will be able to assume operational
responsibility for the options public limit order book (``Book'') in
certain options issues.\3\ The Exchange filed an amendment (``Amendment
No. 1'') \4\ to the proposed rule change on June 4, 1996. The proposed
rule change was published for comment in the Federal Register on June
27, 1996.\5\ The Exchange filed a second amendment (``Amendment No.
2'') to the proposed rule change on October 3, 1996.\6\ No comments
were received on the proposed rule change. This order approves the
Exchange's proposal.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4.
\3\ An ``options issue'' refers to all types of options
contracts (puts and calls) of the same class of options covering the
same underlying stock. See PSE Rule 6.1(a) (7) and (10).
\4\ Amendment No. 1 adds a provision to proposed PSE Rule 6.82,
Commentary .05 stating that no market maker cooperatives may
participate as LMMs in the pilot program. Amendment No. 1 also
replaces a PSE Rule 6.82, Commentary .05 reference to ``April --,
1997'' as the proposed expiration date for the pilot program, with a
reference to ``[Date]''. Letter from Michael D. Pierson, Senior
Attorney, Market Regulation, PSE, to Michael Walinskas, Special
Counsel, Office of Market Supervision (``OMS''), Division of Market
Regulation (``Division''), Commission, dated June 4, 1996.
\5\ See Securities Exchange Act Release No. 37335 (June 19,
1996), 61 FR 33568.
\6\ Letter from Michael D. Pierson, Senior Attorney, Market
Regulation, PSE, to Janet Russell-Hunter, Special Counsel, Office of
Market Supervision (``OMB''), Division of Market Regulation
(``Division''), Commission, dated October 3, 1996. Amendment No. 2
clarifies the purpose of the proposal, amends proposed Rule 6.82(h)
to change a reference to another part of the rule, and requests
accelerated approval of Amendment No. 2.
---------------------------------------------------------------------------
II. Description of the Proposal
The Exchange proposes to amend its rules governing LMMs to allow
approved LMMs to manage the Book function in certain designated options
issues. The Exchange believes that the proposed rule change will give
the Exchange greater flexibility in the operation of its lead market
maker program (``LMM Program''). It will allow approved LMMs to have
greater control over their operations on the Exchange floor. In
particular, it will allow them to set rates for execution services
provided to customers, in a manner similar to that exercised by options
specialists at other exchanges and Designated Primary Market Markers at
the Chicago Board Options Exchange. Accordingly, the Exchange believes
that the rule change will make the PSE's LMM Program more
competitive.\1\
---------------------------------------------------------------------------
\7\ Amendment No. 2, supra note 6.
---------------------------------------------------------------------------
The Book pilot program will be implemented on a limited basis,
involving no more than three LMMs and no more than forty options
symbols in total,\8\ during a one-year pilot phase. No market maker
cooperatives will be permitted to participate in the pilot.\9\ The
Exchange will evaluate the program, and, six months prior to its
expiration, will determine whether to modify it and whether to seek
permanent approval from the Commission. Under the pilot, the designated
LMMs will manage the Book function, take responsibility for trading
disputes and errors, set rates for Book execution, and pay the Exchange
a fee for systems and services.
---------------------------------------------------------------------------
\8\ Amendment No. 1, supra note 4.
Each options issue typically has only one symbol associated with
it, unless LEAPs are traded on that issue, in which case there
usually would be two additional symbols related to the issue, or
unless a contract adjustment is necessary due, for example, to a
merger or stock split, in which case one additional symbol usually
would be added.
\9\ Amendment No. 1, supra note 4.
---------------------------------------------------------------------------
The LMMs who participate during the pilot phase will be selected by
the Options Floor Trading Committee based on some or all of the
following factors: experience with trading an options issue as a market
maker or LMM and willingness to assume LMM responsibilities; trading
volume of the options issue(s); adequacy of capital; willingness to
promote the Exchange as a marketplace; history of adherence to Exchange
rules and securities laws; trading crowd/LMM evaluations conducted
pursuant to Options Floor Procedure Advice B-13; and ability to manage
the Book operation. Only dually- or multiple-traded options issues will
be eligible during the pilot phase.
The Exchange proposes to amend its Rule 6.82 to provide that,
subject to the approval of the Exchange, LMMs will be eligible to
perform all functions of the Order Book Official (``OBO'') in
designated options issues pursuant to Rules 6.51 through 6.59. In that
regard, the Exchange will allow the LMM to use Exchange personnel to
assist the LMM in performing the OBO function, and the Exchange will
charge the LMM a reasonable fee for such use of Exchange personnel. If
the program is made permanent, it is contemplated that LMMs would be
responsible for hiring and maintaining their own employees, but the
Exchange would provide employees to assist LMMs when necessary due to
market conditions. Whether employed by LMMs or by the Exchange,
however, employees working in the Book operation will be subject to all
rules, policies, and procedures established by the Exchange. In
addition, LMMs will be required to resolve trading disputes, subject to
the review of two floor officials, upon the request of any party to
such dispute. LMMs also will be required to disclose Book information
to members upon request, pursuant to PSE Rule 6.57.
With regard to their duties as market makers, LMMs will be required
to perform all obligations provided in Rules 6.35 through 6.40 and
6.82(c). In addition, in executing transactions for their own ``market
maker'' accounts, LMMs will 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 proposal further provides that if the Options Allocation
Committee decides to reallocate an options issue to the market maker
system pursuant to PSE Rule 6.82(f)(i),\10\ the terminated LMM may
receive a proportionate share of the net Book revenues, not to exceed
one-half, for any period specified by the Options Appointment Committee
up to a maximum of five years. The decision to make an award will be
based on various factors, including: the length of the time of LMM
service, the LMM's capital commitment; efforts expended as LMM;
activity level of the options issue when the LMM assumed responsibility
for the Book function; and other relevant factors. The Exchange intends
to develop a procedure for determining ``net Book revenues'' and
specific guidelines for the Options Appointment Committee to follow in
determining the
[[Page 54482]]
amount of net Book revenues, if any, to be awarded.
---------------------------------------------------------------------------
\10\ In Amendment No. 2, the Exchange is making a technical
correction to the proposal by changing the cross reference in
proposed Rule 6.82(h)(1)(e) from (f)(2) to (f)(1). This change is
being made to reflect a change in another filing, and accordingly,
this change to the filing is not substantive. See Amendment No. 2,
supra note 6. See also Securities Exchange Act Release No. 37780,
(October 3, 1996) (approving changes to the LMM Program).
---------------------------------------------------------------------------
The proposal specifies that LMMs who perform the function of an OBO
pursuant to PSE Rule 6.82(h) shall maintain ``minimum net capital,'' as
provided in Rule 15c3-1 under the Act,\11\ and also shall maintain a
cash or liquid asset position of at least $500,000, plus $25,000 for
each options issue over five issues for which they perform the function
of an OBO.
---------------------------------------------------------------------------
\11\ 17 CFR 240.15c3-1
---------------------------------------------------------------------------
The Exchange believes that the proposal is consistent with Section
6(b) of the Act, in general, and Section 6(b)(5), in particular, in
that it is designed to facilitate transactions in securities, to
promote just and equitable principles of trade, and to protect
investors and the public interest.
III. Discussion
PSE Rule 6.82 (``LMM Rule'') sets forth the basic rules and
procedures applicable to the LMM Program. The Commission notes that the
LMM Program was adopted in January 1990 as a pilot program.\12\ The
Commission recently approved changes to the LMM Program that added
several new substantive provisions to the LMM Rule and clarified and
streamlined its existing provisions.\13\ In addition, the pilot LMM
Program recently was extended to September 30, 1997.\14\ The Exchange
is now proposing to establish a pilot program whereby LMMs will assume
operational responsibility for the Book in a limited number of options
issues.
---------------------------------------------------------------------------
\12\ See Securities Exchange Act Release No. 27631 (January 17,
1990), 55 FR 2462.
\13\ Securities Exchange Act Release No. 37780, supra note 10.
\14\ See Securities Exchange Act Release No. 37767 (September
30, 1996).
---------------------------------------------------------------------------
After careful consideration, the Commission finds that the
Exchange's proposal to create a limited pilot program is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange in that the
proposal is consistent with Section 6(b) of the Act, in general, and
Section 6(b)(5), in particular, in that it is designed to facilitate
transactions in securities, to promote just and equitable principles of
trade, and to protect investors and the public interest. Giving LMMs
greater control over their operations on the Exchange floor may
continue to enhance the PSE's LMM Program, thereby improving the market
for listed options on the Exchange. The Book pilot program is approved
for a one year period, to expire on October 31, 1997, unless extended
or permanently approved.
The Commission finds in particular that the program will be
implemented on a limited basis involving no more than three LMMs and no
more than forty options symbols in total during a one-year pilot phase.
The Commission finds the selection criteria for LMMs to participate in
this limited pilot to be appropriate. The Commission finds consistent
with the Act the requirement that any LMMs who perform the function of
an OBO will be required to maintain minimum net capital pursuant to
Rule 15c3-1 under the Act, as well as a cash or liquid asset position
of at least $500,000, plus $25,000 for each options issue over five
issues for which they perform the function of an OBO.\15\ The
Commission finds appropriate that no market maker cooperatives will be
permitted to participate in the pilot.\16\
---------------------------------------------------------------------------
\15\ Proposed PSE Rule 6.82, Commentary .06.
\16\ Amendment No. 1. supra note 4.
---------------------------------------------------------------------------
The Commission believes that the pilot contains adequate safeguards
to permit proper Exchange oversight of the LMMs managing the Book
function. Specifically, the Commission finds appropriate that LMMs will
be designated as OBOs and perform OBO functions pursuant to Rules 6.51
through 6.59.\17\ These functions include the OBO's duty to assist in
the maintenance of a fair, orderly, and competitive market.\18\ LMMs
running the Book will be required to report to an Options Floor
Official any unusual trading activity, transactions, or price changes,
or other unusual market conditions or circumstances that are
detrimental to the maintenance of a fair, orderly, competitive
market.\19\ LMMs also will be required to disclose to members, upon
request, the price and number of contracts which are bid below or that
are offered above the Book information displayed pursuant to Rule
6.55.\20\ The Commission also notes that the proposal incorporates the
requirement that LMMs perform all market maker obligations provided in
Rules 6.35 through 6.40 and 6.82(c).\21\
---------------------------------------------------------------------------
\17\ See Proposed PSE Rule 6.82(h)(1)(a).
\18\ See PSE Rule 6.53.
\19\ See PSE Rule 6.54.
\20\ See PSE Rule 6.57.
\21\ Proposed PSE Rule 6.82(h)(2)(a).
---------------------------------------------------------------------------
The Commission finds consistent with the Act that the proposal
places additional obligations on LMMs, and provides for their support
by the Exchange. The proposal includes a provision subjecting an LMM's
resolution of a trading dispute to the review of two floor officials
upon the request of any party to such dispute.\22\ The proposal also
requires the PSE, for a reasonable fee, to make available Exchange
personnel to assist LMMs in their OBO functions, though if the pilot is
permanently approved, LMMs may be responsible for hiring and
maintaining their own employees. The Commission notes that employees
working in the Book operation, whether employed by an LMM or the
Exchange, will be subject to all rules, policies, and procedures
established by the Exchange. Finally, the Commission finds that the LMM
Rule contains adequate provisions to permit the Exchange to reassign
one or more options issues in the event that an LMM has not performed
its duties satisfactorily.\23\
---------------------------------------------------------------------------
\22\ Proposed PSE Rule 6.82(h)(1)(c).
\23\ See PSE Rule 6.82(f).
---------------------------------------------------------------------------
The Commission finds appropriate the provision of the proposal
permitting an LMM to receive a proportionate share of net Book revenues
for a limited time, in the event that an options issue is reallocated
to the market maker system.\24\ The Commission finds that it is
appropriate for the Exchange to have the discretion to determine what
compensation, if any, an LMM should receive in the event of
reallocation of an options issue.
---------------------------------------------------------------------------
\24\ Proposed PSE Rule 6.82(h)(1)(e).
---------------------------------------------------------------------------
The Commission notes that, pursuant to recent amendments to the LMM
Rule, LMMs will be evaluated by the Options Allocation Committee at
least semiannually.\25\ Before the Book pilot program can be approved
on a permanent basis, or further extended, however, the Exchange must
provide the Commission, within 6 months prior to its expiration, with a
report on the operation of the Book pilot program. Specifically, the
PSE must submit an updated pilot program report by April 1997 that
addresses: (1) Whether there have been any complaints regarding the
operation of the pilot; (2) whether the PSE has taken any disciplinary
or performance action against any member due to the operation of the
pilot; (3) whether the PSE has reassigned any options issues traded
pursuant to the pilot; and (4) the impact of the pilot on the bid/ask
spreads, depth and continuity in PSE options markets.
---------------------------------------------------------------------------
\25\ See PSE Rule 6.82(e)(4) and Securities Exchange Act Release
No. 37780, supra note 10.
---------------------------------------------------------------------------
The Committee finds good cause for approving Amendment No. 2 prior
to the thirtieth day after the date of the publication of notice of
filing thereof in the Federal Register because Amendment No. 2 does not
change the substance of the proposal, rather, it clarifies the purpose
for the proposal and makes a technical correction to the text of the
proposed rule. In addition,
[[Page 54483]]
the PSE's proposal was published in the Federal Register for the full
21 day comment period without any comments being received by the
Commission.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 2. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549. 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. Sec. 552, will be available for inspection and
copying in the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of such filing will also be
available for inspection and copying at the principal office of the
PSE. All submissions should refer to File No. SR-PSE-96-09 and should
be submitted by November 8, 1996.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\26\ that the proposed rule change (File No. SR-PSE-96-09), as
amended, is approved through October 31, 1997.
\26\ 15 U.S.C. 78s(b)(2) (1988).
---------------------------------------------------------------------------
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\27\
---------------------------------------------------------------------------
\27\ 17 CFR 200.3--3(a)(12).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-26783 Filed 10-17-96; 8:45 am]
BILLING CODE 8010-01-M