[Federal Register Volume 65, Number 92 (Thursday, May 11, 2000)]
[Notices]
[Pages 30465-30469]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-11805]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42756; File No. SR-PCX-99-10]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment Nos. 4 and 5 to the Proposed Rule Change by the Pacific 
Exchange, Inc. Amending Its Disciplinary Procedures

May 4, 2000.

I. Introduction

    On April 2, 1999, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') 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 to amend its disciplinary 
procedures. On June 25, 1999, January 18, 2000, and January 19, 2000, 
respectively, the PCX filed Amendment Nos. 1, 2 and 3 to the proposed 
rule change.\3\ The proposed rule change including Amendments Nos. 1, 2 
and 3 were published for comment in the Federal Register on February 
10, 2000.\4\ On April 21, 2000, the PCX filed Amendment No. 4 to the 
proposal. \5\ On April 28, 2000, the PCX

[[Page 30466]]

filed Amendment No. 5 to the proposal.\6\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letters from Michael D. Pierson, Director, Regulatory 
Policy, PCX, to Michael A. Walinskas, Associate Director, Division 
of Market Regulation (``Division''), SEC, dated June 24, 1999 
(``Amendment No. 1'') from Michael D. Pierson to Jennifer Colihan, 
Attorney, Division, SEC, dated January 7, 2000 (``Amendment No. 
2''); from Michael D. Pierson to Kelly Riley, Attorney, Division, 
SEC, dated January 14, 2000 (``Amendment No. 3'').
    \4\ See Exchange Act Release No. 42384 (February 3, 2000), 65 FR 
6675.
    \5\ See Letter from Robert Pacileo, Senior Attorney, Regulatory 
Policy, PCX, to Nancy J. Sanow, Senior Special Counsel, Division, 
SEC, dated April 20, 2000 (``Amendment No. 4''). Among other things, 
Amendment No. 4 added language to prohibit interested PCX staff with 
knowledge of a pending Exchange investigation or disciplinary 
proceeding from making ex parte communications. Amendment No. 4 also 
proposed language to permit an Exchange disciplinary committee to 
issue to interested PCX staff responsible for an ex parte 
communication, or the party who benefited from the communication to 
show cause why the claim of the interested PCX staff should not be 
adversely affected by reason for the ex parte communication, 
including, but not limited to the entry of an adverse summary 
decision.
    \6\ See Letter from Robert Pacileo, Senior Attorney, Regulatory 
Policy, PCX, to Nancy J. Sanow, Senior Special Counsel, Division, 
SEC, dated April 27, 2000 (``Amendment No. 5''). In Amendment No. 5, 
the Exchange proposed to add Rule 10.3(e) which would require a 
member of a Hearing Panel, or the disciplinary committee with 
jurisdiction over a proceeding, to recuse himself or herself in the 
event a conflict of interest exists.
---------------------------------------------------------------------------

    The Commission received no comments regarding the proposal. This 
notice and order approves the proposed rule change, as amended, and 
solicits comments from interested persons on Amendment Nos. 4 and 5.

II. Description of the Proposal

    The PCX is proposing to amend its disciplinary proceedings 
rules,\7\ and in particular, to add new rules to codify the independent 
function of PCX Regulatory Staff; to clarify what communications are 
improper in the context of pending investigations or disciplinary 
proceedings; and to provide PCX Regulatory Staff with the ability to 
issue formal complaints for the alleged violation of Exchange rules.
---------------------------------------------------------------------------

    \7\ The Commission notes that the Exchange has proposed a 
similar disciplinary structure and procedures for the Pacific 
Equities, Inc. See Exchange Act Release No. 42178 (Nov. 24, 1999), 
64 FR 68136 (Dec. 6, 1999) (File No. SR-PCX-99-39).
---------------------------------------------------------------------------

A. Independence of Regulatory Staff

    PCX proposes to amend Rule 10.2 governing the procedures for 
investigating possible violations of Exchange rules to ensure the 
independence of the PCX Regulatory Staff, and guarantee its separation 
from the Exchange's commercial interests. The rule is being modified to 
explicitly state that the Exchange's Regulatory Staff will function 
independently of the commercial interests of the Exchange and will have 
the sole discretion to investigate possible violations within the 
disciplinary jurisdiction of the Exchange. The proposed rule further 
provides that no member of the Board of Governors or the Executive 
Committee or non-Regulatory Staff may interfere with or attempt to 
influence the process or resolution of any pending investigation or 
disciplinary proceeding.
    The Exchange is also proposing to make various technical and 
housekeeping changes to the text of PCX Rule 10.2, which will now cover 
both Exchange investigations and regulatory cooperation.

B. Ex Parte Communications

    The Exchange is proposing to adopt new PCX Rule 10.3 to codify 
specific provisions governing ex parte communications. The new rule 
codifies what communications regarding pending investigations and 
disciplinary proceedings are improper.
    The proposed ex parte rules make clear that no person who is a 
subject of a pending Exchange investigation or pending disciplinary 
proceeding or any interested PCX staff member\8\ may make an ex parte 
communication to a member of the Board of Governors, a member of any 
committee with disciplinary jurisdiction, or any member of the Exchange 
Regulatory Staff. The proposed rule further provides that no person who 
is a member of a Hearing Panel or the disciplinary committee with 
jurisdiction over an investigation or disciplinary proceeding or any 
interested PCX staff member \9\ may make an ex parte communication to a 
member of the Board of Governors, a member of the Executive Committee, 
any member of Exchange Regulatory Staff, or the subject of a pending 
Exchange investigation or disciplinary proceeding. Next, the proposed 
rule prohibits members of the Board of Governors and the Exchange 
Committee, as well as interested PCX staff members \10\ from making an 
ex parte communication to any member of Exchange Regulatory Staff, the 
subject of a pending Exchange investigation or pending disciplinary 
proceeding or a member of a Hearing panel or the disciplinary committee 
with jurisdiction over the investigation or disciplinary proceeding.
---------------------------------------------------------------------------

    \8\ See Amendment No. 4, supra note 5.
    \9\ See Amendment No. 4, supra note 5.
    \10\ See Amendment No. 4, supra note 5.
---------------------------------------------------------------------------

    With respect to the disclosure of prohibited communications, 
proposed PCX Rule 10.3(b) provides that any person who receives or 
makes a communication prohibited by the Rule must promptly submit a 
copy of any written communications and/or a substantive description of 
any oral communications to Exchange Regulatory Staff for inclusion in 
the record of the investigation or disciplinary proceeding.
    Proposed Exchange Rule 10.3(c) sets forth remedies applicable to 
situations in which prohibited communications have been made. 
Specifically, the rule provides that any member, member organization, 
associated person, or interested PCX staff member who made, or 
knowingly caused to be made, a communication prohibited by subsection 
(a) will be subject to disciplinary action. The rule further provides 
that an Exchange disciplinary committee, to the extent consistent with 
the interests of justice, may issue to the member, member organization 
or associated person responsible for the communication or who benefited 
from the communication an order to show cause why the claim, defense or 
interest of the member, member organization or associated person should 
not be adversely affected by reason of such ex parte communication, 
including but not limited to the entry of an adverse summary decision.
    Proposed PCX Rule 10.3(d) clarifies that nothing in the rule on ex 
parte communications prohibits the members of a disciplinary committee 
or Exchange Regulatory Staff from discussing a pending investigation or 
disciplinary proceeding at a meeting of the committee in connection 
with: (1) The adjudication of the investigation pursuant to the Minor 
Rule Plan; (2) the determination of whether to impose informal 
discipline; (3) the determination of whether to authorize a complaint 
or take no further action; or (4) the determination of whether to 
accept an offer of settlement.
    Proposed Commentary .01 to Exchange Rule 10.3 defines an ``ex parte 
communication'' as an oral or written communication made without notice 
to all parties, i.e., Exchange Regulatory Staff and the subjects of 
investigations or respondents in disciplinary proceedings. The 
Commentary further states that a written communication is ex parte 
unless a copy has been previously or simultaneously delivered to all 
interested parties. It further provides that an oral communication is 
ex parte unless it is made in the presence of all interested parties 
except those who, on adequate prior notice, declined to be present.\11\
---------------------------------------------------------------------------

    \11\ In Amendment No. 4, the PCX deleted Commentary .02 to PCX 
Rule 10.3 which provided that a disciplinary proceeding will be 
considered to be pending from the date that a Complaint has been 
issued pursuant to Rule 10.5 until the proceeding, including any 
appeals, becomes final. The PCX represented in Amendment No. 4 that 
it will amend SR-PCX-00-06 to include this as a commentary to 
another PCX disciplinary rule.
---------------------------------------------------------------------------

C. Complaints

    PCX Rule 10.3, which the PCX proposes to renumber as Rule 10.4, 
currently provides that formal complaints for alleged violations of

[[Page 30467]]

Exchange rules (and other provisions) may be authorized by the PCX 
Board of Governors, by the Executive Committee of the Exchange, or by 
any standing committee designated by the Board of Governors to review 
disciplinary proceedings. The Exchange is proposing to modify that 
provision so that only Exchange Regulatory Staff designated by the 
Exchange and any standing committee designated by the Board of 
Governors to review disciplinary proceedings has the authority to 
determine whether there is probable cause to issue a formal complaint, 
i.e., probable cause for finding that a violation within the 
disciplinary jurisdiction of the Exchange has occurred and that further 
proceedings are warranted. The PCX also proposes to make certain 
technical changes to the text of current Exchange Rule 10.3 for 
clarification purposes, e.g., changing the term ``charged'' to 
``alleged.''
    Further, PCX proposes to amend its rule governing complaints to 
provide that at any time prior to service of the written answer to the 
Complaint, the Complaint may be amended to allege new matters of fact 
or law. However, after service of the written answer, the Complaint may 
only be amended if the Hearing Panel concludes that good cause exists 
for the amendment based upon the submission of a written motion by the 
Exchange.
    Finally, the Exchange is proposing to adopt new Commentary .01 to 
new PCX Rule 10.4 to provide that the term ``probable cause'' means 
facts and circumstances that establish a reasonable likelihood that the 
person committed the violation at issue.

D. Summary Determinations

    The Exchange proposes to renumber PCX Rule 10.5 to Rule 10.4(c).

III. Discussion

    For the reasons discussed below, the Commission finds that the 
proposed changes to the PCX Rules governing investigations and 
regulatory cooperation, ex parte communications and complaints are 
consistent with the Act, improve the current disciplinary system, and 
should provide fair and efficient procedures for conducting 
investigations.\12\ Therefore, the Commission finds that the proposed 
rule change is consistent with Section 6(b) of the Act,\13\ and in 
particular with Sections 6(b)(5),\14\ 6(b)(6) \15\ and Section 6(b)(7) 
\17\ of the Act.
---------------------------------------------------------------------------

    \12\ In approving this proposal, the Commission has considered 
the proposed rules' impact on efficiency, competition and capital 
formation. 15 U.S.C. 78c(f).
    \13\ 15 U.S.C. 78f(b).
    \14\ 15 U.S.C. 78f(b)(5).
    \15\ 15 U.S.C. 78f(b)(6).
    \16\ 15 U.S.C. 78f(b)(7).
---------------------------------------------------------------------------

    Section 6(b)(5) requires, among other things, that the rules of an 
exchange be designed to prevent fraudulent and manipulative acts and 
practices and to protect investors and the public interest.\17\ Section 
6(b)(6) requires, among other things, that the rules of an exchange 
provide that its members shall be appropriately disciplined for 
violations of the Act, the rules and regulations thereunder or the 
rules of an exchange.\18\ Section 6(b)(7) requires that the rules of an 
Exchange, among other things, should provide a fair procedure for 
disciplining members.\19\
---------------------------------------------------------------------------

    \17\ 15 U.S.C. 78f(b)(5).
    \18\ 15 U.S.C. 78f(b)(6).
    \19\ 15 U.S.C. 78f(b)(7).
---------------------------------------------------------------------------

A. Investigations and Regulatory Cooperation

    The Commission finds that the proposed rule change, which removes 
the authority of the Board of Governors, Executive Committee, the 
Ethics and Business Conduct Committee and the Floor Trading Committee 
to review disciplinary proceedings to be consistent with the 
requirements of the Act.
    The proposal gives the Exchange's Regulatory Staff the authority to 
determine whether to investigate potential violations within the 
disciplinary jurisdiction of the Exchange. This provision should 
prevent inappropriate commercial interests from improperly influencing 
the Exchange's disciplinary process consistent with the requirements of 
Section 6(b)(7).\20\ This proposal should help to ensure that the 
Exchange's disciplinary process operates in a fair manner without 
potential improper, unrelated business processes.
---------------------------------------------------------------------------

    \20\ 15 U.S.C 78f(b)(7).
---------------------------------------------------------------------------

    The Commission believes that the Exchange has struck an appropriate 
balance by permitting Governors and members of the aforementioned 
committees to submit complaints alleging possible violations of 
Exchange Rules and/or violations of the Act to the Regulatory Staff for 
investigation, but then prohibiting them from further participation in 
the investigation or proceedings. In this way, the Governors and 
committee members continue to have a voice and the ability to bring 
potential violations to the attention of the Regulatory Staff, but are 
not given undue control and influence over the proceedings to the 
disadvantage of Exchange members.
    The Commission further finds that the Exchange's explicit proposed 
rule prohibiting members of the Board of Governors or the Executive 
Committee or other non-Regulatory Staff persons from interfering with 
or attempting to influence any pending investigation or disciplinary 
proceeding is appropriate.
    The Exchange's proposed rule accurately echoes the Commission's 
belief that persons responsible for investigations and disciplinary 
proceedings should enjoy autonomy and independence from inappropriate 
pressures. The Commission further finds that the PCX's initiative to 
separate the investigatory functions of the Regulatory Staff from the 
commercial interests of Exchange members is another step toward 
ensuring that the PCX disciplinary process is well insulated and fair 
to all participants.

B. Ex Parte Communications

    The PCX has proposed a new rule that defines and prohibits ex parte 
communications between disciplinary committee members, the Board of 
Governors, and the parties to a disciplinary investigation or 
proceeding. In the Commission's view, it is appropriate for the 
Exchange to prohibit ex parte communications between the disciplinary 
committees and panels and the parties or their representatives during 
the disciplinary proceedings. The Commissions also finds that the 
boundaries set by the Exchange in defining the prohibited 
communications should help ensure that no party can unfairly advance 
his or her position in an investigation or disciplinary proceeding 
through discussion or other communication outside of the proceeding's 
forum. In addition, the Commission finds that the parties subject to 
the prohibition on ex parte communications include those who reasonably 
would be expected to participate in a disciplinary proceeding.
    The Commission also approves of the manner in which the Exchange 
proposes to handle violations of the prohibition on ex parte 
communications. First, the proposed rule requires complete disclosure 
of the communication in the form of a written memorandum describing any 
oral communication and copies of any written communication for 
inclusion in the record of the investigation or disciplinary 
proceeding. The proposed rule then states that the party responsible 
for the ex parte communication will be subject to disciplinary action. 
The proposed rule then grants the disciplinary committee the authority 
to demand that the party who made the ex parte communication,

[[Page 30468]]

or the party who benefited from the communication, show cause why the 
claim, defense or interest of that party should not be adversely 
affected by reason of such ex parte communication, including but not 
limited to the entry of an adverse summary decision. The Commission 
finds that the consequences set out by the Exchange for violating the 
prohibition on ex parte communication are appropriate and should be an 
effective deterrent for committing violations and thus, the Commission 
finds that these provisions are consistent with Section 6(b)(6) of the 
Act.\21\
---------------------------------------------------------------------------

    \21\ 15 U.S.C. 78s(b)(6).
---------------------------------------------------------------------------

    The Commission further believes that it is appropriate to recognize 
certain circumstances under which ex parte communications are 
permissible. The Exchange's proposed rule provides that members of a 
disciplinary committee or Exchange Regulatory Staff are not prohibited 
from engaging in ex parte communications when discussing: (1) The 
adjudication of the investigation pursuant to the Minor Rule Plan; (2) 
the determination of whether to impose informal discipline; (3) the 
determination of whether to authorize a complaint or take no further 
action; or (4) the determination of whether to accept an offer of 
settlement. The Commission finds that lifting the general prohibition 
against ex parte communications in these situations should ensure that 
the disciplinary process operates efficiently by providing all persons 
involved in the settlement process or the pre-complaint resolution 
process with the flexibility to attempt to dispose of a disciplinary 
matter without formal proceedings being initiated.

C. Complaints

    As with the proposed rule governing investigations, the Exchange is 
proposing to modify its rule governing the initiation of formal 
disciplinary proceedings following an investigation to provide that 
only Exchange Regulatory Staff and standing committees designated by 
the Board of Governors to review disciplinary proceedings have the 
authority to determine whether there is probable cause to issue a 
formal complaint, i.e., probable cause for finding that a violation 
within the disciplinary jurisdiction of the Exchange has occurred and 
that further proceedings are warranted. Under the current rule, both 
the members of the Board of Governors and the Executive Committee have 
the authority to initiate disciplinary actions.
    The Commission supports the Exchange's initiative to provide the 
Regulatory Staff and the committee with jurisdiction over disciplinary 
proceedings independent from the Board of Governors and Executive 
Committee. The Commission believes that this independence will allow 
the Exchange to implement a vigorous and evenhanded enforcement 
program.
    The Exchange is also proposing to add a section to its rule that 
would allow the Exchange to amend its complaint freely anytime before a 
Respondent serves his or her answers thereto. However, the proposed 
rule provides that after the Respondent serves his or her answer, the 
Exchange may only amend the complaint with the consent of the hearing 
panel upon a showing of good cause. The Exchange finds that this 
procedure is fair to both parties because it protects those persons 
accused of violating Exchange rules from facing an unlimited number of 
new allegations throughout the disciplinary process, while also 
providing the Exchange with the ability to add new claims. The 
Commission believes that this provision is consistent with both 
Sections 6(b)(6) and 6(b)(7) because it enables the Exchange to bring 
new actions as information regarding potential violations becomes known 
in a manner that is fair to the subject of the complaint. Further, this 
provision also limits the Exchange's ability to delay proceedings by 
continually amending its complaint. After an answer has been submitted, 
the Exchange must show good cause to amend a complaint. This should 
ensure that disciplinary proceedings are completed in a timely fashion 
and provides respondents with a level of certainty as to the 
allegations being asserted. Moreover, by having the hearing panel make 
a finding of good cause to amend a complaint, the Commission believes 
that inappropriate and improper amendments should be prevented. The 
proposal should protect respondents from unlimited amendments which 
could lead to uncertain proceedings and undue delays in the 
disciplinary process.
    Finally, the Commission believes that this amendment is consistent 
with Section 6(b)(5) of the Act \22\ because it permits the Exchange, 
subject to specified restrictions, to amend its complaints to enforce 
its rules. This should ensure that members are disciplined for 
violations alleged to have been committed. Thus, the rule should assist 
the Exchange in seeking to prevent fraudulent and manipulative acts by 
its members to sufficiently protect investors and the public interest.
---------------------------------------------------------------------------

    \22\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

IV. Amendment No. 4

    The Commission finds good cause for approving Amendment No. 4 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. In Amendment No. 4, the Exchange added interested 
PCX staff members to the category of persons who are prohibited from 
engaging in ex parte communications. The Commission believes that this 
addition will provide extra assurance to those involved in disciplinary 
proceedings that the proceedings will be conducted fairly and 
impartially. Additionally, in the event that an interested PCX staff 
member does participate in an ex parte communication in violation of 
the proposed Rule, Amendment No. 4 allows an Exchange disciplinary 
committee to demand that the interested PCX Staff member show cause why 
the claim of the PCX should not be adversely affected because of the ex 
parte communication, thus holding the Exchange to the same level of 
responsibility as those persons being investigated.
    Finally, Amendment No. 4 makes technical non-substantive changes to 
the proposal such as moving a commentary to another location within the 
disciplinary rules, and correcting language to provide for parallel 
construction of sentences and clarity.
    The Commission finds that the PCX's proposed changes in Amendment 
No. 4 further strengthen and clarify the proposed rule change and raise 
no new regulatory issues. Further, the Commission believes that 
Amendment No. 4 does not significantly alter the original proposal 
which was subject to a full notice and comment period. Therefore, the 
Commission finds that granting accelerated approval to Amendment No. 4 
is appropriate and consistent with Section 19(b)(2) of the Act.\23\
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

V. Amendment No. 5

    The Commission finds good cause for approving Amendment No. 5 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. In Amendment No. 5, the Exchange seeks to adopt 
language that would prohibit any member of a disciplinary committee or 
a hearing panel from participating in a proceeding if that person has a 
conflict of interest or bias, or if circumstances otherwise exist where 
his or her fairness might reasonably be questioned. The

[[Page 30469]]

Commission believes that the addition of this provision is appropriate 
in that it will increase the level of fairness and impartiality in 
disciplinary proceedings and will aid in the dispassionate application 
of the disciplinary rules. The Commission believes that the PCX has 
proposed a reasonable standard under which an adjudicator or 
participant in the disciplinary process must recuse him or herself or 
may be disqualified by the Chief Executive Officer of the PCX.

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 4 and 5, including whether the 
proposed amendments are 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. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed amendment that are 
filed with the Commission, and all written communications relating to 
the amendment 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 at the 
Commission's Public Reference Room. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
PCX.
    All submissions should refer to File No. SR-PCX-99-10 and should be 
submitted by June 1, 2000.

VII. Conclusion

    For all of the aforementioned reasons, 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.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-PCX-99-10), as amended, is 
approved.
---------------------------------------------------------------------------

    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
---------------------------------------------------------------------------

    \25\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-11805 Filed 5-10-00; 8:45 am]
BILLING CODE 8010-01-M