[Federal Register Volume 65, Number 110 (Wednesday, June 7, 2000)]
[Notices]
[Pages 36206-36208]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14256]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42848; File No. SR-PCX-99-18]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 1 to the Proposed Rule Change by the Pacific Exchange, 
Inc., Relating to Facilitation Crosses

May 26, 2000.

I. Introduction

    On June 4, 1999, the Pacific Exchange, Inc. (``PCX'' 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 to give member firms a participation right in 
trades proposed as facilitation crosses in certain circumstances; and 
to allow facilitation crosses for broker-dealer orders. Notice of the 
proposed rule change was published for comment in the Federal Register 
on September 21, 1999.\3\ On May 26, 2000, the PCX filed Amendment No. 
1 to the proposal. \4\ No comments were received on the proposal. This 
order approves the proposed rule change, as amended, accelerates 
approval of Amendment No. 1, and solicits comments from interested 
persons on that amendment.
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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. 41867 (September 13, 
1999), 64 FR 51171.
    \4\ The substantive modifications of Amendment No. 1 are 
incorporated in the description of the proposal in Section II below, 
and are further discussed in Section III below.
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II. Description of the Proposal

    PCX Rule 6.47(b) sets forth the procedures by which a floor broker 
representing the order of a member firm's public customer may cross it 
with a contra side order provided by the firm from its own proprietary 
account. In these circumstances, the firm is said to be 
``facilitating'' the customer order, and

[[Page 36207]]

the transaction is called a ``facilitation cross.''
    Under the current version of the rule, a floor broker seeking to 
execute a facilitation cross must first bring the transaction to the 
trading floor and request a market from the trading crowd. After 
receiving bids and offers from the crowd, the floor broker must propose 
a price at which to cross the order that improves upon the price 
provided by the crowd. However, before the floor broker can execute the 
cross, the market makers in the crowd are given the opportunity to take 
all or part of the transaction at the proposed price.
    Under the current rule, if the crowd does not want to participate 
in the trade, the floor broker may proceed with the cross. If the crowd 
wants to take part of the order, however, the crowd has precedence and 
the floor broker may cross only that amount remaining after the crowd 
has taken its portion. If the crowd wants to take the entire order, the 
floor broker will not be able to cross any part of the order.
    The proposed rule change, applicable to both equity options and 
index options,\5\ would entitle the floor broker, under certain 
conditions, to cross a specified percentage of the customer order on 
behalf of the member firm before market makers in the crowd can 
participate in the transaction. This provision would apply only to 
orders of 200 contracts or more. The percentage of the floor broker's 
guarantee would depend upon whether the price at which the order is 
ultimately traded is at the crowd's best bid or offer in response to 
the broker's initial request for a market, or at an improved price.
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    \5\ Telephone conversation between Robert P. Pacileo, Senior 
Attorney, Regulatory Policy, PCX, and Ira L. Brandriss, Attorney, 
Division of Market Regulation, the Commission, on May 23, 2000 
(``Telephone conversation with the PCX'').
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    First, the floor broker would be granted a right under the proposal 
to execute a facilitation cross event at the price that does not 
improve upon the best bid or offer provided by the crowd in response to 
his initial request for a market. The proposed rule change provides 
that where the trade takes place at the market provided by the crowd, 
all public customer orders in the book \6\ and those represented in the 
crowd at the time the market was established would first need to be 
satisfied. Once these public customer orders are satisfied, the floor 
broker would be entitled to facilitate 25% of the contracts remaining 
in the customer order.
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    \6\ Telephone conversation with the PCX.
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    The proposed rule change further provides that if the floor broker 
proposes the facilitation cross at a price between the best bid and 
offer provided by the crowd in response to his initial request for a 
market--and the crowd then wants to take part or all of the order at 
the improved price--the floor broker would be entitled to priority over 
the crowd to facilitate 40% of the contracts \7\ remaining after any 
public customer orders represented at that improved price have been 
satisfied.\8\
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    \7\ See Amendment No. 1, which reduces the proposed percentage 
guarantee from 50% to 40%.
    \8\ Such orders are included within the meaning of ``all public 
customer orders represented in the trading crowd'' in the proposed 
rule text. Telephone conversation with the PCX
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    In the case of orders for less than 200 contracts, the proposed 
rule change makes clear that the floor broker would be permitted to 
facilitate a customer order by following PCX Rule 6.47(b) procedures, 
but would not receive any priority over the crowd.\9\
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    \9\ See Amendment No. 1, concerning proposed subsection 
6.47(b)(1). In this case, the members of the trading crowd would 
have priority over the floor broker seeking to cross a transaction. 
Telephone conversation with the PCX.
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    As under the current version of the PCX facilitation cross rule, 
the order tickets for both the customer order and the firm's 
facilitation order would be required under the proposal to display all 
the terms of the orders, including any contingencies involving, and all 
related transactions in, either options or the underlying security. 
Similarly, the floor broker would continue to be required to disclose 
all securities that are components of the customer order before 
requesting the crowd's market.\10\
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    \10\ As codified in PCX Rule 6.46, the floor broker must make 
all persons in the crowd aware of his request for a market, and must 
allow adequate time for a response. In its proposed amendments to 
Rule 6.47, the PCX has deleted current references to these 
procedural obligations to avoid redundancy. Telephone conversation 
with the PCX.
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    The proposed rule change adds a stipulation that would require the 
floor broker to clearly disclose to the crowd that he is intending to 
execute a facilitation cross when he initially asks for its market. 
Once the trading crowd provides that market, it would remain in effect 
under the proposal until (a) a reasonable amount of time has passed; 
(b) a significant change has occurred in the price of the underlying 
security of the option; or (c) the market is improved. ``Significant 
change'' would be interpreted on a case-by-case basis by two Floor 
Officials, based upon the extent of recent trading in the option and 
the underlying security and any other relevant factors.
    The proposed rule change also provides that if the trade takes 
place at the quoted bid or offer of the Lead Market Maker (``LMM'') in 
the options class being traded, the guaranteed participation to which 
the LMM is ordinarily entitled in such case \11\ would apply only to 
the number of contracts remaining after all public customer orders have 
been filled and the facilitating firm's crossing rights have been 
exercised. Further, the total number of contracts allocated in the 
aggregate to the facilitating firm and the LMM as the result of their 
guaranteed participations could not exceed 40%.\12\
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    \11\ See PCX Rule 6.82(d)(1).
    \12\ See Amendment No. 1, concerning proposed subsection 
6.47(b)(5).
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    The proposed rule change makes clear, however, that it is not 
intended to prohibit either a floor broker or LMM from trading more 
than their percentage entitlements if the other members of the trading 
crowd do not choose to trade with the remainder of the order.\13\ The 
proposal further makes clear, in accordance with PCX Rule 6.82, that if 
the trade takes place at a price other than that of the LMM's quoted 
bid or offer, the LMM would not be entitled to a guaranteed 
participation.\14\
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    \13\ Id., concerning proposed subsection 6.47(b)(6).
    \14\ Thus the LMM participation right is not a concern where the 
facilitating firm receives a 40% crossing right, because that right 
is granted only when the trade occurs between the best bid and offer 
given by the crowd, which is by definition at a price other than the 
LMM's quoted bid or offer.
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    The proposed rule change also provides that the members of the 
crowd who establish the facilitation market in response to the floor 
broker's initial request would have priority over all other non-public 
customer orders \15\ that were not represented in the crowd at the time 
that market was established, except for orders that improve upon those 
quotes. Further, a floor broker holding a customer order and a 
facilitation order who calls for a facilitation market would be deemed 
to be representing both the customer order and the facilitation order, 
so that the customer order and the facilitation order would also have 
priority over all other non-public customer orders \16\ that were not 
being represented in the trading crowd at the time the market was 
established.
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    \15\ See Amendment No. 1, concerning proposed subsection 
6.47(b)(6).
    \16\ Id.
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    Finally, the proposed rule change would permit facilitation crosses 
for broker-dealer orders.\17\
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    \17\ Current Rule 6.47(b) authorizes facilitation crosses only 
for public customer orders.
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III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the provisions of the Act applicable to a 
national securities exchange, particularly those of section

[[Page 36208]]

6(b)(5) \18\ and section 6(b)(8) \19\ of the Act, and the rules and 
regulations thereunder.\20\ The Commission believes that the proposal 
will enable the PCX to better compete with other options exchanges in 
attracting the order flow of broker-dealer firms seeking to facilitate 
customer orders, with adversely impacting the prices those orders 
receive.
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    \18\ 15 U.S.C. 78f(b)(5). Section 6(b)(5) requires that the 
rules of a national securities exchange be designed to, among other 
things, promote just and equitable principles of trade, remove 
impediments to and perfect the mechanism of a free and open market, 
and, in general, to protect investors and the public interest. It 
also requires that those rules not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.
    \19\ 15 U.S.C. 78f(b)(8). Section 6(b)(8) requires that the 
rules of the exchange do not impose any burden on competition not 
necessary to appropriate in furtherance of the purposes of the Act.
    \20\ In approving 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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    The Commission finds that the PCX's proposal to grant participation 
rights, under certain conditions, to member firms seeking to execute 
facilitation crosses on the Exchange is reasonable. Currently, PCX 
market makers have priority rights for the full size of a customer 
order over the firm that brings a crossing transaction to the PCX 
floor, as long as the market makers are willing to trade at the 
proposed price.
    While the proposal entitles the member firm to a specified 
percentage of a facilitation transaction when executed at the trading 
crowd's best bid or offer, it does not eliminate the crowd's ability to 
trade with a portion of the order proposed to be crossed, or even so 
substantially reduce that ability so as to raise serious concern that 
the proposal would reduce price competition by the crowd. Moreover, the 
Commission believes that the proposal may contribute to better prices 
for crossing transactions. Specifically, it provides an incentive for 
upstairs firms to improve on the prices quoted by the crowd by offering 
these firms a greater participation in the trade when they better the 
crowd's price. In addition, market makers will always have an 
opportunity to improve the market and compete for a greater portion of 
the trade.
    In evaluating the proposed rule change, the Commission considered, 
among other matters, whether the PCX's proposal to guarantee that a 
member firm could cross up to 40% of an order would reduce the 
incentive of crowds to compete for orders, and thus impair the price 
discovery mechanism of the Exchange's market.
    In its recent approval of the application of the International 
Securities Exchange (``ISE'') for registration as a national securities 
exchange, the Commission discussed the same concern with respect to the 
ISE's proposed ``facilitation mechanism,'' a system designed to effect 
a type of facilitation guarantee in an electronic context. The 
Commission wrote:

    It is difficult to assess the precise level at which guarantees 
may begin to erode competitive market maker participation and 
potential price competition within a given market. In the future, 
after the Commission has studied the impact of guarantees, the 
Commission may need to reassess the level of these guarantees. For 
the immediate term, the Commission believes that 40% is not clearly 
inconsistent with the statutory standards of competition and free 
and open markets.\21\
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    \21\ See Securities Exchange Act Release No. 42455 (February 24, 
2000), 65 FR 11388 (March 2, 2000).

    By the same token, the Commission believes that the PCX's proposed 
rule change, which allocates no more than 40% of an order to the firm 
seeking to facilitate an order, is not inconsistent with the statutory 
standard. The Commission notes, moreover, that for those crossing 
transactions in which an LMM is entitled to an allocation in addition 
to the proposed allocation for the facilitating firm, the PCX has 
included a provision to limit the combined allocations awarded to the 
firm and the LMM an aggregate of no more than 40% of the order.
    Although facilitation cross rules have heretofore been limited to 
public customer orders, the Commission believes it is reasonable to 
permit the PCX to allow firms to facilitate orders of broker-dealers--
to the degree permitted under the proposed rule change--in its belief 
that this will enable the PCX to better compete with other exchanges in 
attracting order flow to its market.
    The Commission finds good cause, pursuant to section 19(b)(2) \22\ 
of the Act, for approving Amendment No. 1 to the proposal prior to the 
thirtieth day after the date of publication of notice of filing thereof 
in the Federal Register. Amendment No. 1 includes the provisions 
described above that limit the total percentage of an order that may be 
guaranteed to no more than 40%, a percentage that the Commission has 
previously found consistent with the Act. It also clarifies the 
application of the facilitation cross rule, as amended by the proposal, 
for orders of less than 200 contracts. Amendment No. 1 further includes 
several changes to the proposed new rule text that clarify its meaning 
and thus strengthen the proposal.\23\ Accordingly, the Commission finds 
good cause, consistent with Sections 6(b)(5) \24\ and 19(b)(2) \25\ of 
the Act to accelerate approval of Amendment No. 1 to the proposed rule 
change.
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    \22\ 15 U.S.C. 78s(b)(2).
    \23\ Among these is a textual revision that makes clear that 
members of the trading crowd who established the facilitation market 
will not maintain priority over any order that improves the market.
    \24\ 15 U.S.C. 78f(b)(5).
    \25\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether it is 
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 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 Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the PCX. All 
submissions should refer to File No. SR-PCX-99-18 and should be 
submitted by June 28, 2000.

V. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-PCX-99-18), as amended, be and hereby 
is approved.
    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority. \26\
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    \26\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-14256 Filed 6-6-00; 8:45 am]
BILLING CODE 8010-01-M