50036 Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices

1The Exchange originally submitted this filing to

the SEC on May 20, 1997. On June 3, 1997, the

Exchange submitted Amendment No. 1 to the filing.

The Exchange resubmitted the entire filing on June

11, 1997. The resubmitted filing incorporates the

substance of the June 3, 1997, Amendment No. 1.

All subsequent references in this order to

‘‘Amendment No. 1’’ refer to the amendment, dated

Aug. 1, 1997, submitted as an amendment to the

June 11, 1997 filing. See note 5, infra.

2 17 CFR 240.19b–4.

3See Securities Exchange Act Release No. 38740

(June 13, 1997), 62 FR 33448 (June 19, 1997).

4Comment letters to the Commission were

received from Thomas D. Burke, Newbridge

Securities, Inc., dated July 1, 1997; Steven A.

Denning, General Atlantic Partners, dated July 2,

1997; Theodore E. James, Jr., Van Kasper &

Company, dated July 3, 1997; Junius W. Peake,

University of Northern Colorado, dated July 7, 1997;

Theodore R. Aronson, Aronson & Partners, dated

July 7, 1997; Praveen K. Gottipalli, Symphony Asset

Management, dated July 8, 1997; Robert A. Hill,

Melvin Specialists, Inc., dated July 9, 1997; Tim

McCarthy, Charles Schwab, dated July 10, 1997;

Todd Greenberg, ProActive Capital Management,

dated July 10, 1997; Matt Fong, Treasurer, State of

California, dated July 10, 1997; Harold S. Bradley,

American Century Investment Management, Inc.,

dated July 15, 1997; James E. Buck, New York Stock

Exchange, Inc. (‘‘NYSE’’), dated July 15, 1997; Tom

C. Tinsley, Baan Company, N.V., dated July 17,

1997; Bill Porter and Christos M. Cotsakos, E*Trade

Group, Inc., dated July 21, 1997.

5Letter from John C. Katovich, Senior Vice

President, General Counsel, and Director of Legal

Affairs, PCX, to Michael Walinskas, Senior Special

Counsel, Division of Market Regulation, SEC, dated

Aug. 1, 1997. In Amendment No. 1, PCX made a

technical amendment to its short sale rule, and

provided clarification regarding the application of

Rule 10a–1 under the Act to short sales in the PCX

Application. Also in Amendment No. 1, PCX

responded to comments made by the NYSE.

6Letter from John C. Katovich, Senior Vice

President, General Counsel, and Director of Legal

Affairs, PCX, to Michael Walinskas, Senior Special

Counsel, Division of Market Regulation, SEC, dated

Aug. 29, 1997. In addition to Amendment No. 2, the

PCX also submitted two letters containing

supplemental information. See Letter from John C.

Katovich, Senior Vice President, General Counsel,

and Director of Legal Affairs, PCX, to Michael

Walinskas, Senior Special Counsel, Division of

Market Regulation, SEC, dated Aug. 29, 1997

(regarding issues related to the Intermarket Trading

System) (‘‘PCX ITS Letter’’), and Letter from John

C. Katovich, Senior Vice President, General

Counsel, and Director of Legal Affairs, PCX, to

Michael Walinskas, Senior Special Counsel,

Division of Market Regulation, SEC, dated Aug. 29,

1997 (regarding interaction of the PCX Application

with the PCX floor) (‘‘PCX Floor Letter’’).

7Memorandum from John C. Katovich, Senior

Vice President, General Counsel, and Director of

Legal Affairs, PCX, to Michael Walinskas, Senior

Special Counsel, Division of Market Regulation,

SEC, dated Sept. 16, 1997. In Amendment No. 3,

PCX clarified the manner in which Primary Market

Protection (‘‘PMP’’) orders will be executed once

the Application is implemented. The letter also

includes several trading scenarios that illustrate the

operation of the Application vis-a-vis PCX

specialists.

8The OptiMark System was developed by

OptiMark Technologies, Inc. (‘‘OTI’’), a computer

technology firm located in Durango, Colorado,

based on certain patent-pending technology referred

to as ‘‘OptiMark TM.’’ OTI has represented that the

PCX Application is expected to be one of several

different trading services based on that technology

that will be made available from the OptiMark

System for other exchanges and markets in the

future. OTI expects its wholly-owned subsidiary,

OptiMark Servicers, Inc. (‘‘OSI’’), which currently

plans to apply for registration as a broker-dealer, to

be responsible for operating portions of the PCX

Application for the Exchange and delivering the

trading service to the Exchange’s members and their

customers. OTI is licensing the OptiMark System to

OSI for purposes of the PCX Application.

9This rule filing addresses trading in PCX

Securities only. PCX represents that if and when it

proposes to extend the Application to options or

other types of securities listed or traded on the

Exchange, a rule change proposal will first be filed

with the Commission.

Institution and settlement of injunctive

actions.

Institution and settlement of

administrative proceedings of an

enforcement nature.

Formal orders of investigation.

At times, changes in Commission

priorities require alterations in the

scheduling of meeting items. For further

information and to ascertain what, if

any, matters have been added, deleted

or postponed, pleased contact: The

Office of the Secretary at (202) 942–

7070.

Dated: September 22, 1997.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–25463 Filed 9–22–97; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39086; File No. SR–PCX–

97–18]

Self-Regulatory Organizations; Pacific

Exchange, Inc.; Order Approving

Proposed Rule Change and Notice of

Filing and Order Granting Accelerated

Approval of Amendment Numbers 1, 2

and 3 to Proposed Rule Change

Relating to the PCX Application of the

OptiMark System

September 17, 1997.

I. Introduction

On June 11, 1997, the Pacific

Exchange, Inc. (‘‘PCX’’ or ‘‘Exchange’’)

submitted to the Securities and

Exchange Commission (‘‘SEC’’ or

‘‘Commission’’), pursuant to Section

19(b) of the Securities Exchange Act of

1934 (‘‘Act’’) 1 and Rule 19b–4

thereunder,2 a proposed rule change to

establish rules for a new exchange

facility called the PCX Application of

the OptiMark System (‘‘PCX

Application’’ or ‘‘Application’’). Notice

of the proposed rule change appeared in

the Federal Register on June 19, 1997.3

Fourteen comment letters were received

in response to the proposal.4 On August

1, 1997, PCX submitted an amendment

(‘‘Amendment No. 1’’) to the proposal,

as well as two letters containing

supplemental information.5 On August

29, 1997, PCX submitted a second

amendment (‘‘Amendment No. 2’’) to

the proposal.6 On September 16, 1997,

PCX submitted a third amendment

(‘‘Amendment No. 3’’) to the proposal.7

This order approves PCX’s proposal, as

amended.

II. Description of the Proposal

A. Summary of the PCX Application

and Purpose

The Exchange proposes to establish

rules for a new exchange facility called

the PCX Application of the OptiMark

System. The PCX Application of the

‘‘OptiMark System’’ 8 is a computerized,

screen-based trading service intended

for use by Exchange members and their

customers. The OptiMark System would

provide automatic order formulation,

matching, and execution capabilities in

the equity securities listed or traded on

the Exchange (‘‘PCX Securities’’). The

OptiMark System would be used in

addition to PCX’s traditional floor

facilities, to buy and sell PCX

Securities.9

Specifically, the Application would

allow PCX members and their customers

to submit anonymously from their

computer terminals ranges of the trading

interest to the OptiMark Systems. At

specified times during the trading day,

the OptiMark System would conduct

certain calculations against such

expressions of interest to identify

specific orders capable of execution. All

orders formulated by the OptiMark

System would be automatically

executed on the Exchange, except to the

extent that they are executed on other

market centers through the Intermarket

Trading System (‘‘ITS’’). The Exchange

has stated that the proposed facility

would meet institutional investors’

growing demand for a new trading

medium. The Exchange also expects

retail investors to benefit from the

operation of the PCX Application.

B. Description of the Proposed PCX

Application Operation

The PCX Application was developed

jointly by the Exchange and OTI.

Exchange members and their customers

will trade on the OptiMark System in

the manner described below:

Proposed Method of Operation

Two distinct operations would be

involved in running the PCX

Application: (i) The central information

processing system and related

administrative and communications
Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices 50037

10A non-member User’s credit limits, as they may

be established from time to time by a Designated

Broker (or its clearing broker if applicable), will be

programmed into the OptiMark System. In addition,

the Designated Broker will be notified as its

potential exposure to its customers, individually or

in the aggregate, approaches the established credit

limits.

11PCX recently amended its rules in order to

trade equity securities in minimum increments of

1⁄16 of a dollar. See Securities Exchange Act Release

No. 38780 (June 26, 1997), 62 FR 36087 (July 3,

1997).

terminal network of the OptiMark

System, which includes computers that

collect and process data, log activities,

and switch messages from and to other

systems and carriers, as well as the

communication network linking such

computers with customer terminals; and

(ii) the computer hardware and software

needed (collectively, the ‘‘PCX

Interfaces’’) for the OptiMark System to

communicate with PCX’s computerized

order system (including any terminals

in use by PCX specialists or floor

brokers). The Exchange would continue

to operate its electronic linkages with

the ITS, Consolidated Quote System

(‘‘CQS’’), and the Consolidated Tape

System (‘‘CTS’’), as they currently exist.

The Exchange would have direct

ownership of and control over the PCX

Interfaces. The OptiMark System would

provide such electronic

communications and information

services needed for the PCX Application

to operate. From time to time, various

services provided by the OptiMark

System would be modified to allow for

system improvement and enhancement.

The Exchange would assure that, at all

relevant times, the material terms and

conditions of the PCX Application

would comply fully with the applicable

rules of the Exchange.

Access to the PCX Application

The PCX Application would be

available to all members of PCX and,

through them, to non-members such as

institutional investors and other nonmember broker-dealers. Each interested

member and non-member customer

would be eligible to enter into a

subscription agreement (‘‘User

Agreement’’) with OTI and also to

execute an agreement with OSI

authorizing the delivery of the trading

service made available from the

OptiMark System.

The OptiMark System subscribers

(‘‘Users’’) would log in from their own

computer terminals and communicate

with the OptiMark System over

customary commercial information

services and networks of their choice.

Those Users that serve as specialists and

floor brokers on the Exchange could also

communicate with the OptiMark System

from certain computer terminals located

on the floor of the Exchange. Security

codes and protocols would be required

to log in to the OptiMark System. Once

logged in, Users with authorized access

to the PCX Application would be able

to submit certain expressions of their

trading interest in a PCX Security to the

OptiMark System. Users would be

responsible for all of such expressions

and any other messages submitted to the

OptiMark System under their passwords

and security codes.

Under PCX’s proposal, each member

of the Exchange would be granted

access to the PCX Application directly

as a User. Any orders formulated and

matched by the OptiMark System based

on the expressions of trading interest

received from a member User would be

automatically routed, executed and

reported in that User’s name. Each such

member User would be responsible for

all transactions resulting from the PCX

Application for its own or customer

accounts in the same way that it is

currently responsible for transactions on

the floor.

Non-member Users would be required

to designate in advance member firms

(‘‘Designated Brokers’’) that would

authorize their access to the PCX

Application. Under a non-member’s

agreement with a Designed Broker

(‘‘Give-Up Agreement’’), the Designated

Broker would accept responsibility for

that non-member User’s transactions

and provide a written statement to the

Exchange to that effect. Under the

Designated Broker’s agreement with OSI

(‘‘Transmission Consent Agreement’’),

the Designated Broker would authorize

any and all orders formulated and

matched by the OptiMark System based

on the expressions of trading interest

received from the non-member User to

be automatically routed, executed and

reported in the Designated Broker’s

name. Both agreements must be in force

before any non-member User may be

given access to the PCX Application. At

a minimum, the provisions in these

agreements would include any credit

limits that may be imposed by a

Designated Broker (or its clearing broker

if applicable) on a non-member User; 10

the Designated Broker’s undertaking

that it is responsible for the nonmember User’s transactions; and such

other terms and conditions that may be

agreed to from time to time.

Entry of Profiles

Under PCX’s proposal, a User would

submit an expression of its trading

interest in the form of a ‘‘satisfaction

profile’’ (‘‘Profile’’), which would

indicate the User’s degree of satisfaction

or willingness (expressed as a number

between zero and one) to trade at each

coordinate of a price/size grid. A User

may depict a varying degree of its

trading preferences, covering a range of

prices and sizes, in a Profile.

The price/size grid over which

Profiles are entered would be unitized

into individual coordinates. The price

axis would be divided into the

minimum trading increments in the

relevant security being traded.11 The

size axis would be divided into 1,000

share increments. A User could create a

three-dimensional Profile over each

coordinate in the desired region of the

price/size grid by indicating a degree of

willingness (a ‘‘satisfaction value’’) to

trade at that coordinate. Such

willingness to trade or satisfaction value

could range from the most satisfactory

(i.e., ‘‘1’’ satisfaction value) to a cut-off

point at which a transaction at that price

and size becomes undesirable (i.e., ‘‘0’’

satisfaction value).

The delineation of the size axis into

1,000 share increments for purposes of

defining a Profile is distinguishable

from the minimum units of trading in

the PCX Application, which are in

round lots. An example provided in the

Exchange’s proposal would be a User

seeking to submit a buy Profile for 4,100

shares that shows a 100% willingness to

trade at the price of 20, decreasing to no

willingness as the price reaches 22.

Because of the 1,000 share increments

on the size axis, the User’s interest in

excess of 4,000 shares (i.e., the 100

shares) would be reflected in the next

available higher coordinate size—5,000.

To draw this Profile on the grid, the

User would assign the satisfaction value

of 1 to all the coordinates with the

associated size of 5,000 shares or less

and price of 20 or below. As the

associated price increases from 20 to 22,

the satisfaction value of the relevant

coordinates would decrease steadily

down to 0. According to the Exchange,

the grid size of 5,000 shares does not

mean that the User actually would

receive a 5,000 share trade in excess of

the desired amount, because the User

could enter an instruction as part of the

Profile to limit the transaction size to

4,100 shares.

According to the proposal, each User

may specify, with respect to each Profile

submitted, an associated maximum

quantity of shares in any round lot

multiples starting at 1,000 shares;

provided, however, those Profiles

submitted by PCX specialists and

certain system-generated CQS Profiles

(as discussed below) would each have

the associated round lot size reflected in

the relevant limit order book or
50038 Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices

12PCX would have access to all non-member

trade information held by a member in order to

perform surveillance. Telephone conversation

between John C. Katovich, Senior Vice President,

General Counsel, and Director of Legal Affairs, PCX,

and Michael Walinskas, Senior Special Counsel,

Division of Market Regulation, SEC, Sept. 4, 1997.

13 17 CFR 240.10a–1.

14Letter from John C. Katovich, Senior Vice

President, General Counsel, and Director of Legal

Affairs, PCX, to Richard R. Lindsey, Director,

Division of Market Regulation, SEC, dated August

29, 1997.

15According to the Exchange, the PCX specialists

may also submit Profiles based on their own

proprietary trading strategies, in addition to Profiles

reflecting public limit orders on their books. To the

extent that a PCX specialist chooses to represent a

proprietary trading interest in its designated

security by submitting a Profile, that particular

Profile will have lower time priority than that of the

Profile submitted by any other User in the security,

thereby preventing the specialist from trading ahead

of any agency orders submitted by Users. Time

priorities are discussed below.

quotation, which may be less than 1,000

shares. In addition, Users may, at their

option, set boundary conditions on a

Profile to restrict the total number of

shares that may be purchased or sold

within any particular price or size

range. Similarly, Users may, at their

option, place restrictions on any

potential purchase or sale of shares

through the ITS.

Users would submit Profiles through

their own computers or computers on

the floor of the Exchange. All Profiles

received by the Application from a User

would be treated confidentially and

would be viewed only by that User.

Unlike orders entered on the Exchange’s

traditional floor facilities, Profiles

would not be widely disseminated to

elicit any trading interest when they are

received. Instead, they would be logged

and maintained by the OptiMark System

until they are centrally processed. As

discussed further below, Profiles would

not be executable outside of the

specified times. As trading interest

contingent upon such periodic

processing, Profiles received by and

kept within the OptiMark System would

have no standing against orders on the

floor and no bearing on the Exchange’s

traditional auction-pricing mechanism.

The Exchange has represented that, in

accordance with its general audit trail

requirements, all Profiles submitted by

Users would be appropriately marked as

proprietary or agency. In addition, each

would be time-stamped with a unique

serial number when received by the

OptiMark System.12 Users would be

able to revise or cancel their own

Profiles at any time prior to

commencement of the next scheduled

central processing. According to the

Exchange, because it would be

important for Users to be able to adjust

their outstanding Profiles in a timely

manner in response to sudden market

developments, adjustments would be

processed in the next central processing

scheduled to take place more than one

second after receipt. Submitting a

revised Profile would result in a new

time stamp, unless the only change

made is a reduction in the maximum

quantity of shares previously specified.

According to the Exchange, all Users

would be held responsible for the terms

and conditions contained in their

Profiles. Each User would assume any

and all responsibility for canceling or

revising its Profile. Users would be able

to specify in advance whether to cancel

their outstanding Profiles or to keep

such Profiles active in the event of an

unexpected interruption experienced in

their own telecommunications linkage

to the OptiMark System. If a User

decided to keep its Profile active, it

would be accountable for any and all

transactions resulting from the PCX

Application based on such Profile.

Under PCX’s proposal, the first match

in a Cycle (as defined below), if it

involves a short sale, will only be

effected if it meets the requirements of

Rule 10a–1 under the Act,13 i.e., if it is

at a price above the last sale price

reported on a consolidated transaction

reporting system immediately prior to

commencement of the Cycle, or at the

last reported price if such price is above

the next preceding different price. After

the first transaction in the Cycle, short

sale orders will only be executed at a

price: (i) Above the price of the

immediately preceding match within

the Cycle, or (ii) equal to the

immediately preceding price if such

price is above the next preceding

different price. PCX has requested an

exemption from Rule 10a–1, the

Commission’s short sale rule, to permit

matches within a Cycle (those

subsequent to the initial match) to

utilize the immediately prior match as

a reference trade for determining short

sale rule compliance.14

The OptiMark System would perform

the necessary credit verification

procedures on each Profile submitted by

a non-member User. Such procedures

would ensure that the maximum

absolute dollar value of each Profile

received by the OptiMark System, when

added to the non-member Users’ current

credit usage, is consistent with the

applicable credit limits. All Profiles not

meeting the credit validation

requirement would be deactivated.

Interaction With Existing Market

Interest

According to the Exchange, the PCX

Application is designed to provide

Users with certain automated access to

and interaction with quotations

emanating from other participating

market centers of the ITS. At the

specified times during the trading day

when central processing by the OptiMark System is scheduled to occur, the

prevailing bid and offer quotations in

CQS from each such market that may be

reached by ITS, including the

Intermarket Trading System/Computer

Assisted Execution System interface

(‘‘ITS/CAES’’), would be transformed

into a pair of buy and sell Profiles

(‘‘CQS Profiles’’). Each CQS Profile

would have, for the relevant limit price

and size, a satisfaction of 1 for all the

corresponding coordinates in the price/

size grid. The Exchange has represented

that creation of these CQS Profiles and

their interaction with the Profiles

submitted by Users would ensure that

the PCX Application is consistent with

the intermarket price protection

requirement under the ITS Plan.

According to the Exchange’s proposal,

the PCX Application is also designed to

serve as an additional trading service for

the Exchange specialists and floor

brokers to use in handling existing

market interest on the floor. In their

capacity as Users, the specialists and

floor brokers would be able to submit

Profiles based on their customer limit

orders. The PCX specialists would be

provided with a uniquely designed

electronic interface at their posts that

would provide simple retrieval

instructions to facilitate designation of

customer orders on their limit order

books for inclusion as Profiles in the

OptiMark System. Such an interface

also would permit PCX specialists to

revise and/or cancel the relevant Profile

if any of the limit orders reflected in the

Profile subsequently became executable

against some other market interest. The

Profiles created from a PCX specialist’s

book would be treated the same as any

other Profiles submitted by Users of the

OptiMark System.15 Similarly, floor

brokers would have the ability to use

existing terminals or designated

OptiMark System terminals on the

trading floor to submit Profiles if they

wish to use the PCX Application to fill

existing customer interest.

Central Processing

All Profiles received by the OptiMark

System (including CQS Profiles) for

each relevant security would be

centrally processed by computer at one

or more specified times during the

trading day in order to generate one or

more orders of identified prices and

sizes at which execution may occur

immediately (‘‘orders’’). Such
Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices 50039

16See Amendment No. 3, supra, note 7.

processing would involve a series of

high-speed calculations (‘‘Cycle’’).

Cycles would be based on a computer

algorithm that is designed to measure

and rank all relevant mutual satisfaction

outcomes by matching individual

coordinates from intersecting Buy

Profiles and Sell Profiles. The matching

algorithm of the OptiMark System is

intended to compute optimal trade

results for Users based on their different

willingness to trade across a wide range

of price and size. A buy coordinate and

a sell coordinate, each with a full

satisfaction value of 1, would be

matched, based on price, standing, time

of entry, and size. If one or both

coordinates have a partial satisfaction

value of less than 1 (but greater than 0),

they would be matched, generally based

on the mutual satisfaction value—that

is, the product of the specific

satisfaction values associated with the

buy coordinate and sell coordinate.

The Exchange has represented that

Profiles would be processed according

to the following terms concerning

matching eligibility restrictions and

priority principles:

1. Eligibility Restrictions. At

commencement of a Cycle, each

individual coordinate with a non-zero

satisfaction value from all buy Profiles

and all sell Profiles received by the

OptiMark System (including CQS

Profiles) in a given PCX Security would

be grouped into the Buy Profile Data

Base or the Sell Profile Data Base,

respectively. Each individual

coordinate, no matter how small or large

in the corresponding size, from either

Profile Data Base would be eligible to be

matched with one or more coordinates

from the other Profile Data Base and

would result in one or more orders,

provided that:

1.1 No buy and sell coordinates could be

matched in violation of any applicable User

instructions for the respective Profiles,

including: (a) The maximum quantity

associated with the Profile, (b) any boundary

conditions restricting the aggregate number

of shares that may be bought or sold at a

particular price or size range, and (c) the

restrictions on any potential sale or purchase

through ITS; and

1.2 No buy and sell coodinates could be

matched from contra CQS Profiles.

1.3 No buy and sell coordinates could be

matched at a price inferior to that of another

coordinate with standing (as defined below)

that is eligible for matching. A buy (sell)

coordinate has Standing if: (a) It has 1

satisfaction value and (b) all coordinates

having the same price and a smaller size,

down to and including the minimum trading

increment (100 shares), are included in the

associated Profile at 1 satisfaction value;

provided, however, that no coordinate from

a Profile containing any boundary conditions

restricting the aggregate number of shares

that may be bought or sold at a particular size

range has Standing. Each coordinate from a

CQS Profile would have Standing. By

contrast, no coordinate from a Profile

submitted by a User on an ‘‘all-or-none’’ basis

would have Standing.

2. Priority Principles. The methods for

considering potential matches between

buy and sell coordinates in the Profile

Data Bases would vary, depending on

whether both coordinates represent

satisfaction values of 1 or less than 1. As

a result, these would be two separate

stages of a Cycle:

2.1 Aggregation Stage. The OptiMark

System initially would process eligible buy

and sell coordinates in the Profile Data Bases,

each with the full satisfaction value of 1 only.

At this stage of calculation (‘‘Aggregation

Stage’’), smaller-sized coordinates may be

aggregated to build sufficient size to be

matched with larger-sized coordinates to

generate orders in accordance with the

following rules of priority, subject to the

applicable eligibility restrictions:

(A) Price aggressiveness. A coordinate with

a more aggressive price (i.e., a higher price

for a buy coordinate and a lower price for a

sell coordinate) would have priority over

coordinates with less aggressive prices.

(B) Standing. Among the coordinates with

the same price, a coordinate with Standing

would have priority over all other

coordinates without Standing.

(C) Time of entry. Among the coordinates

with the same price and Standing, the time

of the entry of the associated Profile would

determine relative priority, with earlier

submissions having priority. All Profiles

submitted by Users would be appropriately

time-stamped with a unique serial number

when received by the OptiMark System;

provided, however, that the effective time of

entry for any Profile submitted by a PCX

specialist representing proprietary trading

interest in the specialist’s designated security

would fall behind that of a Profile submitted

by any other User for that security. Because

each CQS Profile would be generated from

the relevant market’s most current quotation

prevailing at the time of commencement of

a Cycle, the effective time of entry of a CQS

Profile would be later than that of any other

Profile submitted by a User, including a PCX

specialist’s proprietary trading in the

specialist’s designated security.16

(D) Size. Among the coordinates with the

same price, standing and time of entry,

priority would be determined by size, with

larger sizes having higher priority.

2.2 Accumulation Stage. Upon

completion of the Aggregation Stage, the

OptiMark System would consider potential

matches between eligible buy coordinates

and sell coordinates in the Profile Data Bases

where one or both parties have less than 1

(but greater than 0) satisfaction values. At

this stage of calculation (‘‘Accumulation

Stage’’), only those buy and sell coordinates

with the same associated price and size

would be matched to generate orders in

accordance with the following rules of

priority, subject to the applicable eligibility

restrictions:

(A) Mutual satisfaction. A potential match

with a higher mutual satisfaction value (the

product of the two satisfaction values) would

take precedence over other potential matches

with lower mutual satisfaction values.

(B) Time of entry (based on the earlier

Profile). Among the potential matches with

the same mutual satisfaction, the match with

the earlier time of entry, as determined

initially by the effective time of entry

assigned to the earlier of the buy and sell

Profiles involved (the ‘‘earlier Profile’’),

would have priority over other potential

matches.

(C) Size. Among the potential matches with

the same mutual satisfaction and time of

entry for the earlier Profile, priority would be

given to one with a larger size.

(D) Time of entry (based on the later

Profile). Among the potential matches with

the same mutual satisfaction, time of entry

(for the earlier Profile), and size, the match

with the earlier time of entry, as determined

this time by the effective time of entry

assigned to the later of the buy and sell

Profiles involved (the ‘‘later Profile’’), would

have priority over other potential matches.

(E) Price assignment. In regard to all

remaining ties between potential matches,

which would consist solely of the

coordinates for a single pair of buy and sell

Profiles from two Users that may be matched

with the same mutual satisfaction, time of

entry and size, but at different prices, priority

would be given to the match at a price more

favorable to the User whose Profile has the

earlier time of entry. By way of example,

among the last potential matches remaining

at the price of 10 and also at 101⁄8, if the sell

Profile is the earlier Profile, then the match

would take place at the price of 101⁄8. The

Commission notes that two or more Profiles

that are entered into the OptiMark System

representing the same number of shares may

result in executions at differing prices

depending on the other information and

conditions entered into the System.

The Exchange has represented that,

for purposes of the PCX Application, the

specific times at which Profiles would

be centrally processed would vary,

depending on the security involved. No

Cycle, however, would be scheduled

until after the opening of the PCX

market for any such security. Similarly,

no Cycle would be scheduled at or after

the closing of the PCS market for that

security. The maximum frequency with

which Cycles may take place throughout

the trading day would be every 90

seconds, while the minimum would be

once a day.

The Exchange has represented that

the exact frequency of Cycles as to any

given PCX Security would be

determined by OSI, taking into account

the general characteristics of the

security (e.g., trading volume, price, and

number of shareholders), the associated

Profile flow over a period, and the

current level of interest expressed by
50040 Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices

17Telephone conversation between John C.

Katovich, Senior Vice President, General Counsel,

and Director of Legal Affairs, PCX, and Michael

Walinskas, Senior Special Counsel, Division of

Market Regulation, SEC, Sept. 4, 1997.

18See Amendment No. 3, supra, note 7.

19 Id.

Users. From time to time, OSI may alter

the frequency of Cycles in response to

subsequent developments. PCX has

represented that OSI will consult with

PCX prior to altering the frequency of

any Cycle.17 Any change in the

frequency of Cycles would be effective

upon three days’ advance notice to

Users. Such notice would be provided

electronically, using the same

telecommunications linkage and

protocols available to Users for

submitting Profiles. At all relevant

times, Users would be fully informed as

to when the next Cycle in a particular

PCX Security would take place.

The Exchange would assure that the

frequency of Cycles remains

commensurate with the financial

community’s need and demand for the

trading service. In addition, the

Exchange would assure that the PCX

Interfaces and the OptiMark System

have sufficient capacity in place to

handle any material increase in the

volume of data prior to implementing a

change in the frequency of Cycles.

Order Execution and Reporting

The Exchange would make available

the necessary PCX Interfaces to permit

orders in PCX Securities from the

OptiMark System to be executed, either

on the Exchange or on other market

centers participating in ITS through the

appropriate Exchange communications

linkage. The Exchange would permit

one or more pairs of orders resulting

from intersection of the Profiles

submitted by Users (including PCX

specialists and floor brokers) to be

routed and executed on the Exchange.

Every trade resulting from the execution

of a pair of orders on the Exchange

would be appropriately reported, by

way of the traditional Exchange linkage

to the CTS processor for dissemination,

in the sequence in which orders are

generated from the Cycle. The Exchange

would report these trades, similar to the

way it currently reports other trades in

PCX Securities to the CTS. Accordingly,

consistent with the existing reporting

practices, a series of orders generated

from a single Cycle for the same seller

with different buyers at an identical

price would be printed on the Tape as

one transaction. In general, the report

for any transaction resulting from the

PCX Application would not be

distinguished on the Tape from the

trade report of any other order executed

on the PCX floor.

As for one or more orders

representing matched coordinates from

CQS Profiles, and other contra Profiles,

the Exchange would submit an ITS

commitment reflecting each such order

and seeking execution on market centers

other than PCX. Every ITS commitment

would be sent under the give-up of the

relevant member User or the Designated

Broker, by way of the traditional

Exchange linkage to the ITS, in the

sequence in which orders are generated

from the Cycle. Each ITS commitment

would be assigned a ‘‘T–1’’ (one minute)

time period as specified in the ITS Plan.

The Exchange envisions sending ITS

commitments resulting from the PCX

Application in the same way other ITS

commitments are currently sent from

the Exchange. According to the

Exchange, ITS commitments resulting

from the PCX Application would not be

distinguishable from other ITS

commitments.

The Exchange would continue to

apply all existing rules governing

trading on its equity trading floor. For

example, market orders routed from

members to the Exchange would

continue to be executed in the same

manner. Similarly, ITS commitments

received from ITS participants other

than PCX would be executed against the

Exchange’s prevailing quotations as

specified under the ITS Plan. As for

limit orders, PCX specialists and floor

brokers would be afforded an additional

(but not alternative) opportunity to fill

such interest through the PCX

Application. To the extent that the

Exchange specialists and floor brokers

submit Profiles to the OptiMark System

based on customer interest in their

books, the handling of any such Profiles

and any resulting trade executions

through the PCX Application would be

fully consistent with the parameters

under which public limit orders are

currently filled.

Moreover, PCX specialists would

remain fully responsible for managing

their limit order books. Accordingly, if

a specialist elected not to reflect a

customer limit order in the OptiMark

System, it would remain accountable for

execution at any more favorable price

that could have been obtained if such

order were processed through the PCX

Application. In such a case, consistent

with the Exchange’s existing floor

procedures and practices, the specialist

would be required to satisfy or cause to

be satisfied the customer limit order so

held, either at the limit price specified,

or at any better price generated by the

Application. PCX has represented that

this guarantee is limited to customer

limit orders booked prior to the

commencement of a Cycle. Therefore,

orders booked after the commencement

of a Cycle would not be guaranteed an

execution at prices obtained as a result

of such Cycle.

In Amendment No. 3 to its filing, PCX

clarified that, even if the specialist does

not submit a Profile for a limit order in

its book, the limit order will receive

‘‘the limit price or a better price if one

occurred in that cycle, up to the amount

of the order or orders executed in

OptiMark.’’ 18

Specifically, after a Cycle of the

Application is completed, the

Application sends the orders to the PCX

floor in a batch. The batch of orders,

which will be automatically executed,

‘‘will be in a specific, deterministic

order, as defined by the Aggregation and

Accumulation Stage’’ 19 (discussed

above). According to PCX, the order of

execution will be provided to the

specialist, in the same manner as

executions performed in another

market, such as NYSE. The specialist

will have, out of that batch of

executions resulting from a Cycle, the

prices and size of each execution. If at

the beginning of a Cycle a specialist has

a limit order in the book that was not

reflected as a Profile in the Application,

and, as a result of orders generated

through the Application, the booked

order becomes eligible for execution, the

price that will be given to the booked

order will be based upon the best price

that occurs out of the batch of orders

generated by the Application, up to the

size of the booked order not entered into

the Application as a Profile.

The Exchange presented the following

example: There is a booked order to buy

1,000 shares with a 10 limit price, and

the specialist does not express the order

as a Profile in the Application. The

immediately succeeding Cycle of the

Application generates orders resulting

in transactions at the following prices:

1,000 at 101⁄8, 500 at 10, and 1,000 at

97⁄8. Without the existence of the

Application, an execution in the same

security on the PCX at 10 would trigger

an execution of the booked order at 10.

With the implementation of the

Application, the batched transactions

resulting from a Cycle would be viewed

as a unit for purposes of determining the

price at which the booked order should

be filled. The specialist, therefore,

would look for the best price resulting

from the Cycle in determining the price

at which to fill the booked order. In this

case, the transaction resulting at a price

of 97⁄8 for 1,000 shares would be the

determining price, and the specialist

would be obligated to fill the order at
Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices 50041

20See Amendment No. 3, supra, note 7, at 2.

21 Id. PCX will codify this clarification through a

rule amendment with the Commission. In this

regard, PCX stated that the amendment ‘‘will be

consistent with the overall premise that under no

circumstance can a specialist accept an execution

arising out of orders generated from an OptiMark

cycle, without first taking care of any eligible

booked orders that were put in the book before the

cycle began.’’ Id.

22The Exchange’s hours are currently 6:30 a.m.

(P.T.) to 1:30 p.m. (P.T.).

97⁄8. If, on the other hand, the Cycle

resulted in a series of transactions that

included only 500 shares at the prices

stated above, and the specialist

nevertheless had a booked limit order

for 1,000 at 10 (which was not entered

into the Application), the specialist

would be obligated to fill the first 500

shares of the booked order at 97⁄8 and

the remaining 500 shares at 10, the next

best price generated by the Cycle.

In Amendment No. 3, PCX provided

an example of how limit orders booked

with PCX specialists would interact

with the Application. In the example, a

specialist would have two booked limit

orders at buy, the first for 1,000 shares,

and the second for 500 shares, both at

a price of 30. The example assumes that

the specialist did not enter the 1,000

share order into the Application, but the

specialist did enter the 500 share order

into the Application as a Profile. In the

example, the next Cycle of the

Application resulted in a transaction of

291⁄2 for the 500 share order entered into

the Application as a Profile. In such a

case, the specialist would be required to

fill both orders at 291⁄2.

In Amendment No. 3, PCX also

further clarified the manner in which

PMP would operate in connection with

the Application. Generally, according to

the PCX,

[i]f an order is received and specifically

marked PMP (primary market protection),

this means that the firm sending the order

has usually requested that the order only get

filled if within the range of the designated

‘‘primary’’ market (usually the NYSE and

AMEX). In such a case, the specialist is

operating under the understanding that the

order will not get filled outside the

‘‘primary’’ market range.20

In order to ensure that PMP orders

can be integrated into the Application,

PCX represented that:

during regular ‘‘primary’’ market trading

hours, an order specifically marked PMP will

have to be treated just like any other booked

order when executions result from OptiMark

matches, even if the ‘‘primary’’ market range

has not traded at that price. Similarly, a PMP

order reflected into OptiMark as a profile,

which is matched in OptiMark and results in

an execution, will require that the PMP limit

order be filled, even if the price is out of

range from the * * * otherwise existing

‘‘primary’’ market, however defined.21

PCX will undertake to amend its rules

so that the operation of the Application

would be considered as an exception to

Rule 5.32 regarding the execution of

orders marked PMP.

The Exchange has also represented

the operation of the PCX Application

would be consistent with the

Exchange’s intermarket price protection

obligations under the ITS Plan. The

OptiMark System incorporates existing

market interest emanating from each of

the ITS participant markets to which it

is not directly linked in the form of CQS

Profiles. Because of the rules of priority

for considering potential matches

between buy coordinates and sell

coordinates from any Profiles (including

CQS Profiles), all orders that are priced

inferior to the quotations of another

market center would be generated and

executed on PCX only upon submission

of appropriate ITS commitments seeking

to reach such better-priced interest. As

a result, the Exchange has represented

that execution of any such orders on

PCX would not violate the trade-through

rule under the ITS Plan.

The Exchange has represented that all

Users would be informed of executions

that take place against the Profiles that

they submitted for their own or

customer accounts promptly after the

trades occur. If an ITS commitment

resulting from the PCX Application is

canceled or only partially filled, the

OptiMark System would notify the

relevant User and restore to the Profile

the volume of the security represented

by the unfilled order. All such reports

would be sent electronically, using the

same telecommunications linkage and

protocols that were used to submit the

Profiles initially. Unless specified

otherwise by non-member Users in

advance, executions would not be

reported to relevant Designated Brokers

until after the close of the trading day

in order to limit market impact and

other such adverse effects of nonmember Users’ trading.

Clearance and Settlement

The Exchange has represented that

transactions in PCX Securities resulting

from the PCX Application, including

any ITS commitment sent to another

market center and accepted, would clear

and settle in the same way as other

transactions occurring on the Exchange

floor. All orders generated by the

OptiMark System that are executed on

PCX or another market center through

ITS would be reported and entered into

the comparison system on a locked-in

basis. Orders generated by the OptiMark

System on behalf of a member User and

the resulting transactions would be

cleared and settled using that member

User’s mnemonic (or its clearing

broker’s mnemonic). Orders generated

by the OptiMark System on behalf of a

non-member User and the resulting

transactions would be cleared and

settled using the appropriate Designated

Broker’s mnemonic (or its clearing

broker’s mnemonic).

The Exchange or any operator,

administrator or licensor of the

OptiMark System would not be

responsible for any User’s failure to pay

for PCX Securities purchased or to

deliver PCX Securities sold. Neither OTI

nor OSI would be deemed to be a party

to or a participant in, as principal or as

agent, any trade or transaction entered

into or otherwise conducted by Users

while using the OptiMark System for

the purposes of clearance and

settlement.

Hours of Operation

The PCX Application would be

initially available for execution of

orders and routing of ITS commitments

during the regular PCX hours after the

opening and prior to the closing.22 In

the event of a suspension in trading of

a security listed or traded on the

Exchange, the Exchange would suspend

the related trading activities respecting

that security through the PCX

Application. In addition, the Chairman

or, in the Chairman’s absence, Chief

Operating Officer, or other PCX

Officer(s) as the Chairman may

designate, may determine that market

conditions warrant a market-wide halt

pursuant to the Exchange’s Policy

Statement on Market Closings. Trading

on the PCX Application of the OptiMark

System would be covered by such a

market-wide halt. The Exchange may

suspend the trading activities through

the PCX Application relating to one or

more PCX Securities at any time upon

consultation with OTI if deemed

necessary and proper to preserve system

capacity and integrity.

Audit Trail and Surveillance

The Exchange would maintain, or

cause to be maintained, a detailed audit

trail of each transaction resulting from

the PCX Application, including time

sequenced records of Profiles submitted

to the OptiMark System, orders

resulting from a Cycle, and their

execution and reporting through PCX

facilities. Such data would be stored

and preserved for a period of not less

than three years, the first two years in

an easily accessible place, to assure that

the Exchange has sufficient information

for exercising its regulatory oversight.
50042 Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices

23See supra, note 4.

24Pub. L. No. 94–29, 89 Stat. 131 (1975).

25 15 U.S.C. 78k–1.

26See Letter from Tim McCarthy, Charles

Schwab, supra, note 4.

27See id.

28See Letter from Harold S. Bradley, American

Century Investment Management, Inc., supra, note

4.

29See Letter from James E. Buck, NYSE, supra.

note 4.

30 Id. at 2.

The Exchange would apply appropriate

equity trading surveillance procedures

to monitor transactions resulting from

the PCX Application.

System Capacity and Integrity

The Exchange believes that the PCX

Interfaces and the OptiMark System

would provide sufficient capacity to

handle the volume of data reasonably

anticipated for the PCX Application.

The Exchange would have in place

security procedures designed to prevent

unauthorized access to the PCX

Application and to safeguard the PCX

Interfaces. The Exchange would obtain

similar assurances from OTI and OSI

that reasonable security procedures are

in place to safeguard the OptiMark

System and to protect against threats to

the proper functioning of the OptiMark

System, including any networks used by

the OptiMark System. The Exchange

would also obtain appropriate

assurances that proper system reliability

and system capacity exists to ensure the

integrity of the data handled and timely

response of the OptiMark computers in

connection with the PCX Application.

Fees for the PCX Application

Transactions resulting from the PCX

Application would be subject to the

Exchange’s customary assessment of

transaction charges and the

Commission’s exchange transaction fee

under Section 31 of the Act. As a

sponsor of the OptiMark System within

the meaning of Rule 17a–23 under the

Act, OSI, which currently plans to apply

to register as a broker-dealer, would be

compensated by way of usual and

customary commissions, on a cents-pershare-filled basis, for transactions

effected by a member User for its own

customer accounts through the PCX

Application. With respect to

transactions effected by a non-member

User, OSI would be paid commissions

on a similar basis from the relevant

Designated Broker.

III. Comments Received

The Commission received fourteen

comment letters in response to its

request for comments on the PCX

proposal.23 All of the comment letters,

except for a letter submitted by the

NYSE, supported the PCX’s proposal.

Letters in support of the proposal were

submitted by institutions, broker-dealers

(including underwriters, specialists, and

retail and clearing brokers), the

Treasurer of the State of California, and

from academia.

Those submitting letters in favor of

the implementation of the OptiMark

System provided various reasons for

their support of the PCX proposal. For

example, commenters stated that the

OptiMark System would provide an

alternative to the traditional method of

order execution and would be the first

system available to allow institutions to

use complex trading strategies in a

secure environment.

Several commenters stated that the

OptiMark System would provide both

retail and institutional participants with

an improved ability to buy or sell

securities in a manner that matches

their objectives. Commenters stated that

both retail and institutional customers

would benefit from better prices.

One broker-dealer, for example, stated

that the OptiMark System would enable

its retail customers to obtain price

improvement derived from a mixture of

retail and institutional order flow

between PCX floor brokers and

specialists. Another stated that the

system would be beneficial in allowing

for anonymous interaction between

retail orders and institutional orders.

In addition, some commenters

focused specifically on the

confidentiality of the OptiMark System.

One commenter noted that, currently,

trading interest may be difficult to

assess because of concerns about

information integrity and the market

impact cost of large orders. Another

stated that one of the biggest problems

that institutions face today is attempting

to keep their decisions to buy or sell

securities confidential. These and other

commenters argued that OptiMark

would provide a solution to such

problems. One commenter stated that

the system would allow a portfolio

manager to add qualitative information

to each order on a non-disclosed basis.

Several commenters stated that the

OptiMark System would promote

liquidity, and two commenters stated

that the Application would reduce

market volatility. Several commenters

stated that OptiMark would promote

market efficiency and reduce

transaction costs by lowering the market

impact of trades.

Commenters also argued that the

OptiMark System would further the

development of the national market

system (‘‘NMS’’) envisioned in the

Securities Acts Amendments of 1975,24

and as reflected in Section 11A of the

Act.25 One such commenter stated that

‘‘OptiMark represents precisely the kind

of ‘new data processing and

communications techniques’ that

Congress thought when it passed the

1975 Securities Act Amendments would

create the opportunity for more efficient

and effective market operations, and

would foster efficiency, enhance

competition, facilitate the offsetting of

customer orders, and contribute to best

execution.’’ 26 The same commenter

stated that OptiMark’s operation as a

facility of an exchange, ‘‘with the

accompanying linkage to other markets

through the ITS system, should ensure

that OptiMark has a positive impact on

the national market system as a

whole.’’ 27

One commenter also stated that

OptiMark would promote free market

competition and would ‘‘erod[e] the

private club benefits previously afforded

members of dominant exchanges and

compel * * * limit order disclosure to

the public markets.’’ 28

In contrast to the views of the

supporting commenters, NYSE

submitted a comment letter opposing

the PCX rule filing (‘‘NYSE Comment

Letter’’).29 The NYSE asked the

Commission not to approve the filing,

but to require PCX to further explain

and clarify its proposal. In its letter,

NYSE expressed several concerns about

the possible implementation of the

OptiMark System. First, NYSE

contended that the system would have

the effect of ‘‘creating a hidden market’’

within PCX, which it believed would be

detrimental to other trading interest on

PCX and to the NMS, and contrary to

established PCX auction rules.30 NYSE

argued that marketable trading interest

processed through the Application

would not be exposed to the PCX

auction or to the NMS until after a

transaction has occurred. In NYSE’s

view, OptiMark Profiles would

constitute orders that should be

incorporated into PCX’s floor-based

trading system. More specifically, NYSE

contended that Profiles equal to or

better than the price of the thendisseminated PCX quotation should be

quoted in the same manner as other

orders received by PCX. In addition,

NYSE argued that a trade resulting from

use of the OptiMark System that is

printed on PCX would impose new and

additional price protection

responsibilities on PCX specialists.

NYSE claimed that the PCX filing was

silent about the right or obligation of

PCX floor brokers to ‘‘break up,’’ and

provide potential price improvement
Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices 50043

31The NYSE cited, in particular, the language in

the PCX’s filing that states:

In no event will the Exchange or any operator,

administrator or licensor of the OptiMark System be

responsible for any User’s failure to pay for the PCX

Securities purchased or to deliver the PCX

Securities sold. Neither OTI nor OSI will be deemed

to be a party to or a participant in, as principal or

agent, any trade or transaction entered into or

otherwise conducted by Users while using the

OptiMark System for the purposes of clearance and

settlement.

Letter from James E. Buck, NYSE, supra, note 4,

at 5–6.

32 ID. at 6.

33See Letter from John C. Katovich, Senior Vice

President and General Counsel, PCX, to Richard R.

Lindsey, Director, Division of Market Regulation,

SEC, dated May 19, 1997 (‘‘PCX May 19 Letter’’).

34See Letter from James E. Buck, NYSE, supra,

note 4, at 4. NYSE also noted it would not generally

comment on this because it understood that

Commission staff would not grant the requested

exemption from Rule 10a–1 under the Act. Id.

35 Id.

36 Id.

37See Amendment No. 1, Supra, note 5.

38 Id. at 2.

39 Id.

40The PCX has equity trading floors both in San

Francisco and Los Angeles.

for, Profiles crossed or matched within

the OptiMark System and routed to the

PCX floor for execution.

NYSE raised concerns about the

potential effect of the Application on

PCX’s relationship with the ITS with

respect to access and liability for

clearance and settlement. NYSE stated

its belief that the Application’s access to

ITS would be different from that

currently used by PCX for the sending

of ITS commitments pursuant to the ITS

Plan. NYSE argued that it would be

premature for the Commission to

approve PCX’s filing until PCX has

provided the ITS participant markets

with a clear and detailed understanding

of how PCX intends for OptiMark to

access the ITS. NYSE also claimed that

PCX was attempting to amend the terms

of the ITS Plan to limit PCX’s liability

beyond the authority set forth in the ITS

Plan.31

Finally, NYSE stated that the PCX

filing did not clearly reflect that all ITS

price protection rules would be

followed by the users of the

Application. NYSE noted that ITS price

protection rules specify the obligations

of participant members for satisfying

trade-throughs, Block Policy trades, and

locked markets involving other ITS

participant markets, and that these

obligations include a requirement to

issue ITS commitments to trade. Next, it

highlighted that PCX’s filing stated that

users would be able to ‘‘place

restrictions on any potential purchase or

sale of shares through ITS.’’ 32 NYSE

believes this language suggests that a

PCX member (or member’s customer)

could place restrictions on the use of

ITS that would ignore the ITS price

protection rules. Accordingly, NYSE

suggested PCX’s filing be amended to

note the limitation on a user’s right to

place limitations on the use of ITS for

price satisfaction purposes.

Further, NYSE questioned OptiMark’s

proposed compliance with the

Commission’s short sale rule. NYSE

noted a letter sent by the PCX to the

Commission’s Division of Market

Regulation in May 1997, requesting

relief from the short sale rule.33 NYSE

stated that an exemption ‘‘would not be

appropriate for a system such as

OptiMark which provides price

discovery.’’ 34 NYSE also referred to

PCX’s proposed amendment to PCX

Rule 5.14, which proposed that ‘‘[t]he

Exchange’s short sale rule (Rule 5.18)

shall not be applicable to any resulting

transaction in the Exchange.’’ 35 NYSE

argued that the approval of such a

proposed rule would ‘‘establish a clear

conflict that could lead to inadvertent

regulatory violations.’’ 36 NYSE

recommended that PCX amend its

proposal to delete both PCX Rule 5.14

and the above-quoted proposed

language.

On August 1, 1997, PCX submitted to

the Commission a letter responding to

issues raised in the NYSE Comments

Letter.37 In response to NYSE’s

comment that the Application would

create a ‘‘hidden market,’’ PCX stated

that the Application would operate in a

manner consistent with existing

principles of the current auction market

now in place at PCX as well as at NYSE.

PCX represented that ‘‘[b]ids or offers

announced on the PCX floor or in the

specialist’s book will continue to be

collected and disseminated by the PCX

in full compliance with Rule 11AC1–1’’

under the Act, and that PCX’s

continuous auction facilities, separate

and apart from the periodic auction

conducted by the Application, would

continue to be available to members.38

PCX argued that ‘‘[t]he fact that

Profiles will not be disseminated as

quotes does not create a hidden market’’

because the Profiles are analogous to

indications of interest, and not bids and

offers.39 PCX further argued that the

Application represents a periodic call

market facility and that quotes in such

market have no meaning because

trading interest remains a generalized

expression of interest until it is

processed during the call. PCX argued

that no Profile is eligible for execution

until the time of the call, in contrast to

a quote, which is a firm bid or offer

available for execution at any time. In

this regard, PCX believes that the

display of any Profile in an open quote

stream would contradict the desire of

Users submitting Profiles and would

impair the integrity of the quote system

because individual Users would

represent multiple and differing price

values for any given buy or sell interest.

Thus, PCX stated that it should not be

required to display in the PCX quotation

User Profiles, including those

coordinates with a satisfaction value of

1.

In response to the NYSE argument

that the Application would impose new

price protection responsibilities on PCX

specialists, PCX stated that although the

Exchange would require its specialists,

under PCX Rule 5.32(a), to honor their

obligations for executions at the same or

better prices that occur as a result of the

Application, this requirement would not

constitute a new obligation. As an

example, PCX outlined how PCX

specialists guarantee the price of

executions that occur on the ‘‘other city

floor’’ 40 of the PCX, noting that under

certain circumstances, a PCX specialist

may be obligated to fill an order at a

price obtained from the ‘‘other’’ PCX

floor. PCX noted that the guarantee

requirements imposed on PCX

specialists regarding transactions

effected through the Application will

likely influence them to reflect

frequently their book orders in the

OptiMark system, although they would

not be obligated to do so. Further, if a

specialist did not honor its obligations

to execute an order, based upon an

execution that occurs in the primary

market or within the PCX market, the

specialist would be found to be in

violation of existing PCX rules.

PCX also disagreed with the NYSE’s

comment that the PCX proposal does

not comply with PCX’s crossing rules,

specifically PCX Rules 5.14 (a) and (b).

According to PCX, under these rules

members are responsible for assuring

that all existing bids or offers, at or

better than the cross price, are filled at

their limits. PCX argued that although

the OptiMark System would help a User

find other trading interest through the

central processing of Profiles, this is not

the same as a cross transaction on the

Exchange floor, where both sides of the

trade are brought to the specialist’s post

by a broker. PCX emphasized that when

coordinates from Profiles happen to

match at the time of the call, it is

fortuitous and can not be considered a

cross as defined in either PCX or NYSE

rules. PCX further stated that when two

Profiles with overlapping coordinates

give the appearance of a cross, the

processing of these Profiles against other
50044 Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices

41See Amendment No. 1, supra, note 5, at 4.

42 Id. at 5.

42 Id.

44 Id. at 1–2.

45See Letter from James E. Buck, Senior Vice

President and Secretary, NYSE, to Jonathan G. Katz,

Secretary, SEC, dated Aug. 20, 1997 (‘‘NYSE Second

Comment Letter).

46 Id. at 1.

47 Id.

48 Id. at 2.

49 Id. at 3.

50 Id. at 4.

trading interest in the PCX Application

may not result in a match between the

two Profiles. Rather, the priorities

established by the Application could

effectively ‘‘break up’’ any such

potential match.

With respect to NYSE’s comment on

ITS access, the Exchange argued that the

Application would not change the

method of system access in any manner

that calls for an ITS Plan amendment.

Instead, the Exchange stated that the

Application would be an additional

exchange facility, through which the

Exchange would be able to honor its

existing ITS commitments. The

Exchange emphasized that the

Application would merely provide more

convenient electronic access for the

benefit of its members and their

customers, and as such, the Application

would ‘‘complement one ‘example’ of

system access described in Section 6 of

the ITS Plan through added flexibility,

thereby promoting the increased use of

ITS through information and

telecommunications technology

innovation, all as intended by the ITS

Plan and as required by the Commission

under Section 11A of the Exchange

Act.’’ 41

With respect to NYSE’s argument that

the PCX filing would ‘‘effectively amend

the terms of the ITS Plan to limit PCX’s

liability beyond the terms specified in

the Plan,’’ PCX responded that the filing

would not have such an effect; similar

limitations on liability have not been

construed or applied so as to limit an

ITS Participant’s contractual obligations

arising under Section 9 of the ITS Plan.

PCX further stated that NYSE itself

limits its liability for any damages

sustained in connection with the use of

its facilities, citing NYSE Constitution,

Article II, Section 6.

PCX strongly disagreed with NYSE’s

comment that PCX’s proposed User

restrictions on potential purchases or

sales of shares through the ITS would

have the effect of obviating the ITS price

protection rules, stating that the

Exchange ‘‘adheres strictly to the ITS

price protection rules.’’ 42 The Exchange

stated that its filing ‘‘repeatedly

provides that no orders may be executed

on the Exchange at a price inferior to

that of other outstanding trading interest

with standing, which includes CQS

Profiles derived from the quotes of other

ITS Participants.’’ 43 The Exchange also

stated that Users placing restrictions on

any potential purchase or sale of shares

through ITS would be required to forgo

any potential transactions that would

cause a trade-through. The Exchange

concluded that permitting a User to

place limitations on the use of ITS at the

User’s own risk is consistent with the

ITS plan because it does not implicate

the ITS price protection rules.

The PCX letter also mentioned the

PCX’s May 1997 request for exemptive

relief from the short sale rule and noted

that it understood that such relief would

not be granted. Accordingly, the PCX

submitted a proposed amendment to

PCX Rule 15.3(b), which (as modified by

a subsequent amendment) would add

the following language to the Rule:

and provided further that no Orders

designated as ‘‘sell short’’ may be generated

for execution at a price: (i) Below the price

of the immediately preceding match (or the

last sale price reported on a consolidated

transaction reporting system immediately

prior to commencement of the Cycle in the

case of the initial match of that Cycle) or (ii)

at such price unless such price is above the

next preceding different price.44

On August 20, 1997, NYSE submitted

to the Commission a second comment

letter responding to issues that the PCX

raised in Amendment No. 1.45 In its

letter, NYSE expanded upon points

raised in its initial comment letter. For

example, NYSE again raised the

‘‘hidden market’’ issue. NYSE argued

that the PCX was proposing ‘‘to sponsor

two markets (its ‘regular’ market and the

OptiMark cycles) with minimal

interaction between the two.’’ 46 NYSE

also challenged OptiMark’s claim that

the Cycles would constitute a periodic

call market because Cycles would be as

frequent as every 90 seconds. As a

result, NYSE argued, Users could enter

a priced order into a ‘‘nearly-continuous

auction, without disclosing the order to

the regular market, even if the order

matches or improves the national best

bid and offer.’’ 47 NYSE argued that this

activity would stand in direct conflict

with recent Commission efforts to

integrate all trading interest in the

national market system, whether

through electronic communication

networks or otherwise.

In addition, NYSE reiterated that the

Application would be inconsistent with

PCX’s own auction rules, claiming that

orders and executions resulting from the

Application would not be integrated

with other PCX trading interest and, as

such, would not be like other PCX

executions. NYSE stated that PCX’s

rules require that all orders be

integrated into the PCX auction and

interact with other trading interest

taking place on the PCX floor. NYSE

argued that, contrary to PCX’s auction

rules, an order entered on the PCX after

the commencement of a Cycle of the

Application would ‘‘not interact with an

OptiMark ‘order’ that is ‘routed and

executed on the [PCX], even if the more

recent PCX order is at a better price or

has priority over the OptiMark

‘order.’ ’’ 48

In addition, NYSE argued that the

PCX’s proposed amendment regarding

its intended compliance with the

Commission’s short sale rule, as

explained in the PCX’s Amendment No.

1, is inconsistent with the wording and

purposes of the rule. NYSE

characterized PCX’s proposal as

prohibiting short sales in the

Application on minus ticks or zero

minus ticks based on the last ‘‘match’’

in the Application, and that the

Application would rely on the last

transaction reported to the CTS only for

the initial Cycle. NYSE argued that Rule

10a–1, by contrast, regulates short

selling based on consolidated last sales,

giving an exchange an option of using

the last sale on that exchange. NYSE

therefore argued that an exchange

‘‘cannot regulate short sales based on

sales in only one component of an

exchange’s trading system.’’ 49

NYSE also addressed the

Application’s access to, and liability for

clearance and settlement through, the

ITS. With respect to access, NYSE took

issue with the PCX’s statement that the

Application ‘‘will complement one

‘example’ of system access’’ described

in the ITS Plan. NYSE argued that this

statement ‘‘raises serious questions of

access to NYSE market and to the

markets of the other ITS Participants.’’ 50

NYSE stated that PCX intends to make

a detailed presentation at an ITS

Committee meeting in September 1997,

and argued that it would be premature

for the Commission to act on the PCX’s

filing before the meeting and further

consideration of the issue.

With respect to the PCX’s proposal

regarding liability for clearance and

settlement with respect to the

Application, NYSE restated its earlier

position that the PCX’s proposal is

inconsistent with Section 9 of the ITS

Plan, which requires each Participant to

assume responsibility for settling certain

uncompared ITS trades. NYSE argues

that the PCX’s proposal attempts to

amend the ITS Plan to limit the PCX’s

liability beyond the terms of the Plan.
Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices 50045

51See PCX Floor, Letter and PCX ITS Letter,

supra, note 6.

52PCX Floor Letter, supra, note 6, at 1.

53 Id.

54 Id. at 2.

55PCX ITS Letter, supra, note 6. See also, PCX

Rule 5.23.

56 15 U.S.C. § 78(f)(b)(5).

57 In approving the proposal, the Commission has

considered the proposal’s impact on efficiency,

competition, and capital formation. 15 U.S.C.

§ 78c(f).

58 15 U.S.C. § 78k–1.

59 In 1982, when instating the Cincinnati Stock

Exchange’s NSTS as a permanent program, the

Commission stated:

In mandating the development of a NMS,

Congress expressly stated that ‘‘[n]ew data

processing and communications techniques create

the opportunity for more efficient market

operations.’’ . . . In carrying out Congress’

mandate, the Commission has taken an

evolutionary approach by encouraging the

securities industry to take the primary initiative in

fashioning trading mechanisms which are

consistent with the goals of a NMS. The

Commission believes that, as a general matter, the

industry has responded well to changing economic

and technological demands by attempting to

integrate state of the art data processing and

communications technology to develop many new

trading systems which have advanced the objectives

of a NMS. In this respect, the Commission believes

that ITS, the NASD’s [National Association of

Securities Dealers’] Computer Assisted Execution

System (‘‘CAES’’) and the NSTS represent

constructive approaches to integrating trading in

physically dispersed locations. (citations omitted)

Securities Exchange Act Release No. 19315 (Dec.

9, 1982), 47 FR 56236 (Dec. 15, 1982).

60See, e.g., Securities Exchange Act Release No.

19315 (Dec. 9, 1982), 47 FR 56236 (Dec. 15, 1982)

(Commission approval to terminate the NSTS as an

experimental program and extend its duration for

an indefinite period of time); Securities Exchange

Act Release No. 12451 (May 14, 1976), 41 FR 20932

(May 21, 1976) (Commission approval of the MAX

system to operate on a permanent basis); Securities

Exchange Act Release No. 32631 (July 14, 1993), 58

FR 39069 (July 21, 1993) (Commission approval to

operate the SuperMAX system on a permanent

basis); Securities Exchange Act Release No. 17601

(Mar. 4, 1981); 46 FR 16171 (Mar. 11, 1981)

(Commission Notice of the NASD filing of a

proposed rule change for the establishment of

CAES); Securities Exchange Act Release No. 17744

(Apr. 21, 1981), 46 FR 23856 (Apr. 28, 1981)

(Commission order to implement an automated

interface between the ITS and CAES); and

Securities Exchange Act Release No. 18713 (May 6,

1982), 47 FR 20413 (May 12, 1982) (implementing

ITS/CAES interface and operations).

61Securities Exchange Act Release No. 35030

(Nov. 30, 1994), 59 FR 63141 (Dec. 7, 1994). The

Continued

On August 29, 1997, PCX submitted

to the Commission two letters

supplementing the filing and further

addressing issues raised by the NYSE.51

PCX stated that it is incorrect to

characterize an order generated by an

Optimark cycle as a ‘‘cross’’ given that,

under PCX Rule 5.14(a), a cross

transaction is ‘‘a transaction in which a

member effects both the purchase and

sale.’’52 PCX submitted that most

matches resulting from a Cycle would

be based on trading interest reflected in

Profiles submitted by two different

members, and thus would not be crosses

involving the same member. Although

PCX conceded that the same member

could submit both buy and sell Profiles

that could result in a matched order, it

pointed out that the member would

have no control or influence in

determining the outcome of such a

match. PCX concluded that the presence

of member intermediation and trading

discretion is essential to the definition

of ‘‘cross’’ as it is understood and

applied in the context of continuous

auction trading.53

In response to NYSE’s claim that PCX

floor brokers representing customer

interest could ‘‘miss the market’’ if they

chose not to use Optimark, PCX noted

that such an outcome was no different

than the situation where a floor broker

either routes a customer order to

another market or is not present in the

trading crowd when a cross is

announced.54

In the PCX ITS Letter, the PCX

clarified its continued responsibility to

settle trades effected through the PCX

Application, pursuant to the terms of

the ITS Plan. Specifically, PCX stated

that it did not intend to modify any PCX

members’ obligations under the ITS

Plan nor to modify the Exchange’s

obligation under the Plan to ensure

settlement of trades effected via the PCX

Application.55

IV. 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).56 The

Commission finds that the Exchange’s

proposal to establish rules to implement

the PCX Application of the Optimark

System would promote the

Commission’s mandate under Section

6(b)(5) to remove impediments to and

perfect the mechanism of a free and

open market and a NMS, while

protecting investors and the public

interest. In addition, the Exchange’s

proposal with respect to the PCX

Application is consistent with the

Section 6(b)(5) requirements that rules

of an exchange be designed to prevent

fraudulent and manipulative acts, to

promote just and equitable principles of

trade, and are not designed to permit

unfair discrimination among customers,

issuers, or broker-dealers.57

In addition, the Commission finds

that the proposed rule change is

consistent with the requirements of

Section 11A of the Act.58 The

Commission believes that the proposed

Application of the OptiMark System

would further the purposes of Section

11A of the Act and the development of

a NMS by promoting economically

efficient execution of securities

transactions, fair competition among

markets, the best execution of customer

orders, and an opportunity for orders to

be executed without the participation of

a dealer. The PCX Application provides

a new and potentially more efficient

way for the Exchange to match and

execute trading interest. The

Application appears principally

designed to meet the demands of

sophisticated portfolio managers and

other market professionals

implementing complex trading

strategies. These market participants

often require instantaneous access to the

market, and desire to minimize the

market impact of their transactions

through the expression of varied trading

interests on a confidential basis. At the

same time, the Application is designed

to allow retail customers, through

member Users, to interact with

institutional trading interests.

The PCX Application is likely to

promote competition among market

centers because it has the potential to

attract new market participants and to

increase order flow to the Exchange. By

attracting order flow, the Application

may provide a new and enhanced

source of liquidity for investors.

Further, as noted in the majority of the

thirteen comment letters that supported

the proposal, both institutional and

retail investors should benefit from the

Application insofar as their expressions

of trading interest are represented in the

OptiMark System and are executed on

the Exchange. As a result, the

Application could enhance the ability of

investors to have their orders executed

on the PCX. Moreover, the Application

would increase the ability of investors’

orders to interact directly with other

investors orders on the PCX.

The Commission has historically

encouraged exchanges to integrate new

data communications and trade

execution mechanisms into their

markets in furtherance of the

development of the NMS.59 The

Commission, for example, approved the

fully computerized National Securities

Trading System (‘‘NSTS’’) of the

Cincinnati Stock Exchange, the MAX

and SuperMAX Systems of the Chicago

Stock Exchange, and the CAES operated

by Nasdaq.60 In fact, the PCX

Application of the OptiMark System

shares many of the characteristics of the

Chicago Stock Exchange’s Chicago

Match System, which was approved by

the Commission in 1994.61 Like the
50046 Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices

PCX Application differs from Chicago Match in that

it is a periodic, rather than a unitary, call market.

62The PCX Application is properly regulated as

a facility of an exchange, as defined in Section

3(a)(2) of the Act. The PCX Application of OptiMark

would use the PCX’s premises, property, and

services for effecting and reporting transactions. For

a recent discussion of the classification of an

electronic communication and matching system as

a facility of an exchange, see Securities Exchange

Act Release No. 35030, supra, note 61 (concerning

the Chicago Match System).

OSI, which plans to register as a broker-dealer

and comply with Rule 17a–23 under the Act, would

be responsible for operating portions of the PCX

Application for the Exchange and would receive

commissions from Users for transactions. The

Exchange has represented that it will submit any

changes to this structure to the Commission as a

rule filing.

In addition, OTI expects to offer other exchanges

trading services based on the OptiMark System

technology. If another national securities exchange

chooses to use the OptiMark System, it would be

required to file a separate rule filing under Section

19(b) of the Act.

63Further, the Exchange will ensure that the

Application complies with all trading halts and

trading suspensions.

64As with any other exchange application, the

Commission expects to conduct a full EDP review

of the Application and its operations. See, e.g., the

Commission’s Automation Review Policy

guidelines. Securities Exchanges Act Release No.

27445 (Nov. 16, 1989), 54 FR 48703 (Nov. 24, 1989),

and Securities Exchange Act Release No. 29185

(May 9, 1991), 56 FR 22490 (May 15, 1991).

65 17 CFR 240.11Ac1–1.

66See CFR 240.11Ac1–1(a)(4).

67The term ‘‘electronic communications

network’’ means, for the purposes of 17 CFR

240.11Ac1–1(c)(5), ‘‘any electronic system that

widely disseminates to third parties orders entered

therein by an exchange market maker or OTC

market maker, and permits such orders to be

executed against in whole or in part; except that the

term electronic communications network shall not

include: (i) Any system that crosses multiple orders

at one or more specified times at a single price set

by the ECN (by algorithm or by any derivative

pricing mechanism) and does not allow orders to

be crossed or executed against directly by

participants outside of such times; or (ii) Any

system operated by, or on behalf of, an OTC market

maker or exchange market maker that executes

customer orders primarily against the account of

such market maker as principal, other than riskless

principal.’’ See 17 CFR 240.11Ac1–1(a)(8). Rule

11Ac1–1(c)(5)(i) provides that the ‘‘[e]ntry of any

priced order for a covered security by an exchange

market maker or OTC market maker in that security

into an electronic communications network that

widely disseminates such order shall be deemed to

be: (A) A bid or offer under this section, to be

communicated to the market maker’s exchange or

association pursuant to paragraph (c) of this section

for at least the minimum quotation size that is

required by the rules of the market maker’s

exchange or association if the priced order is for the

account of a market maker, or the actual size of the

order up to the minimum quotation size required

if the priced order is for the account of a customer;

and (B) A communication of a bid or offer to a

quotation vendor for display on a display device for

purposes of paragraph (c)(4) of this section.’’ 17

CFR 240.11Ac1–1(c)(5)(i).

68See PCX May 19 Letter, supra, note 33, at 8.

69 Id. at 8–9.

70 Id. at 9.

71Rule 11Ac1–1(a)(4) provides that the terms

‘‘bid and offer’’ mean ‘‘the bid price and the offer

price communicated by an exchange member or

OTC market maker to any broker or dealer, or to any

customer, at which it is willing to buy or sell one

or more round lots of a covered security, as either

principal or agent, but shall not include indications

of interest.’’ (emphasis added) 17 CFR 240.11Ac1–

1(a)(4).

proposed Chicago Match System, the

PCX Application blends some of the

features of a call market with the

continuous auction of the PCX floor.

The operation of such a hybird system

will differ in important respects from

the traditional structure of a trading

floor. For the reasons discussed below,

however, the Commission does not

believe that these differences would

cause the PCX Application to violate the

provisions of the Act.

First, the Commission believes that

the Application, operating as a facility

of an exchange, would have the ability

and capacity to carry out the regulatory

purposes of the Act.62 As part of its

obligations under the Act and pursuant

to its own rules, the Exchange would

conduct all necessary surveillance of the

operation of and trading through the

Application.63 The Exchange has also

represented that the Application would

have a full audit trail capability,

adequate computer capacity to handle

and process User Profiles and order

flow, and adequate computer security to

ensure the safety and confidentiality of

User transmission.64

Second, contrary to the NYSE’s

assertion, the Exchange is not operating

a hidden market in violation of the Firm

Quote Rule.65 Specifically, the

Commission does not believe that the

PCX Application violates the Firm

Quote Rule. The Firm Quote Rule,

among other things, requires exchanges

to collect bids, offers, quotation sizes

and aggregate quotation sizes from

responsible brokers or dealers for

subject securities, and make them

available to quotation vendors.

A bid or offer is defined in the Firm

Quote Rule as the ‘‘bid price and the

offer price communicated by an

exchange member or OTC market maker

to any broker or dealer, or to any

customer.’’ 66 In order to constitute a bid

or offer, therefore, the underlying

trading interest must have been

communicated to at least one other

potential counterparty. Bids and offers

are intended to attract other parties to

deal with the person publishing the bid

or offer at the quoted price. For

example, the Commission recently

deemed the entry of priced orders into

an electronic communications network

(‘‘ECN’’) to be bids and offers where

these orders were widely disseminated

to other parties.67 In contrast, the

essence of the Application is its

anonymity. Only the Application is

aware of the potential trading interest

until trades occur. The PCX represents

that the Application would ‘‘not permit

any interactive communication among

Users whatsoever for any solicitation of

trading interest (not even on an

anonymous basis).’’ 68 The PCX further

represented that the Application

‘‘differs fundamentally from any ‘hit or

take’ or ‘interactive’ trading system,

which allows the display of order price

and size levels by a subscriber for others

to act on.’’ 69 The Commission agrees

with the PCX representation that the

Application ‘‘is not a mechanism by

which system subscribers (1) broadcast

prices to other system subscribers and

(2) trade with one another at those

prices,’’ like an exchange or ECN.70

Accordingly, the Commission believes

that the Application as proposed would

not violate the Firm Quote Rule and

would not fall within the status of an

ECN.

Moreover, Profiles, unlike bids and

offers, are conditional until they are

processed in a Cycle. In this way,

Profiles are analogous to indications of

interest or CAP orders, neither of which

are displayed in exchanges or on

Nasdaq. The terms ‘‘bid’’ and ‘‘offer,’’ as

defined by the Firm Quote Rule, do not

include ‘‘indications of interest.’’ 71 A

Profile is only a generalized expression

of interest with conditions attached and

is not eligible for execution until the

completion of the Cycle. Profiles

entered into the PCX Application can be

revised and cancelled at any time prior

to commencement of the next scheduled

Cycle.

Further, the Commission does not

believe that the PCX Application would

create a hidden market within PCX. The

Commission particularly disagrees with

NYSE’s suggestion that PCX’s proposed

non-dissemination of Profiles to PCX’s

equity floor and other exchange markets

is contrary to the goals of the NMS.

Rather, the Commission believes that

the unique design of the Application

warrants a non-traditional approach in

determining whether to require the

dissemination of trading interest

expressed through operation of the

Application. The Application reflects

the efforts of PCX to establish a trading

system that blends elements of a call

market with a continuous auction

market, with anonymous Profiles being

continuously entered and cancelled

until the next scheduled periodic call

market (performing a Cycle). The failure

to disseminate Profiles does not provide

any other market participant with an

unfair market advantage as a result of

seeing the trading interest that is not

shown to others. Any User only knows

its own Profile; it has no special access
Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices 50047

72For example, if a specialist received a customer

limit order to buy 1,000 shares at 20 prior to the

commencement of a Cycle, and the best priced

order generated by the Cycle was assigned a price

of 191⁄2, involving 900 shares, with the next best

priced order at 193⁄4, involving 1,000 shares, the

specialist would be obligated to fill 900 shares of

the customer limit order at 191⁄2, and fill the

balance at 193⁄4.

73NYSE Second Comment Letter, supra, note 45,

at 2.

74Contrary to NYSE’s understanding, PCX

specialists would not be required to guarantee

customer limit orders booked after the

commencement of a Cycle at prices obtained as a

result of such Cycle.

75Further, Exchange members would be required

to maintain information and records concerning

non-members access for which they are responsible.

The Exchange has represented to the Commission

that it would require its members to make such

non-member User information available to the

Exchange upon request, so that the PCX can fulfill

its duties regarding surveillance.

76See Securities Exchange Act Release No. 35030,

concerning the Chicago Match System, supra, note

61. As with the PCX Application, the CHX required

non-member users of the Chicago Match System to

enter into several agreements to ensure that a CHX

member had responsibility and control over the

non-member’s activities. These responsibilities,

included, among other things, controlling and

clearing the orders entered by non-members,

assuming legal responsibility of the non-member

orders entered, and ensuring appropriate credit

limits. See id. The Commission’s approval order for

the Chicago Match System also noted that the then

anticipated non-member use of the Chicago Match

System was analogous to non-member access to the

NYSE’s Designated Order Turnaround System (now

referred to as ‘‘SuperDOT’’). The SuperDOT System

is an electronic order-routing system that enables

NYSE members and their customers to transmit

market and limit orders in all NYSE-listed

securities directly to the specialist post where the

securities are traded, or to the member firm’s booth.

Non-member customers, however, must obtain the

electronic means to access SuperDOT through a

Continued

to other Users’ Profiles. Moreover, users

have no control or influence in

determining the outcome of a match,

other than through the construction of

their own Profiles.

In addition, the Commission believes

that dissemination of Profiles would

likely be very difficult, given that

Profiles represent contingent trading

interest at different prices, share

amounts, and satisfaction levels. Any

accurate dissemination of Profiles, other

than Profiles containing only a

satisfaction value of one, would need to

be expressed in a three-dimensional

format, which could create confusion

for investors.

Third, the Commission believes that

trading interest on the PCX floor would

be adequately integrated into the PCX

Application. Specifically, specialists

and floor brokers would be able to

reflect customer trading interest by

entering Profiles into the PCX

Application. In addition, if a specialist

does not submit a limit order to the

Application, the Exchange would

require that specialist to guarantee the

execution of the limit order at the price

of an order derived from a Cycle that is

priced at or better than the limit order’s

price, up to the amount of shares

executed as a result of the particular

Cycle.72 Floor brokers, similarly, would

remain subject to best execution

obligations. The NYSE has pointed out

the possibility that, during a small

window of a few seconds, if a limit

order were sent to the Exchange

immediately following the

commencement of a Cycle, this order

would not have the opportunity to

interact with the Profiles entered into

the PCX Application.73 Thus, once the

Cycle is completed, resulting orders sent

to the PCX for execution at such limit

order’s price or better would bypass the

limit order, even though such limit

order had priority under the PCX’s

current rules. The Commission

acknowledges that there is a possibility

of this scenario occurring. Because of

the virtually instantaneous nature of the

Cycles, however, such a scenario is

likely to occur very infrequently.74

Fourth, the Commission notes the

Exchange’s representations that the

operation of the PCX Application would

be consistent with the Exchange’s and

its members’ obligations under the ITS

Plan. Specifically, the Exchange

represents that the PCX Application

would be operated in a manner

consistent with the Exchange’s

intermarket price protection obligations

under the ITS Plan. The PCX

Application would incorporate existing

market interest from each of the ITS

participant markets in the form of CQS

Profiles. All orders priced inferior to the

quotations of another ITS participant

market would be executed on the

Exchange only upon submission of

appropriate ITS commitments seeking to

reach such better-priced interest. For

orders representing matched

coordinates from CQS Profiles and other

Profiles, the Exchange would submit an

ITS commitment reflecting each such

order for execution on other market

centers to which the OptiMark System

is not directly linked. Every ITS

commitment would be sent under the

give-up of the member User or the

Designated Broker, by way of the

traditional Exchange linkage to the ITS,

in the sequence in which orders are

generated from the Cycle.

PCX has represented that it proposes

to send ITS commitments resulting from

the PCX Application in the same way as

other ITS commitments are currently

sent by the Exchange. The Commission

notes that PCX has represented that the

Application will be implemented in a

manner fully consistent with the ITS

Plan, and PCX is engaged in discussions

with other ITS participants regarding

the requirements of the ITS Plan.

The Commission believes that PCX

has adequately represented that its

proposed disclaimer of liability

(proposed PCX Rule 15.8) covering the

operation of the PCX Application does

not operate to change or modify in any

way PCX’s obligations for clearance and

settlement of trades matched through

the Application and submitted for

execution on another market center

pursuant to the ITS Plan.

Fifth, the Commission also believes

that the PCX will meet its obligation

with respect to the reporting of

transactions resulting from the

Application. The Exchange has

represented that transactions resulting

from orders routed to the PCX floor from

the Application would be reported to

the CTS in the sequence in which such

orders are generated from a Cycle. The

Exchange has represented that it would

report these trades in a manner similar

to the way it currently reports other

trades in PCX Securities to the CTS.

Transaction reports resulting from a

Cycle of the Application, moreover,

would not be distinguishable on the

CTS from the trade report of any other

order executed on the PCX floor.

Although such transaction reports may

occur in rapid sequence, with numerous

reports being generated in a short period

of time, the individual transaction

reports would still be reported and

displayed in order of the execution of

the transactions.

Sixth, although non-members would

have access to the Application, such

access would only be through an

Exchange member broker-dealer. Before

submitting Profiles to the PCX

Application, non-members would be

required to designate a member firm

that would authorize their access to the

PCX Application and accept

responsibility for these non-member

transactions. The Exchange states that it

expects the Designated Brokers, or the

clearing brokers of the Designated

Brokers, to impose credit limits on nonmember Users of the PCX Application.75

Other exchanges have allowed nonmembers to access their facilities

through member broker-dealers under

similar conditions. For example, the

Chicago Stock Exchange’s Chicago

Match System provided for direct nonmember access through personal

computers and modems, using a

member broker-dealer give-up. The nonmember access permitted by the

Commission with respect to the Chicago

Match System is substantially similar to

the non-member User access proposed

by PCX.76
50048 Federal Register / Vol. 62, No. 185 / Wednesday, September 24, 1997 / Notices

broker-dealer member. Like the Chicago Match

System, the NYSE’s SuperDOT system requires

NYSE members to monitor customers’ electronic

orders and to provide the NYSE with an

acknowledgement indicating their responsibility for

orders. See id.

77The NYSE asserted that new Rule 15.4

proposed by PCX improperly stated that ‘‘the

Exchange’s short sale rule (Rule 5.18) shall not be

applicable to any resulting transaction in the

Exchange.’’ See Letter from James E. Buck, NYSE,

supra, note 4, at 4. The Commission notes that the

PCX has removed this statement from proposed

new Rule 15.4. 78 15 U.S.C. §§ 78f and 78s(b)(2).

79 15 U.S.C. § 73s(b)(2).

80CFR 200.30–3(a)(12).

Seventh, PCX is adopting reasonable

requirements for the clearance and

settlement of transactions resulting from

the Application. In particular, the

Commission believes it is appropriate

for PCX to require that: (i) All orders

generated by the Application that are

executed on PCX or another market

center through ITS be reported and

entered into the comparison system on

a locked-in basis; (ii) orders generated

by the Application on behalf of a

member User and the resulting

transactions be cleared and settled using

that member User’s mnemonic (or its

clearing broker’s mnemonic, as

applicable); and (iii) orders generated by

the Application on behalf of a nonmember User and the resulting

transaction be cleared and settled using

the appropriate Designated Broker’s

mnemonic.

Finally, the Commission believes that

PCX has established that short sales

effected through the Application,

pursuant to the requested exemption

and in accordance with the restrictions

contained in proposed Rule 15.3(b),

would not be susceptible to the

practices that Rule 10a–1 is designed to

prevent. PCX has amended its proposal

to provide for substantial compliance

with Rule 10a–1.77 PCX represents that

the first match of a Cycle, if it involves

a short sale, would be in compliance

with Rule 10a–1. Subsequent matches

would use the price of the immediately

preceding match in the Cycle, rather

than the last trade in the consolidated

transaction reporting system as a

reference. The Division of Market

Regulation, by delegated authority,

intends to grant PCX an exemption from

Rule 10a–1 to permit matches within a

Cycle (those subsequent to the initial

match) to use the immediately prior

match as a reference for determining

compliance with Rule 10a–1. The

Commission, therefore, believes that

PCX has adequately addressed concerns

arising under the short sale rule.

The Commission finds that good

cause exists to grant approval to

Amendment Nos. 1, 2, and 3 to the

proposed rule change on an accelerated

basis. Collectively, these amendments

reflect PCX’s proposed handling of short

sales affected through the Application

and clarify PCX specialist obligations

relating to price protection for orders

generated by the Application. The short

sale amendment narrows the scope of

the proposed short sale exemption

attendant to OptiMark transactions.

Moreover, as stated above, the

Commission has determined that PCX’s

proposed short sale restrictions

substantially mirror the requirements of

Rule 10a–1 and are designed in a

manner that will not permit the types of

short sale practices Rule 10a–1 was

designed to prohibit. Accordingly, the

Division intends to issue PCX an

exemption from Rule 10a–1. In addition,

the Commission believes that the

amendments pertaining to specialist

price protection obligations resulting

from orders generated by the

Application merely clarify and provide

explanatory examples of how the PCX

rules relating to the Application will

ensure price protection of limit orders.

The Commission therefore finds good

cause to accelerate approval of

Amendment Nos. 1, 2, and 3.

V. Solicitation of Comments

Interested persons are invited to

submit written data, views and

arguments concerning Amendment Nos.

1, 2, and 3. 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. § 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 above-mentioned selfregulatory organization. All submissions

should refer to the file number in the

caption above and should be submitted

by October 15, 1997.

VI. Conclusion

For the reasons discussed above, the

Commission finds that the proposal is

consistent with the Act.78

It therefore is ordered, pursuant to

Section 19(b)(2) of the Act,79 that the

proposed rule change (SR–PCX–97–18)

is hereby approved, as amended.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.80

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–25319 Filed 9–23–97; 8:45 am]

BILLING CODE 8010–01–M

SMALL BUSINESS ADMINISTRATION

Mid-Atlantic States Regional Fairness

Board; Public Hearing

The Mid-Atlantic States Regional

Fairness Board will hold a public

meeting on Thursday, September 25,

1997, at the CitiCorp Center, 135 E. 35th

Street, 14th Floor, Room J, New York,

NY, to inform the small business

community of the existence of a

regulatory enforcement oversight

process and of SBA’s desire to collect

information regarding businesses’

experience with regulatory enforcement

actions, and to discuss such matters as

may be presented by members, staff of

the U.S. Small Business Administration,

or others present.

For further information, please

contact Gary P. Peele at (312) 353–0880.

Dated: September 12, 1997.

Debra Silimeo,

Deputy Associate Administrator, Office of

Communications and Public Liaison.

[FR Doc. 97–25274 Filed 9–23–97; 8:45 am]

BILLING CODE 8025–01–P–M

DEPARTMENT OF TRANSPORTATION

Surface Transportation Board

[STB Ex Parte No. 290 (Sub No. 5) (97–

4)]

Quarterly Rail Cost Adjustment Factor

AGENCY: Surface Transportation Board,

DOT.

ACTION: Approval of rail cost adjustment

factor.

SUMMARY: The Board has approved a

fourth quarter 1997 rail cost adjustment

factor (RCAF) and cost index filed by

the Association of American Railroads.

The fourth quarter 1997 RCAF

(Unadjusted) is 1.104. The fourth

quarter 1997 RCAF (Adjusted) is 0.738.

The fourth quarter 1997 RCAF–5 is

0.718.

EFFECTIVE DATE: October 1, 1997.