[Federal Register Volume 62, Number 230 (Monday, December 1, 1997)]
[Notices]
[Pages 63593-63595]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-31390]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39345; File No. SR-Phlx-97-35]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc. To Adopt a Contingency 
Market Maker System for Foreign Currency Options

November 21, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on July 17, 
1997,\1\ the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the self-regulatory 
organization. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ The Exchange filed Amendment No. 1 to the proposed rule 
filing on November 4, 1997, the substance of which is incorporated 
into this notice. See letter from Philip H. Becker, Senior Vice 
President, General Counsel and Chief Regulatory Officer, Phlx, to 
Michael Walinskas, Senior Special Counsel, Market Regulation, 
Commission, dated November 4, 1997.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Phlx proposes to adopt a contingency plan to trade foreign currency 
options (``FCOs'') pursuant to a Market Maker System. The contingency 
Market Maker System would provide a modified trading system to ensure 
the continuity of FCO trading in the situation where a specialist unit 
is not available. In summary, the contingency Market Maker System would 
be contained in a new provision, Rule 1014(j), which states that 
assigned ROTs will be responsible for making markets and honoring the 
minimum guarantee (ten-

[[Page 63594]]

 up) rule. Markets will be continuously disseminated and the 
responsibility to provide customers with minimum size guarantee markets 
pursuant to Rule 1033(a) shall apply. Assigned ROT participant 
organizations would be required to be available from the opening of 
trading on 50% of the trading days. An Exchange employee, assigned to 
be the Quote Monitor, would handle certain specialist-type functions. 
In addition, the proposed rule change amends Rule 1047, Commentary .01, 
to state that, in accordance with the FCO market maker system, the 
Quote Monitor is responsible for conducting trading rotations in the 
FCOs utilizing the market maker system. Further, the proposed rule 
change amends Rules 1017 and 1019 to clarify that orders would not be 
entrusted to a specialist respecting the FCO market maker system. 
Finally, the proposed rule change incorporates a disclaimer of 
liability into the proposal as proposed paragraph (j)(ii) of Rule 1014.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV blow. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange has traded FCOs pursuant to a specialist system since 
1982. Earlier this year, due to the resignation of a specialist unit in 
that FCO, the Exchange determined to delist options on the European 
Currency Unit (``EUC''), only offering such options pursuant to its 
customized facility under Rule 1069.\2\ This situation prompted a 
review of the specialist system on the FCO trading floor and 
recognition that ensuring the continuity of FCO trading where a 
specialist cannot be promptly replaced may require a different system.
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    \2\ See Securities Exchange Act Release No. 38764 (June 24, 
1997), 62 FR 35535 (July 1, 1997) (SR-Phlx-97-26). The proposal at 
hand is not intended to replace SR-Phlx-97-26, such that FCOs on the 
ECU would continue to be available only on a customized basis, 
pursuant to Rule 1069.
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    Thus, the purpose of this proposal is to adopt rules and procedures 
to govern situations where a specialist resigns from that function and 
no replacement specialist unit is immediately available for a 
particular FCO. As such, the proposal is a contingency plan, not 
intended as a permanent method of trading FCOs. As a contingency plan, 
it would be implemented until a specialist unit becomes available or 
the Exchange determined to take other action, such as request permanent 
approval of the market maker system or delist that FCO. Because the 
Phlx Board of Governors has already approved this proposal, the 
contingency plan would be implemented upon approval by the FCO 
Committee once the contingency occurs, or, depending upon the immediacy 
and circumstances, the chairperson of that Committee or their designee. 
In crafting this FCO contingency plan, the Exchange considered various 
methods of trading options, including the lead and primary market maker 
systems of other exchanges. The Exchange determined that such systems 
were intended for new products that required incentives for long-term 
commitment of time, personnel and capital, and are thus not appropriate 
for FCOs. Instead, the Exchange has determined to implement a pure 
market maker system. Thus, according to the Exchange, issues of trade 
allocation, book allocation or additional capital are not raised by the 
proposal, because existing ROTs would be acting as market makers under 
the proposal.
    Currently, all ROTs on the foreign currency options floor are 
considered to be assigned in all FCOs. As such, no minimum number of 
ROTs is required for the proposed market maker system. Once the market 
maker system is implemented in a given situation, all assigned ROTs 
would be required to participate. To further assure adequate market 
maker participation, the proposal requires that assigned ROTs' 
participant organizations will be subject to an additional requirement 
of availability from the opening of trading on 50% of trading days. The 
Exchange intends to establish procedures requiring at least one ROT 
from each participant organization to be present throughout the trading 
day for 50% of the trading days during a specified period, thereby 
ensuring a minimum level of ROT presence on every trading day. 
Surveillance of this requirement would consist of a sign-in procedure 
in the trading crowd, with the Quote Monitor maintaining a log for 
Surveillance Department review. Failure to comply with this requirement 
would be considered a violation of proposed Rule 1014(j). In addition, 
floor brokers will be required to ensure the presence of an ROT in the 
trading crowd, pursuant to Rule 1063. Further, ROTs can be called into 
the crowd pursuant to Rule 1014 (b) and (c), and failure to honor such 
a request may result in disciplinary action.
    ROTs will have market making responsibilities to replace certain 
specialist functions, such as updating markets and the components to 
pricing models. As ten-up markets would remain in effect, if the best 
bid/offer is established by someone other than an ROT and is not for at 
least ten contracts, participation for the additional contracts needed 
to meet the minimum ten contract requirement would be supplied at that 
same price by the assigned ROT(s). Thus, the essence of the proposed 
Market Maker System is ROT responsibility.
    Certain specialist-type functions would be handled by the Quote 
Monitor, who would be an Exchange employee. Other options exchanges 
utilize exchange employees for similar functions.\3\ The Exchange 
believes that the use of a Quote Monitor is appropriate and should 
facilitate disseminating firm markets in affected FCOs. The Quote 
Monitor would be responsible for establishing, monitoring, and updating 
FCO markets under the market maker system. The Quote Monitor would 
maintain the Auto-Quote System with input from the assigned ROTs, which 
shall automatically update these FCO markets, based on the spot value 
of the underlying foreign currency and the pricing model selected by 
the assigned ROTs in that FCO, pursuant to a procedure established by 
the Exchange. The Quote Monitor would be responsible for regularly 
requesting market quotations, as well as updated components to the 
relevant pricing model, such as interest rates and volatility levels, 
from assigned ROTs. Assigned ROTs would be required to voice markets in 
these FCOs in a loud and audible manner and update those markets, as 
well as other components relevant to the pricing model. The Quote 
Monitor would staff this position during all trading hours. The number 
of Quote Monitors will vary depending on the number of FCOs trading 
pursuant to the proposed Market Maker System. The Quote Monitor would 
also post bids and offers as instructed loudly and audibly by Floor 
Brokers. The Floor Broker would be responsible for the posted bid/

[[Page 63595]]

 offer until he or she had properly informed the Quote Monitor that it 
is withdrawn. The Floor Broker responsibilities applicable to markets 
maintained by the Quote Monitor are included in Rule 1063(e).
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    \3\ See e.g., CBOE Rule 7.1.
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    The implementation of the proposed market maker system would result 
in elimination of the specialist or limit order book, as the Quote 
Monitor's responsibilities would be directed at monitoring markets but 
not holding orders. Currently, FCO specialists maintain a specialist 
limit order book. Generally, smaller customer orders are placed on the 
book, but the book is not limited to customer orders. Depending upon 
the option and the market conditions, an FCO book's content varies. 
Orders on the book at the time of the implementation of the market 
maker system would be canceled, and could be re-entered for 
representation by floor brokers. The Exchange would announce the 
required cancellation of such orders by memorandum to FCO 
participants.\4\
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    \4\ This procedure is similar to the current procedure used for 
equity index options when there is a change in contract terms or a 
transfer of the book. See Floor Procedure Advice A-6.
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    The Exchange has been informed of a decreased use in the book. The 
Exchange believes this decreased use is a result of decreased FCO 
volume, increased costs and the more institutional nature of FCO 
trading. All of these factors were taken into account when determining 
to eliminate the book. The Exchange acknowledges that eliminating the 
book is a departure from the procedures of other exchanges employing a 
market maker system, who generally utilize an exchange employee to 
operate the book. Although the Exchange considered this approach, it 
was determined that venturing into the business of operating a limit 
order book was not appropriate for the Exchange to do on a sudden, 
contingency basis in light of both the liability as well as operational 
and staffing burdens. The Exchange also cites to the institutional 
nature FCO trading, including larger sizes, which diminishes reliance 
on the limit order book. Certain FLEX products currently trading on 
other exchanges do not offer a limit order book, in view of the 
institutional nature of FLEX options. In fact, FCO customized options, 
pursuant to Phlx Rule 1069, trade without a specialist or limit order 
book. The Exchange believes that this experience, coupled with the need 
for quick implementation of the contingency plan in order to provide a 
continuous auction market for FCOs, despite the absence of a 
specialist, outweighs the benefits of providing a limit order book.
    Because the proposal replaces the specialist system with a market 
maker system, the Exchange proposes to amend certain other rules to 
clarify that a specialist's traditional responsibilities would not 
apply under the proposal. For instance, for purposes of Rule 1047, 
Trading Rotations, Halts and Suspensions, Commentary .01, new paragraph 
(e) would state that, in accordance with the FCO Market Maker System as 
defined in Rule 1014(j), the Quote Monitor is responsible for 
conducting trading rotations in those foreign currency options 
utilizing the Market Maker System. In addition, Rules 1017 and 1019 
would clarify that orders would not be entrusted to a specialist 
respecting the FCO Market Maker System, as defined in Rule 1014(j).
    Because the proposed Quote Monitor functions would involve a new 
type of activity by Exchange employees, a disclaimer of liability is 
incorporated into the provision as paragraph (j)(ii). Specifically, in 
no event shall the Exchange be liable to any person or organization or 
to its members, participants, member organizations or participant 
organizations (hereinafter referred to collectively as ``members'') or 
persons associated therewith for any loss, (including any indirect or 
consequential loss), expense, damages or claims arising out of any 
errors or omissions in the collection and dissemination of any foreign 
currency options quotations by a Quote Monitor.
    The Complete text of the proposed rule change is available at the 
Commission and at the office of the Exchange.
2. Statutory Basis
    The Exchange believes that the proposal is consistent with Section 
6(b) of the Act \5\ in general, and in particular, with Section 
6(b)(5),\6\ in that it is designed to promote just and equitable 
principles of trade, remove impediments to and perfect the mechanism of 
a free and open market, as well as to protect investors and the public 
interest, by providing a contingency plan for the trading of FCOs 
without an assigned specialist unit.
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    \5\ 15 U.S.C. 78f(b).
    \6\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the publication of this notice in the Federal 
Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve the proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. 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 at the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
Exchange. All submissions should refer to File No. SR-Phlx-97-35 and 
should be submitted by December 22, 1997.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-31390 Filed 11-28-97; 8:45 am]
BILLING CODE 8010-01-M