[Federal Register Volume 65, Number 191 (Monday, October 2, 2000)]
[Notices]
[Pages 58834-58837]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-25133]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43328; File No. SR-PCX-00-13]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change by the Pacific 
Exchange, Inc. Relating to the Entry of Computer-Generated Orders

September 22, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on May 16, 2000, the Pacific Exchange, Inc. (``PCX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission'' or 
``SEC'') the proposed rule change as described in Items I, II and III 
below, which Items have been prepared by the Exchange. On August 16, 
2000, the Exchange filed Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice of filing and order 
granting accelerated approval to the proposed rule change.
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    \1\ 15 U.S.C. 788s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange revised the proposed rule 
to allow computer-generated orders to be sent to the Exchange via 
the Member Firm Interface (``MFI'') if they are properly designated 
as such. See Letter from Michael Pierson, Vice President, Regulatory 
Policy, PCX, to Nancy J. Sanow, Assistant Director, Division of 
Market Regulation, Commission, dated August 15, 2000 (``Amendment 
No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange proposes to adopt Rule 6.88 (``Rule'') to restrict the 
entry of certain electronically created option orders on the Exchange 
via the Exchange's Member Firm Interface (``MFI''). The text of the 
Rule is set forth below.

POETS

Pacific Options Exchange Trading System

Rule 6.88

    (a) POETS is the Exchange's automated trading system comprised 
of the options order routing system, the automated execution system 
(Auto-Ex), the on-line limit

[[Page 58835]]

order book system (Auto-Book), and the automatic market quote update 
system (Auto-Quote). Orders may be sent to POETS via the Exchange's 
Member Firm Interface (MFI).
    (b) Except as provided in subsection (b)(1), Member firms may 
not enter orders via the MFI or permit the entry of orders via the 
MFI if those orders are created and communicated electronically 
without manual input (``computer generated orders''). Except as 
provided in subsection (b)(1), order entry by public customers or 
associated persons of Member Firms must involve manual input such as 
entering the terms of an order into an order-entry screen or 
manually selecting a displayed order so that the order will be sent. 
Nothing in this Rule prohibits Member Firms from electronically 
sending to the Exchange orders manually entered by customers into 
front-end communications systems (e.g., Internet gateways, online 
networks, etc).
    (1) Computer generated orders may be sent to the Exchange via 
the MFI only if they are properly designed with a ``CG'' in the 
``additional instruction'' field. Orders so designated will be re-
routed for representation by a Floor Broker. Computer generated 
orders are not eligible for automatic execution via the Auto-Ex 
System.

para.5232  Exchange Sponsored Hand Held Terminals for Floor Brokers

    Rule 6.89[6.88]--No change.

para.5233  Proprietary Brokerage Order Priority Terminals

    Rule 6.90[6.89]--No change.
* * * * *

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 Exchange 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 V below. The Exchange has prepared summaries, set forth in 
Sections A, B and 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 purpose of the proposed rule change is to restrict the direct 
entry of certain option orders that are created and communicated 
electronically, i.e., without manual imput, into the Exchange's POETS 
system.\1\ The Exchange represents that the text of the Rule is similar 
to the text of Rule 717(f) of the International Securities Exchange 
(``ISE'').\5\
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    \4\ See Securities Exchange Act Release No. 27633 (January 18, 
1990), 55 FR 2466 (January 24, 1990) (approving implementation of 
POETS). POETS is the Exchange's automated trading system. It is more 
fully described infra.
    \5\ ISE Rule 717(f) states:
    ``Members may not enter, nor permit the entry of, orders created 
and communicated electronically without manual input (i.e., order 
entry by Public Customers or associated persons of Members must 
involve manual input such as entering the terms of the order into an 
order-entry screen or manually selecting a displayed order against 
which an off-setting order should be sent), unless such orders are 
non-marketable limit order to buy (sell) that are priced higher 
(lower) than the best bid (offer) on the Exchange (i.e., limit 
orders that improve the best price available on the Exchange). 
Nothing in this paragraph, however, prohibits Electronic Access 
Members from electronically communicating to the Exchange orders 
manually entered by customers into front-end communications systems 
(i.e., Internet gateways, online networks, etc.).'' See Securities 
Exchange Act Release No. 42455 (February 24, 2000), 65 FR 11388 
(March 2, 2000) (approving application of ISE for registration as a 
national securities exchange).
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    Subsection (a) of the Rule briefly describes the POETS system. 
Specifically, Subsection (a) states that POETS is the Exchange's 
automated trading system comprised of the options order routing system, 
the automatic execution system (``Auto-Ex''), the on-line limit order 
book system (``Auto-Book''), and the automatic market quote update 
system (``Auto-Quote''). Subsection (a) further states that orders may 
be sent to POETS via the Exchange's MFI. This subsection is intended to 
provide background for the provision on computer-generated orders, 
which is contained in Subsection (b).
    Subsection (b) states that except as provided in subsection (b)(1), 
member firms may not enter orders via the MFI or permit the entry of 
orders via the MFI if those orders are created and communicated 
electronically without manual input. Subsection (b) defines such orders 
as ``computer-generated orders.'' It further states that, except as 
provided in subsection (b)(1), order entry by public customers or 
associated persons of member firms must involve manual input such as 
entering the terms of an order into an order-entry screen or manually 
selecting a displayed order so that the order will be sent. It further 
states that nothing in the Rule prohibits member firms from 
electronically sending orders that are manually entered by customers 
into front-end communications system (e.g., Internet gateways, online 
networks, etc.) to the Exchange.
    Subsection (b)(1) of the Rule states that computer-generated orders 
may be sent to the Exchange via the MFI only if they are properly 
designated with a ``CG'' in the ``additional instruction'' field. 
Orders so designated will be re-routed for representation by a floor 
broker. Finally, Subsection (b)(1) states that computer-generated 
orders are not eligible for automatic execution via the Auto-Ex system.
    The Exchange represents that its business model depends upon market 
makers for competition and liquidity. Public customer orders on the PCS 
receive priority over market maker bids and offers.\6\ The Exchange 
believes that allowing electronic entry directly into the Exchange's 
POETS system could give customers with order-generating systems a 
significant advantage over market makers. In its view, this could 
undercut the Exchange's business model. The Exchange notes that under 
the proposed rule change, computer-generated orders can still be sent 
for execution on the Exchange; however, they may not be sent for 
execution directly via POETS. The Exchange also notes that the Rule is 
similar to ISE Rule 717(f); however, the ISE Rule permits computer-
generated orders to be entered on the ISE only if they are 
``nonmarketable limit orders to buy (sell) that are priced higher 
(lower) than the best bid (offer) on the Exchange.'' By contrast, the 
PCX proposal allows all computer-generated orders to be entered on the 
PCX.
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    \6\ See PCX Rules 6.52(a) (types of orders permitted to be 
maintained in the limit order book), 6.75(a)-(b) (priority of bids 
and offers), 6.86 (guaranteed markets for public customers) and 
6.87(a) (eligibility of public customers for use of Auto-Ex System).
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    Currently, PCX member firms that are located off the trading floor 
may send option orders to the trading floor in three different ways. 
First, a member firm representative may call a PCX member firm 
representative on the trading floor on the telephone and place an 
order. The member firm representative, while present in a member firm 
booth on the trading floor, would then either have the order taken 
manually to a floor broker in the trading crowd for representation of 
the order, or have the order sent electronically to a floor broker (via 
a hand-held terminal) in the trading crowd who would then represent it. 
Second, a member firm

[[Page 58836]]

representative may send an order to a member firm representative in a 
booth on the trading floor via an electronic transmitter. (This 
transmitter would be proprietary equipment of a member firm). The 
member firm representative in the booth would then have the order 
represented in the trading crowd in one of the two ways described 
above. Third, a member firm representative may send an order 
electronically through the MFI, which links member firms with the 
Exchange's electronic trading system, POETS. Eligible orders sent 
through the MFI to POETS may be: (1) Automatically executed against 
orders in the limit order book; (2) placed in the limit order book (if 
they are not marketable); (3) automatically executed via Auto-Ex; or 
(4) routed to a floor broker hand-held terminal in the trading crowd.
    Accordingly, under the rule change, computer-generated orders may 
be sent to the Exchange in any of the three ways described above. 
However, if they are submitted electronically to the Exchange via the 
MFI, they must be properly identified with a ``CG'' indicator. All 
properly identified computer-generated orders that are sent via the MFI 
will be re-routed for representation by a floor broker. When an order 
is re-routed, it is transmitted either: (1) To a member firm booth on 
the trading floor; or (2) to a floor broker in the trading crowd via 
the floor broker hand-held terminal,\7\ depending upon the instructions 
of the member firm that is responsible for the order. As noted above, 
orders transmitted to a member firm booth may be subsequently 
transmitted to a floor broker in the trading crowd either by placing 
the order telephonically \8\ or by manually taking the order to the 
floor broker in the crowd. An order that is transmitted to a floor 
broker may be placed in the limit order book for representation by the 
Order Book Official as long as that order is a ``non-broker/dealer 
customer order.''
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    \7\ See PCX Rule 6.88.
    \8\ See PCX Rule 6.2(h)(4)(C).
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    The Exchange notes that under the rule change, properly marked 
computer-generated orders that are sent via the MFI will be-routed in 
the same manner in which broker-dealer orders that are sent via the MFI 
are currently re-routed. When a broker-dealer order is routed to a 
floor broker in the trading crowd, the order is vocalized and, if the 
order represents the best bid or offering price on the PCX, the Market 
Quote Terminal Operator (``MQTP'') will cause the order to be 
displayed. Computer-generated orders for the accounts of broker-dealers 
will be handled in the same manner under the proposed rule change. 
However, if a computer-generated order is for the account of a public 
customer, it may be represented by a floor broker in the trading crowd, 
in which case the MQTO will cause it to be displayed, or the floor 
broker may place the order in the limit order book, in which case the 
Order Book Official at that trading post will cause it to be displayed 
and will continue to represent it.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
with Section 6(b) \9\ of the Act, in general, and furthers the 
objectives of Section 6(b)(5),\10\ in particular, in that it 
facilitates transactions in securities, removes impediments to and 
perfects the mechanism of a free and open market and a national market 
system, and promotes just and equitable principles of trade.
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    \9\ 15 U.S.C. 78f(b).
    \10\ 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 burden on competition that is not necessary or appropriate 
in furtherance of the purpose of the Act.

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

    Written comments on the proposed rule change were neither solicited 
nor received.

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

    The PCX has requested that the proposed rule change be given 
expedited review and accelerated effectiveness pursuant to Section 
19(b)(2) of the Act.

IV. Commission's Findings and Order Granting Accelerated Approval 
of the Proposed Rule Change

    After careful review, the Commission finds that the proposed rule 
change is consistent with the provisions of the Act applicable to a 
national securities exchange, particularly Section 6(b)(5) \11\ and 
Section 6(b)(8) \12\ of the Act, and the rules and regulations 
thereunder.\13\
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    \11\ 15 U.S.C. 78f(b)(5). Section 6(b)(5) requires that the 
rules of a national securities exchange be designed to, among other 
things, promote just and equitable principles of trade, remove 
impediments to and perfect the mechanism of a free and open market, 
and, in general, to protect investors and the public interest. It 
also requires that those rules not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.
    \12\ 15 U.S.C. 78f(b)(8). Section 6(b)(8) requires that the 
rules of the exchange do not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Act.
    \13\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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    The Commission has carefully considered whether the Rule inhibits 
competition between the PXC's automated customers and those who do not 
employ automated means of order entry. The Commission notes that in the 
equity markets, for example, limit orders from public customers have 
been a valuable source of quote competition. Nonetheless, the 
Commission recognizes that the PCX's business model depends on market 
makers for competition and liquidity. Allowing electronic order entry 
into Auto-Ex could give automated customers a significant advantage 
over market makers. This could undercut the PCX's business model. 
Moreover, the Rule would allow electronically generated orders to be 
sent o the Exchange via the MFI if they are properly designated with a 
``CG'' in the instruction field. Properly designated orders are then 
routed to the trading crowd for representation by a floor broker. 
However, the order is not eligible for execution through Auto-Ex.
    The Commission approved a similar rule for the fully automated 
options exchange, the ISE. In approving the application of the ISE for 
registration as a national securities exchange, the Commission 
explicitly recognized that the ISE's business model ``depends on market 
makers for competition and liquidity.'' \14\ Recognizing that allowing 
electronic order entry into the ISE could ``give automated customers a 
significant advantage over [the ISE's] market makers,'' the Commission 
stated that it was unable to conclude that the limitation violated the 
statutory requirements.\15\
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    \14\ See supra note 4.
    \15\ Id.
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    ISE Rule 717(f) regarding computer-generated orders specifically 
permits the entry of non-marketable limited orders that improve the 
best price available on the ISE. This provision is designed to 
accommodate non-marketable limit orders because these orders serve to 
increase competition and improve quotes. Similarly, non-marketable 
electronically generated limit orders that improve the best price on 
the PCX will be permitted to enter the Exchange through the MFI, if 
they are properly designated with a ``CG'' in the ``additional 
instruction'' field. These

[[Page 58837]]

orders will be routed from the MFI to the trading crowd for 
representation by a floor broker.
    Although the ISE and PCX rules are not identical, both ISE Rule 
717(f) and PCX Rule 6.88 permit non-marketable limit orders that 
improve the price to be sent to the exchange and routed to the relevant 
trading mechanism for execution. It is the Commission's view that the 
Exchange's approach strikes a reasonable balance. It provides 
protection to PCX market makers; at the same time, it permits properly 
designated electronically generated orders to be represented by a floor 
broker in the trading crowd. As it stated with respect to its approval 
of ISE Rule 717(f), the Commission is unable to conclude that the new 
PCX Rule violates any statutory requirements.
    The Commission further notes that the Rule does not prohibit 
electronically generated orders from being sent to the PCX; rather, 
merely prevents them from being entered into Auto-Ex. Thus, properly 
designated electronically generated orders will be routed through the 
MFI to the trading crowd for representation by a floor broker. PCX 
rules require that all customer orders be executed at the PCX's 
displayed bid or offer at the time the order is represented in the 
crowd.\16\ Depending upon the circumstances, the order may be filled at 
a price better than the PCX's displayed bid or offer. Therefore, 
although, electronically generated customer orders will not be eligible 
for automatic execution through Auto-Ex under the Rule, they will still 
be entitled to receive an execution price that is as good as or better 
than the PCX's displayed bid or offer.
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    \16\ See PCX Rule 6.86(a).
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    The Commission finds good cause for approving the proposed rule 
change, as amended, prior to the thirtieth day after publication of 
notice thereof in the Federal Register pursuant to Section 19(b)(2) of 
the Act. Specifically, the Commission has approved similar proposals 
filed by the ISE \17\ and the Chicago Board Options Exchange, Inc. 
(``CBOE'').\18\ Approval of this proposal on an accelerated basis will 
enable the PCX to compete on an equal basis with these other exchanges 
and thus is consistent with Section 6(b)(8) of the Act.
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    \17\ See supra note 5.
    \18\ Securities Exchange Act Release No. 43285 (September 12, 
2000), 65 FR 56972 (September 20, 2000) (approving SR-CBOE-00-01).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room, 450 Fifth Street, 
NW., Washington, DC 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the PCX. All 
submissions should refer to File No. SR-PCX-00-13 and should be 
submitted by October 23, 2000.

VI. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-PCX-00-13), as amended, adopting Rule 
6.88, is approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority. \19\
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    \19\ 17 CFR 200.30-3a(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-25133 Filed 9-29-00; 8:45 am]
BILLING CODE 8010-01-M