[Federal Register Volume 65, Number 194 (Thursday, October 5, 2000)]
[Notices]
[Pages 59486-59488]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-25597]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43384; File No. SR-PCX-00-31]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the Pacific Exchange, Inc. 
Relating to PACEX Reports for Options Order Flow Providers

September 29, 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 August 18, 2000, the Pacific Exchange, Inc. (``PCX'' 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 PCX. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The PCX proposes to begin furnishing Pacific Exchange Customer 
Execution (``PACEX'') Reports to its order flow providers on a daily 
basis. PACEX Reports are designed to provide objective data on option 
order executions so that PCX order flow

[[Page 59487]]

providers can assess the quality of the executions they receive on the 
PCX. The text of the proposed rule change is available at the principal 
offices of the PCX.

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 PCX 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 below. The PCX has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of the statments.

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

    The Exchange is adopting a new procedure to provide PCX order flow 
providers with objective data so that they can assess the quality of 
the executions they receive on their option orders at the PCX.\3\ This 
rule filing is intended to provide a description of the data to be 
furnished and to provide a general summary of the PCX's electronic 
systems involved in transmitting and executing option orders.
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    \3\ The PCX recently adopted a new fee on market makers' 
transactions in designated equity option issues. The funds are made 
available to Lead Market Makers, who may use the funds to pay order 
flow providers for their options order flow. In publishing the PCX's 
proposed rule change, the Commission stated its concerns that 
brokers who are paid to send their customers' orders to one exchange 
have a conflict of interest that may reduce their commitment to the 
duty they owe the customers to obtain the best execution available. 
See Securities Exchange Act Release No. 43290 (Sept. 13, 2000), 65 
FR 57213 (Sept. 21, 2000).
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1. Pacific Exchange Customer Execution Reports
    The PCX intends to begin furnishing PACEX Reports to its order flow 
providers on a daily basis. The PACEX Reports will provide objective 
data on the quality of execution that order flow providers receive at 
the PCX. Specifically, the Reports will include statistical information 
on:
    <bullet> Price Improvement--this shows the number of trades and 
option contracts receiving improved pricing on the PCX; and
    <bullet> Turnaround Time--this shows the time it took to execute a 
given customer's order on the PCX.
    PACEX Reports provide data on all option orders routed to the PCX 
electronically that remain in an electronic environment. This includes 
all orders sent through the member firm interface and executed 
automatically via an automatic execution system (``Auto-Ex''), as well 
as all option orders routed to a floor broker hand-held terminal, 
executed by open outcry, and reported electronically.
    The Exchange will provide PACEX Reports to order flow providers on 
a daily basis, whether electronically or in ``hard'' copy. Upon 
request, the Exchange will also send the raw data from the Reports to 
order flow providers so that they may analyze the data in a manner that 
suits their own requirements.
    a. Price Improvement Statistics. PACEX Reports show the dollar 
amount by which order flow providers improved upon the PCX's prevailing 
best bid or offer (``BBO'') in executing their orders at the PCX. 
Specifically, PACEX Reports provide data on price improvement for each 
of the following four classifications: (1) Orders executed via Auto-Ex; 
(2) orders executed by a hand-held terminal; (3) market orders; and (4) 
marketable limit orders. Within each of these four categories, the 
PACEX Reports show the percentage of trades that were executed at 
prices: (1) where the PCX improved the national best bid or offer 
(``NBBO''); (2) where the PCX set the NBBO; (3) where the PCX matched 
the NBBO; (4) where the NBBO was set by another market; and (5) where 
the PCX was the BBO. With regard to category (5), where the PCX was the 
BBO, the Reports show the amount by which an execution via a hand-held 
terminal was less favorable than the then-prevailing NBBO. The Reports 
do not cover orders that were executed during the opening rotation--
whether by automated opening rotation or manually--or during a ``fast 
market,'' as described in PCX Rule 6.28.
    PACEX Reports also provide summary information with respect to: (1) 
Orders executed via Auto-Ex; (2) orders executed by a hand-held 
terminal; (3) market orders; and (4) marketable limit orders. The 
Report shows, for each classification, the aggregate dollar amount that 
the customer saved per contract, the average trade size (in numbers of 
option contracts), and the average turnaround time during a specific 
time period.
    b. Details on Turnaround Time. Turnaround time shows how quickly 
orders were executed on the PCX. The Report provides data on turnaround 
time for each of the following four classifications: (1) Orders 
executed via Auto-Ex; (2) orders received and reported by a hand-held 
terminal; (3) market orders; and (4) marketable limit orders. PACEX 
shows within each of these four categories the percentage of trades 
that were executed within: (a) 0 to 1 seconds; (b) 1 to 5 seconds; (c) 
5 to 15 seconds; (d) 15 to 60 seconds; (e) 1 minute to 3 minutes; (f) 3 
to 10 minutes; (g) 10 to 15 minutes; and (h) 15 to 30 minutes.
    For each of these eight time frames, PACEX Reports also show the 
percentage of trades that were executed during the regular session and 
the percentage of trades that were executed during the opening session, 
i.e., during the opening rotation, which may include executions during 
the Automated Opening Rotation or during a manual opening rotation.
2. PCX Electronic Trading System
    a. POETS. The Pacific Options Exchange Trading System (``POETS'') 
is the PCX's automated options trading system, which includes an 
options routing system, an automatic execution system (``Auto-Ex''), an 
on-line limit order book system, and an automatic market quote update 
system. Option orders may be sent to POETS via the Exchange's Member 
Firm Interface (``MFI''). Market and marketable limit orders that are 
sent through the MFI first check the limit order book for an eligible 
contra side.\4\ Any unfilled portion of an inbound order will be 
executed by Auto-Ex, subject to the maximum Auto-Ex size parameters. 
Non-marketable limit orders may be directed to the limit order book 
either electronically or manually, subject to established order type 
and maximum size parameters. Prior to the opening, market orders may be 
directed to the limit order book so that they may participate in the 
Automated Opening Rotation. Orders in the limit order book executed in 
strict price/time priority sequence.
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    \4\ The Exchange notes that this procedure has been in effect 
since the inception of POETS in 1989.
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    b. Auto-Ex. Market and marketable limit orders sent through the MFI 
will be executed by Auto-Ex if they meet the order type and size 
requirements designated by the Exchange. Orders executed on Auto-Ex 
receive the PCX's disseminated market price or better. Pursuant to PCX 
Rule 6.87, Lead Market Makers (``LMMs'') may set Auto-Ex to provide 
automatic price improvement when the national best bid or offer 
(``NBBO'') is better than the PCX's BBO by one trading increment. In 
addition, LMMs may set Auto-Ex to execute inbound orders at the NBBO 
price regardless of whether it is only one trading increment better 
than the PCX's

[[Page 59488]]

BBO, i.e., orders may be executed at prices that may be multiple 
trading increments better than the PCX's then-prevailing BBO. 
Furthermore, LMMs may execute improved prices regardless of whether the 
NBBO is locked or crossed. Auto-Ex prevents inbound orders from being 
executed at prices inferior to the NBBO. Pursuant to PCX Rule 6.87, 
only non-broker-dealer customer orders are eligible to be executed by 
Auto-Ex. The PCX designates the eligible order size, which may be 
between 20 and 50 option contracts, on an issue-by-issue basis.
    c. Hand-Held Terminals. Member firms may electronically route 
orders to the PCX via the floor broker hand-held terminal system 
pursuant to PCX Rule 6.88. The system allows member firms to route 
their orders directly to POETS, to a member firm booth on the trading 
floor, or to a floor broker who is operating a hand-held terminal 
located in a trading crowd (or elsewhere) on the options floor. 
Accordingly, orders sent through MFI may be transmitted to a floor 
broker almost instantaneously for immediate representation in the 
trading crowd. In the event that option prices have changed to make an 
order immediately executable, the floor broker can submit the order to 
POETS for automatic execution (subject to the Exchange's order size 
requirements). The Exchange notes that the Report uses an extreme 
measurement standard--the NBBO at the time an order reaches the 
Exchange. Consequently, the Exchange believes that the reporting 
process may be subject to some positive or negative price movement. 
This will occur, for example, if there are changes in the price of the 
underlying security or there are other orders reaching the trading 
crowd between the time the original order reaches the trading floor and 
the time it is executed.
    d. AOR. Option orders executed at the opening of trading are 
eligible for execution via the Exchange's Automated Opening Rotation 
(``AOR''). The AOR permits the Exchange to establish electronically, 
for eligible option series, a single price opening for executing 
eligible market and marketable limit orders in the POETS system. Under 
AOR, various series in an option issue may be opened simultaneously, so 
that orders in POETS in that issue are executed within seconds. Once 
the market in an underlying stock has opened, the PCX can open the 
market in the overlying option almost simultaneously. AOR also allows 
automated openings when trading in an issue has been halted and then 
reopened.
    The PCX represents that the PACEX Reporting program is designed to 
provide member firms with greater assurance that they have acted in a 
manner consistent with the fulfillment of their duty of best execution 
when they direct orders to the PCX. Accordingly, the Exchange believes 
that the proposed rule change is consistent with and in furtherance of 
the objectives of the Act, including specifically Section 6(b)(5) 
thereof,\5\ which requires that the rules of exchanges promote just and 
equitable principles of trade, remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and 
protect investors and the public interest.
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    \5\ 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 purposes of the Act.

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

    No written comments were solicited or received with respect to the 
proposed rule change.

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

    Because the PCX has designated this proposed rule change as 
constituting a stated policy, practice, or interpretation with respect 
to the meaning, administration, or enforcement of existing Exchange 
rules and procedures, it has become effective pursuant to Section 
19(b)(3)(A)(i) of the Act\6\ and Rule 19b-4(f)(1) thereunder. \7\ At 
any time within 60 days of the filing of this proposed rule change, the 
Commission may summarily abrogate the rule change if it appears to the 
Commission that the action is necessary or appropriate in the public 
interest, for the protection of investors, or otherwise in furtherance 
of the purposes of the Act.
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    \6\ 15 U.S.C. 78s(b)(3)(A)(i).
    \7\ 17 CFR 240.19b-4(f)(1).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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-
0609. Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written Communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of the 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-00-31 and should 
be submitted by October 26, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-25597 Filed 10-4-00; 8:45 am]
BILLING CODE 8010-01-M