[Federal Register Volume 63, Number 102 (Thursday, May 28, 1998)]
[Notices]
[Pages 29288-29291]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-14120]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40006; File No. SR-PHLX-98-10]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change Relating to Automatic 
Price Improvement for Certain PACE Orders

May 19, 1998.

I. Introduction

    On February 10, 1998, the Philadelphia Stock Exchange, Inc. 
(``Phlx'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt rules relating to a new

[[Page 29289]]

automatic price improvement initiative for PACE orders.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    In proposed rule change was published for comment in the Federal 
Register on March 17, 1998.\3\ No comments were received on the 
proposal. This order approves the proposal as amended.
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    \3\ Securities Exchange Act Release No. 39740 (March 10, 1998), 
63 FR 13083 (March 17, 1998).
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II. Description of the Proposal

    PACE is the Exchange's automated order routing and execution system 
on the equity trading floor. PACE accepts orders for automatic or 
manual execution in accordance with the provisions of Rule 229, which 
governs the PACE System and defines its objectives and parameters. The 
PACE Rule establishes execution parameters for orders depending on type 
(market or limit), size and the guarantees offered by specialists.
    Currently, paragraph (c)(i), Automatic Double-up/Double-down Price 
Improvement,\4\ states that where the specialist voluntarily agrees to 
provide automatic double-up/double-down price improvement to all 
customers and all eligible orders in a security, in any instance where 
the bid/ask of the PACE Quote \5\ is \1/4\ or greater, market and 
marketable limit orders in New York Stock Exchange or American Stock 
Exchange listed securities received through PACE in double-up/double-
down situations for 599 shares or less shall be provided with automatic 
price improvement of \1/8\, beginning at 9:45 a.m. A specialist may 
also voluntarily agree to provide automatic double-up/double-down price 
improvement to larger orders in a particular security to all customers 
under this provision.
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    \4\ For a more complete description of how the Exchange's 
Automatic Double-Up/Double-Down price improvement feature operates 
see Securities Exchange Act Release No. 39548 (January 13, 1998), 63 
FR 3596 (January 23, 1998) (``Double-Up/Double-Down Order'').
    \5\ The PACE Quote consists of the best bid/offer among the 
American, Boston, Cincinnati, Chicago, New York, Pacific and 
Philadelphia Stock Exchanges as well as the Intermarket Trading 
System/Computer Assisted Execution System (``ITS/CAES''). See Phlx 
Rule 229.
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    As a further effort to champion the principle of best execution, 
the Exchange is proposing a more comprehensive automatic price 
improvement initiative. Specifically, specialists could choose to 
provide \1/16\ automatic price improvement to eligible orders in \1/8\ 
or greater markets, or \3/16\ or greater markets. Thus, as compared to 
the current automatic price improvement feature for double-up/double-
down situations which is limited to \1/4\ wide markets or greater, the 
universe of orders eligible for the proposed feature would be expanded. 
Further, the proposal involves automatic price improvement without 
requiring a double-up/double-down situation. This again expands the 
benefits of price improvement to a larger universe of eligible orders.
    Second, where a buy order would be improved to the last sale price 
which is a down tick, or where a sell order would be improved to the 
last sale price which is an up tick, the order is also not eligible for 
automatic price improvement, and is, instead, automatically executed at 
the PACE Quote. The following are examples of the exception to 
automatic price improvement respecting improvement to the last sale:

23-23\1/8\
LS \1/16\-
Buy executed at \1/8\
Sell improved to \1/16\

23-23\1/8\
LS \1/16\+
Buy improved to \1/16\
Sell executed at 23

23-23\3/16\
LS \1/8\-
Buy executed at \3/16\
Sell improved to \1/16\

23-23\3/16\
LS \1/8\+
Buy improved to \1/8\
Sell improved to \1/16\

23-23\3/16\
LS \1/16\-
Buy improved to \1/8\
Sell improved to \1/16\

23-23\3/16\
LS \1/16\+
Buy improved to \1/8\
Sell executed at 23

23-23\1/4\
LS \1/8\ + or-
Buy improved to \3/16\
Sell improved to \1/16\

    These exceptions are intended to cover situations where automatic 
price improvement may not be appropriate in light of overall market 
conditions. In this regard, the Exchange does not believe it is 
customary or appropriate to provide price improvement over the last 
sale price, or, in every case, to the last sale price. Despite these 
exceptions to automatic price improvement under this proposal, the 
Exchange believes that automatic price improvement would be afforded in 
a meaningful way, considering the wider breadth of eligible orders.
    Under the proposal, automatic price improvement would not occur in 
two situations. First, automatic price improvement would not occur to a 
price better than the last sale. More specifically, where a buy order 
would be improved to a price less than the last sale or a sell order 
would be improved to a price higher than the last sale, the order is 
not eligible for automatic price improvement, and is, instead, 
automatically executed at the PACE Quote. The following are examples 
\6\ of this exception (not improving over the last sale):

    \6\ These examples consist of the PACE Quote, the last sale 
price with an up or down tick indicator, and the price at which a 
buy and sell order, respectively, would be executed.
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23-23\1/8\
LS 23 + or -
Buy improved to \1/16\
Sell executed at 23

23-23\1/8\
LS \1/8\ + or -
Buy improved to \1/8\
Sell improved to \1/16\

23-23\3/16\
LS 23 + or -
Buy improved to \1/8\
Sell executed at 23

23-23\3/16\
LS \3/16\ + or -
Buy improved to \3/16\
Sell executed at \1/16\

    This is similar to the current exception from automatic double-up/
double-down price improvement; \7\ however, currently where an improved 
price would be better than the last sale, the order would be stopped at 
the PACE Quote when received. Under this proposal, the order would be 
automatically executed at the PACE Quote when received.
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    \7\ See Securities Exchange Act Release No. 39640 (February 10, 
1998), 63 FR 8510 (February 19, 1998), which creates an exception 
where such price improvement would be better than the last sale 
price (for instance, a buy order would be improved to a price less 
than the last sale or a seller order would be improved to a price 
higher than the last sale); pursuant to this exception, such orders 
are stopped by the specialist at the PACE Quyote when received, 
meaning that the order is guaranteed to receive at least that price 
by the end of the trading day.
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    This proposal would result in automatic price improvement of \1/
16\, as opposed to the current automatic double-up/double-down price 
improvement, which provides for \1/8\ price improvement. Although the 
amount of automatic price improvement will be less under the proposal 
for a particular order, the number of orders receiving price 
improvement of \1/16\ should increase, as explained above. Price 
improvement of \1/16\ recognizes that \1/16\ is the current minimum 
trading increment for PACE issues on the Exchange's equity trading 
floor.\8\ Thus, it reflects the reality of today's

[[Page 29290]]

marketplace, including other price improvement initiatives in the 
industry.
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    \8\ See Phlx Rule 125.
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    Because the proposal would provide automatic price improvement, no 
POES window would occur, similar to the current automatic double-up/
double-down price improvement provision.\9\ Instead, an automatic 
execution occurs at an improved price, with no window, timer or delay. 
Orders not eligible for automatic price improvement due to the two 
exceptions relating to the last sale price are automatically executed 
at the PACE Quote and not subject to the POES delay.
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    \9\ See Double-Up/Double-Down Order, supra note 4, at note 10; 
and Securities Exchange Act Release No. 39640 (February 10, 1998), 
63 FR 8510 (February 9, 1998).
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    Automatic price improvement will not occur where the execution 
price before or after the application of automatic price improvement 
would be outside the primary market high/low range for the day, if so 
elected by the entering member organization. This limitation currently 
appears in Rule 229.07(c)(i)(C), and has applied to both automatic 
double-up/double-down price improvement and manual double-up/double-
down price protection. Similarly, pursuant to paragraph (c)(iii), the 
provision that member organizations entering orders may elect to 
participate in manual double-up/double-down price protection continues 
to apply. However, member organizations will not have the ability to 
elect the proposed automatic price improvement feature.
    Currently, both the automatic double-up/double-down price 
improvement and manual price protection features are jointly subject to 
the entering firm's election.\10\ As a result, electing these features 
where the specialist has not chosen automatic double-up/double-down 
price improvement in that security may currently cause a firm's orders 
to be stopped. Thus, firms who do not want their orders stopped because 
they prefer a prompt execution can currently elect out of both 
features.
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    \10\ This election must be made for all Phlx stocks, not 
security-by-security. See Double-Up/Double-Down Order, supra note 4, 
at note 22.
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    Once automatic price improvement is no longer limited to double-up/
double-down situations, the election for automatic price improvement 
will end, because the reason for allowing a firm's choice will no 
longer exist. Under this proposal, firms electing out of manual price 
protection could nevertheless receive automatic price improvement. For 
instance, where a specialist switches from manual to automatic price 
improvement for a security, the automatic feature would be activated 
even for firms that elected out of the manual feature.
    The Exchange notes that the manual double-up/double-down price 
protection provision, which is mandatory for specialists, will continue 
to be subject to an election by entering member organizations,\11\ who 
may continue to prefer a prompt execution over the opportunity for 
price improvement. Failure to elect will result in the activation of 
the double-up/double-down feature for that User. Specialists continue 
to determine whether to provide automatic price improvement in a 
particular security.
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    \11\ A firm's election continues to apply to all Phlx stocks, 
not security-by-security.
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    The extraordinary circumstances provision currently in the Rule 
would also apply to the new feature, such that automatic price 
improvement may be disengaged in a security or floor-wide in 
extraordinary circumstances with the approval of two Floor Officials. 
In addition to fast market conditions, for purposes of this paragraphs, 
extraordinary circumstances also include systems malfunctions and other 
circumstances that limit the exchange's ability to receive, disseminate 
or update market quotations in a timely and accurate manner.
    The Exchange has determined that, as with many PACE features and 
participation in the PACE System itself, automatic price improvement 
should be made available on a voluntary, symbol-by-symbol basis, so 
that specialists can determine which securities are suitable for the 
program.\12\ The availability of a price improvement feature benefits 
the specialist function, especially in high-volume securities, where 
stopping orders and manual intervention are time-consuming, delay 
execution and do not necessarily result in price improvement.
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    \12\ Some securities are not appropriate for automatic price 
improvement due to, for instance, liquidity, trading patterns and 
volatility situations rendering it unfair for specialists to afford 
price improvement automatically and then manage the resulting 
positions. See Double-Up/Double-Down Order, supra note 4, at note 
11.
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III. 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, with the requirements of Section 6(b).\13\ In particular, 
the Commission believes that the proposal is consistent with the 
Section 6(b)(5) \14\ requirements that the rules of an Exchange be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism of a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest.\15\
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    \13\ 15 U.S.C. 78f(b).
    \14\ 15 U.S.C. 78f(b)(5).
    \15\ In approving the proposed rule change, the Commission notes 
that it has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78f(b).
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    The Commission continues to recognize that the increased 
competition for order flow that results from permitting regional 
specialists to attract orders from other markets by providing price 
improvement opportunities and superior quotations enhances market 
making ability and the quality of customer order execution. The 
Commission has approved proposals by national securities exchanges to 
integrate price improvement opportunities, on both an automatic and 
manual basis, into their automatic execution systems. Approval of the 
Exchange's automatic price improvement initiative will allow small 
orders to receive an execution at a price that may be better than the 
PACE Quote according to certain predefined criteria. Accordingly, the 
Commission believes that the Exchange's present proposal may enhance 
both intermarket competition and order execution quality on the 
Exchange.
    Under the proposal, specialists voluntarily may agree to provide 
automatic price improvement of \1/16\ of a point from the PACE Quote to 
all customers and all market and marketable limit order of up to 599 
shares (or higher, if elected by the specialist) in a particular 
security \16\ on a stock-by-stock basis, in any instance where the bid/
ask spread of the PACE Quote is either \1/8\ or greater than \3/16\ or 
greater. As explained above, this automatic price improvement feature 
is subject to two restrictions. First, no order may be improved to a 
price better than the last sale price; in this situation, the orders 
would be automatically executed at the PACE Quote. Second, where a buy 
order would be improved to the last sale price which is a down tick, or 
where a sell order would be improved to the last sale price which is an 
up tick, the order is also not eligible for automatic price 
improvement, and is, instead, automatically executed at the PACE Quote.
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    \16\ Securities listed on the New York Stock Exchange or the 
American Stock Exchange are eligible for this feature. See Phlx Rule 
229.07.
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    The Commission believes that the adoption of this proposed 
automatic price improvement feature by the

[[Page 29291]]

Exchange is appropriate in that its use by Phlx specialists should 
increase the likelihood that eligible customer orders, particularly 
marketable limit orders, will be executed at an improved price over the 
PACE Quote. With respect to the two conditions above that would cause 
an order to be automatically executed at the PACE Quote, the Commission 
believes that it is reasonable for the Exchange to automatically 
execute such orders at the PACE Quote rather than subjecting them to 
the POES window or stopping them at the PACE Quote. Overall, the 
Commission's Division of Market Regulation previously has noted that 
price improvement windows, such as POES, by themselves rarely provide 
an execution that betters the quoted market.\17\ The Exchange's 
proposal should enhance the price improvement opportunities available 
for PACE orders since a greater number of orders will be eligible for 
automatic price improvement than afforded under the current Double-Up/
Double-Down automatic price improvement feature.
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    \17\ See, Division of Market Regulation, SEC, Market 2000: An 
Examination of Current Equity Market Developments (January 1994), at 
Study V, n. 19.
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    In addition, the Commission believes that the Exchange's automatic 
price improvement initiative is consistent with the maintenance of fair 
and orderly auction markets on national securities exchanges. As the 
examples provided by the Exchange illustrate, the execution criteria of 
the automatic price improvement initiative should contribute to the 
maintenance of an orderly market by Phlx specialists because it helps 
to reduce price variations occurring from trade to trade on low volume. 
Finally, because automatic price improvement may be disengaged under 
extraordinary circumstances for an individual stock or floor-wide with 
the approval of two floor officials, the Exchange is able to increase 
overall systems capacity for systematized orders routed through PACE, 
as well as reduce the market risk exposure to specialists who 
participate in the automatic price improvement initiative. The 
Commission believes that both of these aspects of the automatic price 
improvement initiative are consistent with the maintenance of fair and 
orderly auction markets on national securities exchanges and the 
protection of investors.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-PHLX-98-10) is approved as 
amended.

    \18\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-14120 Filed 5-27-98; 8:45 am]
BILLING CODE 8010-01-M