[Federal Register Volume 66, Number 84 (Tuesday, May 1, 2001)]
[Notices]
[Pages 21801-21803]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-10747]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44216; File No. SR-PCX-00-48]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the Pacific 
Exchange, Inc. Relating to Auto-Ex Between-the-Quotes

April 24, 2001.
    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 December 13, 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 and II below, which Items have been prepared by the Exchange. 
Amendment Nos. 1 and 2 to the proposed rule change were filed on 
January 3, and April 2, 2001, respectively.\3\ The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons and to approve it on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the PCX re-designated the filing as a 
submission pursuant to section 19(b)(2) of the Act, 15 U.S.C. 
78s(b)(2), rather than section 19(b)(3)(A) of the Act, 15 U.S.C. 
78s(b)(3)(A). In Amendment No. 2, the PCX added rule text to provide 
that the Auto-Ex-Between-the-Quotes feature would not permit 
execution of orders at prices that trade through other markets. See 
letters from Cindy L. Sink, Senior Attorney, Regulatory Policy, PCX, 
to Nancy Sanow, Assistant Director, Division of Market Regulation, 
SEC, dated January 2, 2001 (``Amendment No. 1''), and March 29, 2001 
(``Amendment No. 2'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The PCX is proposing to effect a change to its Automatic Execution 
System (``Auto-Ex'') that will allow small-sized customer option orders 
that improve the PCX best bid or offer (``BBO'') to be automatically 
executed by the Auto-Ex System. Below is the text of the proposed rule 
change. New text is in italics.

Pacific Exchange, Inc. Constitution and Rules

* * * * *

Rule 6 Options Trading Automatic Execution System

para. 5231

    Rule 6.87(a)-(1)--No change.
    (m) Auto-Ex-Between-the Quotes. Lead Market Makers may, at their 
discretion, employ the Auto-Ex-Between-the-Quotes

[[Page 21802]]

feature of POETS. This feature will permit the automatic execution 
of limit orders entered into POETS that are: (i) to buy or sell five 
option contracts or less; and(ii) have limit prices that are 
between, but not equal to, the best bid or offering price then being 
disseminated on the PCX. Lead Market Makers must provide the members 
of the trading crowd with at least five minutes notice before 
activating this feature. If the feature is on, Market Makers are 
exempt from the mandatory log-on requirements of Rule 6.87(e)(4). 
This feature does not allow the execution of orders at prices that 
trade-through other markets.
* * * * *

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 III below. THe PCX 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
    This proposal would allow for the automatic execution (by the Auto-
Ex feature of POETS \4\) of small-sized customer limit orders that 
improve the PCX's disseminated best bid or offer. This feature will be 
employed at the discretion of the designated Lead Market Maker 
(``LMM'') in the relevant option issue.
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    \4\ Pacific Option Exchange Trading System.
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    The new feature would operate in the following manner. Assume that 
the PCX best bid or offer (``BBO'') is 5 bid, 5\1/4\ asked. Next, 
assume that a customer limit order to purchase one option contract at 
5\1/8\ is entered electronically on the PCX. If the new feature is not 
operating, the incoming order would be placed in the limit order book 
and displayed automatically, so that the new PCX BBO would be 5\1/8\ 
bid, 5\1/4\ offered. However, if the new feature is operating, the 
incoming order would be executed by the Auto-Ex System before having an 
opportunity to be placed in the limit order book. Consequently, the 
customer's limit order would be immediately executed at its limit price 
and the PCX BBO would remain unchanged from 5 bid, 5\1/4\ asked.
    The PCX guarantees that customers will receive an execution on 
Auto-Ex, at the PCX's disseminated price, for all customer orders for 
up to 20 contracts (and in certain option issues, up to 75 
contracts).\5\ In addition, all customer orders entered electronically 
on the PCX are immediately displayed if they improve the PCX BBO, 
regardless of the size of the order. If a customer limit order to 
purchase one option contract is entered on the PCX and disseminated 
over the Options Price Reporting Authority the price (e.g., 5\1/8\ but 
not the size (one contract) will be disseminated to the public. Thus, 
for example, if the PCX (and national) best bid in a series is 5\1/8\ 
based solely upon a customer order to buy one contract, and a market 
order to sell 20 contracts is then entered on the PCX for automatic 
execution, the market order will be executed at 5\1/8\ (the PCX's 
disseminated price), with one contract trading against the customer 
limit order and 19 contracts trading against the members of the trading 
crowd who are logged on to Auto-Ex--even though they may be bidding 5 
for that particular series.\6\
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    \5\ The PCX provides such guarantees in all option series in 
order to remain competitive with the other options exchanges. See 
PCX Rules 6.86, 6.87.
    \6\ Likewise, if the PCX offered a guaranteed size of 75 
contracts and the inbound order was an order to sell 75 contracts, 
then one contract would trade against the customer limit order and 
74 contracts would trade against the members of the trading crowd.
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    Currently, on the PCX, if a small customer limit order changes the 
PCX BBO, market-makers may manually execute that order to reduce their 
risk of having to trade additional contracts through Auto-Ex at the 
price of the customer limit order. This is a difficult process, 
however, in option issues and series that are so thinly-traded that the 
markets are not displayed on overhead screens on the trading floor, but 
are displayed on ``buried'' screens that have to be called up manually. 
The traders of such issues therefore may not be aware of an order to 
buy one contract at 5\1/8\, for example, that has just been entered. 
Before the traders realize it, another order, to sell 20 contracts at 
5\1/8\, may have just been automatically executed on Auto-Ex, with 19 
of those contracts being sold against those traders' accounts. However, 
if the new feature had been in operation, the order for one contract 
would have been immediately executed and the market-makers would not 
have been required to buy those 19 option contracts at 5\1/8\ when 
their quote was 5 bid.
    The proposed rule change provides that Lead Market Makers may, at 
their discretion, employ the Auto-Ex-Between-the-Quotes feature of 
POETS. It further provides that this feature would permit the automatic 
execution of limit orders entered into POETS that: (i) Are to buy or 
sell five option contracts or less; and (ii) have limit prices that are 
between, but not equal to, the best bid or offering price then being 
disseminated on the PCX. It further states that Lead Market Makers 
would be required to provide the members of the trading crowd with at 
least five minutes notice before activating this feature. If the 
feature is on, market-makers would be exempt from the mandatory log-on-
requirements of PCX Rule 6.87(e)(4).\7\ The rule change would allow the 
LMM to set the number of contracts (from between one to five) that may 
be automatically executed if the new feature is in operation.
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    \7\ PCX Rule 6.87(e)(4) provides, in part, that a market maker 
who has been logged on to Auto-Ex in an option issue at any time 
during an expiration month must continue to be logged on to Auto-Ex 
in that issue whenever present in that trading crowd, until the 
close of business on the next Expiration Friday.
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    The Exchange believes that the proposal would facilitate 
transactions in securities by eliminating the need to execute certain 
very small customer limit orders manually (as in currently the case). 
The Exchange also believes that the proposal would remove opportunities 
for manipulative acts and practices involving small customer orders 
that are entered for the sole purpose of changing the PCX BBO and/or 
the national best bid and offer (``NBBO'').
2. Statutory Basis
    The Exchange believes that this proposal is consistent with section 
6(b) of the Act,\8\ in general, and furthers the objectives of section 
6(b)(5),\9\ in particular, in that it is designated to facilitate 
transactions in securities, to prevent fraudulent and manipulative acts 
and practices, and to promote just and equitable principles of trade.
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    \8\ 15 U.S.C. 78f(b).
    \9\ 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

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

[[Page 21803]]

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposal, 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. 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-00-48 and should 
be submitted by May 22, 2001.

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

    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.\10\ In 
particular, the Commission believes that the proposal is consistent 
with sections 6(b)(5) of the Act,\11\ which requires, among other 
things, that the rules of an Exchange be designed to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market, and to protect investors and the 
public interest.
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    \10\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \11\ 15 U.S.C. 78f(b)(5).
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    The Commission notes that, under current PCX Rules 6.86 and 6.87, 
market-makers taking part in Auto-Ex are required to be firm for a 
minimum of twenty or more contracts at the bid or offer displayed as 
the disseminated market quote. By the operation of these rules, 
therefore, a limit order for a small number of contracts, priced better 
than the disseminated quote, would establish the best bid or offer on 
the Exchange, and thereby commit the Exchange's market-makers to 
electronically execute large numbers of contracts at prices better than 
those at which they are willing to trade.
    The proposed rule change would alter this situation by permitting 
certain small limit orders (those for five or fewer contracts) to be 
automatically executed through operation of the PCX's Auto-Ex system. 
Under the proposal, LMMs would be permitted, at their discretion, and 
upon giving five minutes notice to the crowd, to activate this 
function. While the function is active, market-makers logged on to the 
Auto-Ex system would be excused from compliance with Exchange Rule 
6.87(e)(4) and, therefore, permitted to log off the system. Small limit 
orders that improve the best bid or offer would then be executed, at 
their limit prices, against those market-makers who opt to remain 
logged on to Auto-Ex, or against the lead LMM. The intended effect 
would be to execute a small limit order rather than to display it, 
which potentially would allow a larger contra-side order to enter the 
POETS system, execute against it, and trigger the execution of multiple 
contracts by market-makers at prices they did not quote.
    The Commission believes that the proposed feature should foster a 
fair and orderly market by preserving booked order priority, allowing 
for efficient Auto-Ex executions, and limiting the opportunity for 
``small order baiting.'' \12\ The Commission notes that, according to 
PCX,\13\ the proposed rule change would continue to permit limit orders 
in the Exchange's limit order book to trade against orders in the 
POETS/Auto-Ex system, thereby preserving the priority of booked orders.
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    \12\ ``Small order baiting'' occurs when a customer limit order 
for a minimal number of contracts is entered on one side of the 
market at a better price than the disseminated quote, thereby 
improving the quote. A large customer order on the other side of the 
market is then sent to the Auto-Ex to obtain the better price set by 
the small limit order.
    \13\ Telephone conversation between Cindy L. Sink, Senior 
Attorney, Regulatory Policy, PCX, and Andrew Shipe, Attorney, 
Division of Market Regulation, SEC, April 24, 2001.
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    The Commission finds good cause for approving the proposed rule 
change (SR-PCX-00-48) prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. The proposed 
rule change is designed to automatically execute small customer orders 
at prices better than the disseminated quote in certain circumstances. 
Accordingly, the Commission finds that there is good cause, consistent 
with section 6(b)(5) of the Act,\14\ to approve the proposal on an 
accelerated basis.
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    \14\ 15 U.S.C. 78f(b)(5).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\15\ that the proposed rule change, as amended, (SR-PCX-00-48) is 
hereby approved on an accelereated basis.
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    \15\ 15 U.S.C. 78s(b)(2).
    \16\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-10747 Filed 4-30-01; 8:45 am]
 BILLING CODE 8010-01-M