[Federal Register Volume 61, Number 125 (Thursday, June 27, 1996)]
[Notices]
[Pages 33566-33568]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-16366]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37339; File No. SR-PSE-96-11]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment Nos. 1, 2, and 3 to the Proposed Rule Change by the Pacific 
Stock Exchange, Incorporated, Relating to FLEX Equity Options

June 19, 1996.

I. Introduction

    On April 5, 1996, the Pacific Stock Exchange Incorporated (``PSE'' 
or ``Exchange'') filed a proposed rule change with 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\ to make certain revisions to Exchange rules 
relating to FLEX Equity Options.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    Notice of the proposal was published for comment and appeared in 
the Federal Register on April 26, 1996.\3\ The Exchange filed Amendment 
Nos. 1,\4\ 2,\5\ and 3\6\ to the proposal on April 27, 1996, May 20, 
1996, and May 28, 1996, respectively. No comment letters were received 
on the proposed rule change. This order approves the Exchange's 
proposal, as amended.
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    \3\ See Securities Exchange Act Release No. 37133 (April 19, 
1996), 61 FR 18636.
    \4\ In Amendment No. 1, the Exchange proposes to: (1) permit 
FLEX Equity Options trading on any options-eligible security, 
regardless of whether Non-FLEX Equity Options overlie that security 
and trade on the Exchange; and (2) provide for a guaranteed minimum 
right of participation of at least 25% of the trade for Submitting 
Members indicating an intent to cross and responding to the Request 
for Quotes with a price better than the BBO. See Letter from Michael 
Pierson, Senior Attorney, Market Regulation, PSE, to John Ayanian, 
Attorney, Office of Market Supervision (``OMS''), Division of Market 
Regulation (``Market Regulation''), Commission, dated April 26, 1996 
(``Amendment No. 1'').
    \5\ In Amendment No. 2, the Exchange makes several non-
substantive corrections to PSE Rule 8.103(e)(3), as described more 
fully herein. See Letter from Michael Pierson, Senior Attorney, 
Market Regulation, PSE, to John Ayanian, Attorney, OMS, Market 
Regulation, Commission, dated May 17, 1996 (``Amendment No. 2'').
    \6\ In Amendment No. 3, the Exchange proposes to amend PSE Rule 
8.101(a) to allow FLEX transactions during normal Exchange options 
trading hours on any business day; provided however, that the Board 
of Governors, in its discretion at any time, may determine to narrow 
or otherwise restrict the time set for FLEX options trading. See 
Letter from Michael Pierson, Senior Attorney, Market Regulation, 
PSE, to John Ayanian, Attorney, OMS, Market Regulation, Commission, 
dated May 23, 1996 (``Amendment No. 3'').
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II. Description of the Proposal

    On February 14, 1996, the Commission approved an Exchange proposal 
to list and trade FLEX Equity Options.\7\ FLEX Equity Options permit 
market participants to designate certain contract terms for options of 
such securities, including: exercise price; exercise style (i.e., 
American, European or capped); expiration date; and option type (i.e., 
put, call or spread).
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    \7\ See Securities Exchange Act Release No. 36841 (February 14, 
1996), 61 FR 6666 (February 21, 1996).
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    PSE Rule 8.109(a) currently provides for the selection of ``FLEX 
Qualified Market Makers,'' i.e., market makers whom the Exchange deems 
to be qualified to trade FLEX Equity Options based on the following 
factors: (1) the preference of the registrants; (2) the maintenance and 
enhancement of competition among market makers; and (3) the assurance 
that the market maker will have adequate financial resources.\8\ In 
addition, pursuant to Rule 8.115(a), FLEX Qualified Market Makers may 
not effect any transactions in FLEX Equity Options unless one or more 
letter(s) of guarantee has been issued by a clearing member and filed 
with the Exchange pursuant to Rule 6.36(a). In connection with these 
letters of guarantee, a clearing member must accept financial 
responsibility for all FLEX transactions made by such market makers.
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    \8\ By contrast, under Rules 8.100 et seq., ``FLEX Appointed 
Market Makers'' are those individuals who have been designated by 
the Exchange to trade FLEX options on a specific underlying index 
(``FLEX Index Option'') that has been approved by the Commission for 
FLEX Options trading. See PSE Rules 8.100(a)(1) and 8.109(a).
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    PSE Rule 8.109(a) currently provides that the Exchange shall 
appoint five or more FLEX Qualified Market Makers to each FLEX Equity 
Option prior to its listing.\9\ The Exchange proposes to reduce the 
minimum number of FLEX Qualified Market Makers required under Rule 
8.109(a) from five to three. The Exchange is proposing this change in 
order to enhance its ability to trade FLEX Equity Options on the 
Exchange. The Exchange believes that no undue financial risk to the 
Exchange would result from this change because each transaction of FLEX 
Qualified Market Makers will be backed by a clearing member, which will 
accept financial responsibility for all FLEX transactions made by such 
market makers pursuant to a letter of guarantee.\10\ The Exchange also 
believes that three FLEX Qualified Market Makers will be a sufficient 
number of traders to provide quotations in response to requests for 
quotes because the Exchange expects the FLEX Equity Options will be 
traded in the same trading crowd as Non-FLEX Options on the same 
underlying securities. In this regard, the Exchange notes that under 
the current rules, two FLEX Appointed Market Makers may be designated 
in lieu of five FLEX Qualified Market Makers to trade FLEX Equity 
Options.\11\
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    \9\ With respect to FLEX Index Options, two FLEX Appointed 
Market Makers must be approved to trade FLEX Options on a given 
index before the Exchange may list FLEX Options on that index. FLEX 
Appointed Market Makers must also meet the capital requirements of 
Rule 8.114 (i.e., they must maintain $1 million net liquidating 
equity and/or $1 million net capital (as defined by SEC Rule 15c3-1 
under the Act)), and they must also meet the account equity 
requirements of Rule 8.113(a) (i.e., the net liquidating equity 
maintained in their individual or joint accounts must be at least 
$100,000).
    \10\ See PSE Rule 8.115(a).
    \11\ See PSE Rule 8.109(a).

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[[Page 33567]]

    Under PSE Rule 8.102(f)(1), only those qualified and approved 
underlying securities that are the subject of Non-FLEX Equity Option 
trading on the Exchange may serve as underlying securities of FLEX 
Equity Options traded on the Exchange. In this respect, Rule 
8.102(f)(1) differs from the rules proposed by the American Stock 
Exchange (``Amex'') and the Philadelphia Stock Exchange (``Phlx'') in 
respect of FLEX Equity Option trading on those exchanges.\12\ Proposed 
Amex Rule 903G(c) and proposed Phlx Rule 1069A(a)(1)(B) are 
substantively identical in that any options-eligible security, 
regardless of whether the security is the subject of Non-FLEX Equity 
Options traded on the exchange, may underlie a FLEX Equity Option. The 
Exchange proposes to amend PSE Rule 8.102(f)(1) to conform to similar 
rules proposed by the exchanges mentioned above, to permit FLEX Equity 
Options trading on any options-eligible security regardless of whether 
Non-FLEX Equity Options overlie that security and trade on the 
Exchange.\13\
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    \12\ See Securities Exchange Act Release Nos. 37053 (March 29, 
1996), 61 FR 15537 (April 8, 1996) (File No. SR-Amex-95-57), and 
37048 (March 29, 1996), 61 FR 15549 (File No. SR-Phlx-96-08). See 
also File No. SR-CBOE-96-28 (proposing the same amendment).
    \13\ See Amendment No. 1, supra note 4.
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    Additionally, the Exchange proposes to amend PSE Rule 8.103(e)(3) 
in order to provide a minimum right of participation to Exchange 
members who initiate Requests for Quotes (``RFQ'') in respect of FLEX 
Equity Options and indicate an intention to cross or act as principal 
on the trade.\14\ The proposed rule change will provide that a member 
who submits a Request for Quotes in respect of a FLEX Equity Option and 
indicates an intention to cross or act as principal on the trade, and 
who improves the BBO during the BBO Improvement Interval, has a 
priority right to execute the contra side of the trade for at least 
twenty-five percent (25%) of the trade.\15\
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    \14\ See Amendment No. 1, supra note 4; see also Amendment No. 
2, supra note 5.
    \15\ See Amendment No. 1, supra note 4.
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    Finally, the Exchange proposes to amend PSE Rule 8.101(a) to allow 
FLEX transaction during normal Exchange options trading hours on any 
business day; provided however, that the Board of Governors, in its 
discretion at any time, may determine to narrow or otherwise restrict 
the time set for FLEX options trading. The Exchange believes that this 
proposed rule change is consistent with the other options exchanges 
FLEX Options rules.\16\
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    \16\ See Amendment No. 3, supra note 6.
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    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act in general and furthers the objectives of 
Section 6(b)(5) in particular in that it is designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in facilitating transactions in securities, and to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system.

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. Moreover, the 
Commission believes that the proposed rule change is reasonable in that 
it promotes fair competition among exchanges, and will serve to protect 
investors and the public interest in accordance with Sections 6(b)(5) 
and 11A of the Act.
    The Commission believes that the Exchange's proposal to reduce the 
minimum number of FLEX Qualified Market Makers required under Rule 
8.109(a) from five to three is consistent with the Act. The Commission 
notes that the Exchange's rules currently provide a framework that 
encourages FLEX Qualified Market-Makers, specifically guaranteed by a 
clearing member,\17\ to actively make responsive quotes to provide 
liquidity in FLEX Equity Options. A FLEX Post Official may call upon a 
FLEX Qualified Market-Maker to make responsive quotes in the interests 
of a fair and orderly market.\18\ Moreover, a FLEX Post Official must 
call upon a FLEX Qualified Market-Maker to make a quote in response to 
a Request for Quotes if no quotes are made in response to the RFQ. 
Based on these requirements, the Commission agrees with the PSE that a 
minimum of three FLEX Qualified Market-Makers should be sufficient to 
provide quotations in response to a request for quotes and generally 
accommodate FLEX Equity Options trading.
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    \17\ The Commission notes that FLEX Qualified Market Makers are 
still required under Exchange rules to obtain a specific Letter of 
Guarantee from a clearing member.
    \18\ See PSE Rule 8.109(b).
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    The Commission also believes that the proposed minimum guaranteed 
right of participation of at least 25% of the trade to Exchange members 
who initiate Requests for Quotes in respect of FLEX Equity Options, 
(improves the BBO), and indicate an intention to cross or act as 
principal on the trade, is consistent with Act. In addition, under PSE 
rules, such transactions must, in all cases, be in compliance with the 
priority, parity, and precedence requirements of Section 11(a) of the 
Act,\19\ and Rule 11a1-1(T) \20\ promulgated thereunder. These 
provisions set forth, among other things, the conditions in which 
members must yield priority to public customers' bids and offers at the 
same price.
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    \19\ 15 U.S.C. 78k(a).
    \20\ 17 CFR 240.11a1-1(T).
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    The Commission believes that the Exchange's proposal to permit FLEX 
Equity Options trading on any options-eligible security regardless of 
whether Non-FLEX Equity Options overlie that security and trade on the 
Exchange is reasonable, in that it promotes fair competition among 
exchanges, consistent with Section 11A of the Act, and will perfect the 
mechanism of a free and open market and serve to protect investors and 
the public interest in accordance with Section 6(b)(5) of the Act.
    As originally approved, the PSE determined to restrict the trading 
of FLEX Equity Options to those options which were traded on the 
Exchange as Non-FLEX Equity Options. The PSE rationale for this 
restriction was reasonable and the Commission therefore approved the 
restriction as consistent with the Act. The Commission believes, 
however, that the restriction is not mandated by the Act and that it is 
reasonable for the PSE to conform its rules to those proposed by other 
competing markets seeking to establish FLEX Equity Options trading. The 
Commission notes that PSE FLEX Equity Options must still meet the 
eligibility requirements and criteria set forth in PSE Rule 3.6. The 
change should also promote fair competition among exchange markets 
trading FLEX Equity Options by allowing PSE to trade and compete for 
FLEX Equity Options order flow on more options eligible securities.
    Finally, the Commission believes it is consistent with Section 
6(b)(5) of the Act for the PSE to establish the same trading hours for 
FLEX Options that currently exist for PSE's normal options trading 
hours. The Commission also believes that because of the nature of the 
FLEX market, in contrast to the Non-FLEX market, it is reasonable to 
permit the Board, in its discretion, to narrow or restrict trading 
hours for FLEX Options, so long as such trading hours occur within the 
normal options trading hours of the Exchange.
    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the

[[Page 33568]]

thirtieth day after the date of publication of notice thereof in the 
Federal Register. Specifically, Amendment No. 1 proposes a minimum 
guaranteed right of participation of at least 25% of the trade to 
Exchange members who initiate Request for Quotes in respect of FLEX 
Equity Options, as described above. The Commission believes that the 
amendment is similar to existing provisions in the Exchange rules 
regarding FLEX Index Options and raises no new regulatory issues.
    Furthermore, Amendment No. 1 proposes to conform the PSE's rules 
concerning the selection of underlying securities for FLEX Equity 
Option trading, as described above, to the proposed rules of other 
exchanges on the same subject, and raises no new regulatory issues. 
Additionally, the Amex and Phlx proposals were subject to a full notice 
and comment period, and no comments were received. Accordingly, the 
Commission believes, consistent with Section 6(b)(5) of the Act, that 
good cause exists, to approve Amendment No. 1 to the proposed rule 
change, on an accelerated basis.
    The Commission finds good cause for approving Amendment No. 2 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. Specifically, 
Amendment No. 2 proposes certain non-substantive amendments to PSE Rule 
8.103(e)(3) to clearly distinguish which particular guaranteed minimum 
right of participation is available to a FLEX Equity Option and which 
is available to FLEX Index Option. The Commission believes that 
Amendment No. 2 is a non-substantive amendment and raises no new 
regulatory issues. Moreover, the Commission believes that the amendment 
clarifies and strengthens the proposed rule change and the Exchange's 
FLEX Option rules, generally.
    Accordingly, the Commission believes, consistent with Section 
6(b)(5) of the Act, that good cause exists, to approve Amendment No. 2 
to the proposed rule change, on an accelerated basis.
    The Commission finds good cause for approving Amendment No. 3 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. Specifically, 
the Exchange proposes to amend PSE Rule 8.101(a) to allow FLEX 
transactions during normal Exchange options trading hours on any 
business day; provided however, that the Board of Governors, in its 
discretion at any time, may, with normal trading hours, determine to 
narrow or otherwise restrict the time set for FLEX options trading. The 
Commission believes that the Exchange's proposal to allow FLEX 
transactions during normal Exchange options trading hours on any 
business day, as described above, is similar to that provided under 
other options exchanges' rules regarding FLEX trading hours and raises 
no new regulatory issues.
    Accordingly, the Commission believes, consistent with Section 
6(b)(5) of the Act, that good cause exists, to approve Amendment No. 3 
to the proposed rule change, on an accelerated basis.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 1, 2, and 3 to the proposed rule 
change. 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 in the Commission's Public 
Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of such filing will also be available for inspection and copying 
at the principal office of PSE. All submissions should refer to File 
No. SR-PSE-96-11 and should be submitted by July 18, 1996.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\21\ that the proposed rule change (File No. SR-PSE-96-11), as 
amended, is approved.

    \21\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\2\
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    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-16366 Filed 6-26-96; 8:45 am]
BILLING CODE 8010-01-M