Self Regulatory Organizations; Pacific Exchange, Inc.; Order Approving Proposed Rule Change To Allow Lead Market Makers To Perform Certain Floor Broker Functions

[Federal Register Volume 65, Number 5 (Friday, January 7, 2000)]
[Notices]
[Pages 1214-1215]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-389]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42301; File No. SR-PCX-99-25]


Self Regulatory Organizations; Pacific Exchange, Inc.; Order 
Approving Proposed Rule Change To Allow Lead Market Makers To Perform 
Certain Floor Broker Functions

December 30, 1999.

I. Introduction

    On July 13, 1999, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC''), 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 allow PCX Lead Market Makers 
(``LMM''s) to perform certain Floor Broker Functions. Notice of the 
proposed rule change was published in the Federal Register on September 
21, 1999.\3\ No comments were received on the proposal. This order 
approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 41868 (September 13, 
1999), 64 FR 51173.
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II. Description of the Proposal

    The proposed rule change modifies the Exchange's current rules \4\ 
to allow an LMM to perform certain Floor Broker functions in addition 
to Order Book Official (``OBO'') and Market Maker functions. Under the 
proposed changes, an LMM acting as a Floor Broker will be required to 
use due diligence and perform all other obligations of Floor Brokers 
pursuant to PCX Rules 6.43 through 6.48. An LMM will be permitted, but 
will not be obligated, to accept non-discretionary orders that are not 
eligible to be placed in the Public Order Book, and will be permitted 
to represent such orders as a Floor Broker. An LMM will not be 
permitted to represent discretionary orders, whether as a Floor Broker 
or otherwise, and all orders in the LMM's possession that are eligible 
to be booked will be required to be booked.
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    \4\ See PCX Rule 6.82, ``Lead Market Makers,'' and PCX Rule 
6.83, ``Limitations on Dealings of Lead Market Makers.''
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III. Discussion

    For the reasons discussed below, the Commission finds that the 
proposed rule change is consistent with the Act and the rules and 
regulations under the Act applicable to a national securities exchange. 
In particular, the Commission believes that the proposed rule change is 
consistent with the Section 6(b)(5) \5\ requirements that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, prevent fraudulent and manipulative acts and practices, and 
protect investors and the public interest.\6\ The Commission also finds 
that the proposal may serve to remove impediments to and perfect the 
mechanism of a free and open market by enabling Exchange LMMs to better 
serve customers.
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    \5\ 15 U.S.C. 78f(b)(5).
    \6\ 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 LMM system at the PCX was first approved, on an eighteen-month 
pilot basis, in 1990.\7\ After granting a number of extensions to the 
pilot,\8\ the Commission approved the program on a permanent basis on 
September 22, 1997.\9\ The LMM program was created originally to 
enhance the ability of the Exchange to compete in a multiple trading 
environment, and was designed primarily for new option issues and 
option issues with comparatively low volume. Subsequently, all equity 
and index options traded on the PCX were made eligible for the LMM 
program.\10\
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    \7\ See Securities Exchange Act Release No. 27631 (January 17, 
1990), 55 FR 2462 (January 24, 1990).
    \8\ See Securities Exchange Act Release Nos. 31063 (August 21, 
1992), 57 FR 39255 (August 28, 1992); 31635 (December 22, 1992), 57 
FR 62414 (December 30, 1992); 33854 (April 1, 1994), 59 FR 16873 
(April 8, 1994); 34710 (September 23, 1994), 59 FR 50306 (October 3, 
1994); 36293 (September 28, 1995), 60 FR 52243 (October 5, 1995); 
and 37767 (September 30, 1996), 61 FR 52483 (October 7, 1996).
    \9\ See Securities Exchange Act Release No. 39111 (September 22, 
1997), 62 FR 51710 (October 2, 1997).
    \10\ See Securities Exchange Act Release No. 37780 (October 3, 
1996), 61 FR 53247 (October 10, 1996).
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    Exchange members appointed as LMMs assume responsibilities and 
acquire rights in their appointed options classes that extend beyond 
the obligations and rights of Market Makers who trade in the same 
options issue. In addition to performing the regular obligations of a 
Market Maker, an LMM must assume certain additional obligations that 
are designed to strengthen the LMM's market making activities.
    Pursuant to PCX Rule 6.82, ``Lead Market Maker,'' each LMM is 
responsible for, among other things: assuring that disseminated market 
quotations are accurate; honoring guaranteed markets; determining the 
formula for generating automatically updated market quotations; being 
present at the designated trading post throughout each trading day; 
effecting, with respect to trading as a Market

[[Page 1215]]

Maker, trades that have a high degree of correlation with the overall 
pattern of trading of each series in the option issues involved; 
participating in the automatic execution system; actively promoting the 
Exchange as a marketplace; and responding to competition by offering 
competitive markets and competitively priced services. Subject to 
certain exceptions, LMMs receive a guaranteed 50% participation in 
transactions occurring on their disseminated bids and offers in their 
appointed issues.
    Since its inception, the LMM position at the PCX has been designed 
to incorporate some of the functions performed by Designated Primary 
Market Makers (``DPM''s) at the Chicago Board Options Exchange 
(``CBOE''). Under the original LMM system at PCX, however, an LMM--
unlike a DPM--was not authorized to manage the public limit order book 
(``the Book'') or perform certain Floor Broker functions.\11\
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    \11\ These functions were accorded to DPMs at the CBOE from the 
beginning of the DPM program at that exchange. See Securities 
Exchange Act Release No. 24934 (September 22, 1987), 52 FR 36122 
(September 25, 1987) (first approving the CBOE DPM program and 
depicting the DPM as a position ``akin to a specialist'').
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    The PCX has in recent years sought to broaden the privileges of its 
LMMs to make its LMM system more competitive with similar systems at 
other options exchanges. In October 1996, the Commission approved a PCX 
pilot program that allowed a number of LMMs to perform the functions of 
the PCX OBO (i.e., manage the Book) in certain designated options 
issues.\12\ Participating LMMs were required to resolve trading 
disputes and errors, set rates for Book execution, and disclose Book 
information to members upon request. The pilot was subsequently 
extended and expanded to allow all LMMs to participate as OBOs.\13\ In 
October 1998 this facet of the LMM system was permanently approved by 
the Commission.\14\
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    \12\ See Securities Exchange Act Release No. 37810 (October 11, 
1996), 61 FR 54481 (October 18, 1996).
    \13\ See Securities Exchange Act Release Nos. 38462 (April 1, 
1997), 62 FR 16886 (April 8, 1997); 39106 (September 22, 1997), 62 
FR 51172 (September 30, 1997); 39667 (February 13, 1998), 63 FR 9895 
(February 26, 1998); 40020 (May 21, 1998), 63 FR 29286 (May 28, 
1998); and 40328 (August 17, 1998), 63 FR 45276 (August 25, 1998).
    \14\ See Securities Exchange Act Release No. 40548 (October 14, 
1998), 63 FR 56283 (October 21, 1998). Until recently, the Exchange 
required participating LMMs to use Exchange personnel to assist the 
LMM in performing the OBO function, for which the Exchange charged 
the LMM a staffing fee. In July 1999, the Commission approved a rule 
change allowing qualified LMMs to manage their own employees in 
operating the Book. See Securities Exchange Act Release No. 41595 
(July 2, 1999), 64 FR 38064 (July 14, 1999).
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    The PCX now seeks to further revise PCX Rule 6.82 to permit its 
LMMs to act as Floor Brokers, in addition to performing OBO and Market 
Maker functions. Floor Brokers are registered with the Exchange and are 
permitted to accept and execute options orders received on behalf of 
members while on the Exchange floor.
    The PCX has proposed this rule change for competitive reasons. 
Specifically, the PCX believes that the proposed changes will afford 
its LMMs additional flexibility so that they can better compete with 
DPMs and specialists on other national securities exchanges.\15\ the 
PCX also believes that the proposed changes will allow its LMMs to 
provide customers with a greater level of service and enable the LMMs 
to offer more competitive rates for the execution of customer orders.
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    \15\ The proposed rule change will generally allow LMMs on the 
PCX to perform the same functions that DPMs on the CBOE may perform. 
See CBOE Rule 8.80(c).
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    Under the proposal, an LMM will be permitted, but will not be 
obligated, to accept non-discretionary orders that are not eligible to 
be placed in the Book,\16\ and will be permitted to represent such 
orders as a Floor Broker. In handling an order as a Floor Broker, an 
LMM will be obligated to use due diligence to execute the order at the 
best available price, in accordance with the rules of the Exchange,\17\ 
and will be further subject to all other obligations of Floor Brokers 
specified in PCX Rules 6.43 through 6.48.
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    \16\ The eligibility of orders to be placed in the Book is 
determined by reference to PCX Rule 6.52(a), which governs the types 
of orders that OBOs may accept. Such orders, as indicated in the 
Rule, ``shall include limit orders . . . and such other orders as 
may be designated by the Options Floor Trading Committee.'' 
According to the PCX, the Committee has not designated any 
additional types of orders that may be accepted by OBOs. Orders not 
eligible for the Book include, for example, contingency orders, 
spread orders, straddle orders, and combination orders. Telephone 
conversation between Robert P. Pacileo, Attorney, PCX, and Ira L. 
Brandriss, Attorney, Division of Market Regulation, Commission, on 
August 6, 1999.
    \17\ The PCX represented that it will provide detailed guidance 
concerning these responsibilities in a Regulatory Bulletin that will 
be disseminated to members upon the approval of this proposed rule 
change. The bulletin will specify, among other things, that in 
executing transactions for his own account as a Market Maker, an LMM 
(a) must accord priority to orders he represents as Floor Broker 
over his activity as Market Maker, and (b) must not initiate a 
transaction for his own account that would result in putting into 
effect any stop or stop limit order which may be in the Book or 
which he represents as Floor Broker, except with the approval of a 
Floor Official and a guarantee that the stop or stop limit order 
will be executed at the same price as the electing transaction. 
Telephone conversation between Robert P. Pacileo, Attorney, PCX, and 
Ira L. Brandriss, Attorney, Division of Market Regulation, 
Commission, on November 19, 1999.
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    At the same time, the proposal places restrictions on the types of 
orders that an LMM may represent as a Floor Broker, consistent with 
applicable rules of competing exchange.\18\ An LMM will not be 
permitted to represent discretionary orders, whether as a Floor Broker 
or otherwise. In addition, all orders in the LMM's possession that are 
eligible to be booked will be required to be booked.
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    \18\ See CBOE Rule 8.80(c)(8).
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    The Commission finds that the proposed rule change is an 
appropriate expansion of the functions performed by LMMs. The proposal 
implements a system that has been in place other exchanges, and is 
likely to enhance trading at the PCX. It provides a further incentive 
for Market Makers to become LMMs, and thus may add depth and liquidity 
to PCX-listed issues. The ability of LMMs to serve as Floor Brokers 
should also afford LMMs greater flexibility in responding to varying 
market conditions, and enable them to improve service to PCX customers 
by offering competitive service rates. Finally, by placing LMMs on a 
similar footing as DPMs and specialists at other options exchanges, the 
proposal should encourage further competition among the exchange 
markets.

IV. Conclusion

    It is Therefore Ordered, pursuant to Section 19(b)(2) \19\ of the 
Act, that the proposed rule change (SR-PCX-99-25) is hereby approved.

    \19\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-389 Filed 1-6-00; 8:45 am]
BILLING CODE 8010-01-M