Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Pacific Exchange, Inc. Relating to a Consolidated Limit Order Book for Equity Securities

[Federal Register Volume 64, Number 81 (Wednesday, April 28, 1999)]
[Notices]
[Pages 22888-22896]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-10671]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41304; File No. SR-PCX-99-06)

Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Pacific Exchange, Inc. Relating to a Consolidated Limit
Order Book for Equity Securities

April 16, 1999.
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 March 1, 1999, as amended on April 16, 1999,\3\ the Pacific
Exchange, Inc. (``PCX'' or ``Exchange'') filed with the Securities and
Exchange Commission (``Commission'' or ``SEC'') the proposed rule
change to implement a consolidated limit order book (``CLOB'') as
described in Items I, II and III below, which Items have been prepared
by the Exchange. 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.
\3\ See Letter from Michael Pierson, Director, Regulatory
Policy, PCX to Michael Walinskas, Deputy Associate Director,
Division of Market Regulation, Commission, dated April 16, 1999
(``Amendment No. 1''). Amendment No. 1 made technical changes to the
filing and further described the functioning of the CLOB.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change

The Exchange is proposing to implement a CLOB for orders for equity
securities that are entered into the Exchange's P/COAST trading system.
Proposed new language is italicized; proposed deletions are in
brackets.\4\
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\4\ On August 17, 1998, the Exchange filed an earlier version of
this proposal with the Commission. See File No. SR-PCX-98-39. Since
that time, the Exchange modified the original proposal in several
respects and accordingly, the Exchange has determined to withdraw
SR-PCX-98-39 and refile it as modified.
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* * * * *

para. 3995 Orders: Other Floor

Rule 5.8(a). [Should an order to buy or sell be received from the
other Floor for entering in the specialist's book] When an order is
entered into the Consolidated Limit Order Book at the same price at
which a floor bid or offer is being made at the specialist's post, the
floor bid or offer shall maintain priority so long as the bidder or
offeror remains within the immediate vicinity of the post to which the
security involved is assigned or the order is

[[Page 22889]]

entered with the specialist. The order in the Consolidated Limit Order
Book will [from the other Floor entered with the specialist shall]
obtain priority should the bidder or offeror leave the immediate
vicinity of the Post without entering the order with the specialist.
Where a security is traded by more than one specialist [on both
floors], the specialist who received the order will be responsible for
properly coordinating and synchronizing orders (and executions) with
the specialist on the other Floor.
* * * * *

para. 3999 Priority of Bids and Offers

Rule 5.8(c). When a bid or offer is clearly established as the
first made at a particular price [regardless of the floor], the maker
shall be entitled to priority and shall have precedence on the next
sale at that price, up to the number of shares of stock or principal
amount of bonds specified in the bid or offer irrespective of the
number of shares of stock or principal amount of bonds specified in
such bid or offer.
A member having priority on the floor with a bid or offer may not
increase the size of his bid or offer if objection is made by another
member. By placing his order with the specialist he may maintain his
priority, but in an amount no greater than originally bid for or
offered by him on the Floor. Orders so placed may be accepted as and
retain the status of open orders if so designated at the time of
placement but shall not gain priority over orders existing in the
Consolidated Limit Order Book [specialist's book] at the time the
member secured the Floor with his original bid or offer.
Commentary
.01 No Change.
* * * * *

P/COAST

para.4153 Pacific Computerized Order Access[s] SysTem

Rule 5.25(a)-(f) No change.

Consolidated Limit Order Book

Rule 5.25(g). Incoming Equity orders entered into the Exchange's P/
COAST trading system will be maintained in and executed through the
Exchanges Consolidated Limit Order Book (``CLOB''). Incoming market and
marketable limit orders are immediately executed against orders in the
CLOB based on price and time priority, once they have been displayed
for possible price improvement. Incoming orders other than market and
marketable limit orders will be maintained in the CLOB, but will be
represented by a particular PCX specialist.
(1) Manual-Ex Window. A specialist may not permit an order to
remain in the Manual-Ex Window of P/COAST for more than two minutes
unless:
(a) the order is designated: (i) market-on-close; (ii) all-or-none;
(iii) a ``tick sensitive'' order (including buy minus, sell plus, sell
short, or sell short exempt); (iv) stop; or (v) stop limit; or
(b) execution of the order would result in a double-uptick (or
double-downtick) or would result in a new high (or new low) price for
the day; or
(c) the specialist stops the order; or
(d) there are extraordinary market conditions or systems problems.
* * * * *

para. 4229 Disclosure of Specialists' Orders Prohibited

Rule 5.29(d). No specialist shall directly or indirectly, disclose
to any person other than a [the] co-specialist [on the other Floor], a
member of the Floor Trading Committee, or an official of the Exchange,
any information in regard to orders entrusted to him as a specialist,
except that the specialist may disclose the size of the bid or offer,
and may disclose information contained in [his book] the Consolidated
Limit Order Book:
(i) for the purpose of demonstrating the methods of trading to
visitors to the Floor; or
(ii) to other market centers in order to facilitate the operation
of ITS or any other Application of the System provided, in either case,
that at the same time he makes the information so disclosed available
to all members.
Commentary
.01 No change.
* * * * *

para. 4253 Specialists' Coordination

Rule 5.30(b). Specialists registered in the same security which is
traded by more than one specialist will [on both Floors shall] be
responsible for establishing a unified opening sale in such security
and thereafter throughout each trading session shall maintain such
degree of contact with each other as will [insure] ensure the
interchange of such information respecting existing or indicated
potential bids and offers as may be necessary to maintain fair, orderly
and integrated markets in such securities.

[para. 4255 Responsibility for Coordination

Rule 5.30(c). Whenever a specialist's market or the market on his
respective Floor equals or betters a competitive market, he will
immediately inform the specialist on the other Floor, if technically
possible.]

para. 4257 Orders Represented by Specialists [in the Specialist's
Book on One Floor]

Rule 5.30(d). (1) A specialist holding manual orders must notify
the other specialists trading the security in order for those orders to
have standing. [A specialist on one Floor holding orders in his book
shall notify the specialist on the other Floor of such orders to have
any standing on the other Floor.]
(2) If a specialist notifies a contra specialist of orders in P/
COAST, or if there are orders in the CLOB, the contra specialist may
not execute orders at or through the limit of such orders in P/COAST or
the CLOB without all such orders being filled. [If the specialist on
one Floor notifies the specialist on the other Floor of orders in his
book, there can be no transactions on the other floor by the specialist
for his own account at or through the limit of such orders without all
such orders being filled.]
(3) If a specialist fails to notify the contra specialist of manual
orders or orders in P/COAST and the contra specialist executes a
transaction at or through the limit of such orders, the specialist
failing to notify the contra specialist will be responsible for an
execution of the orders in P/COAST. For purpose of this rule, a
specialist will be deemed to have notified the contra specialist of the
manual orders or orders in P/COAST if they are being represented in the
CLOB. [If the specialist on one Floor fails to notify the specialist on
the other Floor of orders in his book and transactions take place on
the other Floor at or through the limit of such orders, the specialist
failing to notify the specialist on the other Floor will be responsible
for an execution of the orders in his book.]
* * * * *

para. 4271 Suspend Trading

Rule 5.31(b)(1). When the flow of orders in a security traded by
more than one specialist [on both Floors] does not allow [either] a
specialist to maintain an orderly market in such security, such
[either] specialist may suspend trading, and he shall announce such
suspension:
(i) on his respective Floor,
(ii) to the other specialists in the security [on the other Floor]
who also shall suspend trading,
(iii) on the ticker,
(iv) to the ITS Control Center (ICC) for ITS eligible securities.
The specialist first taking action shall immediately notify the
Floor Trading Committee Members of his respective Floor of the
suspension and trading may

[[Page 22890]]

be resumed only at the direction of the Floor Trading Committee.
Rule 5.31(b)(2). When the flow of orders in a security traded by
only one specialist [only on one Floor] does not allow the specialist
to maintain an orderly market in such security, the specialist may
suspend trading, and he shall announce such suspension:
(i) on his respective Floor,
(ii) to the other Floor,
(iii) on the ticker,
(iv) to the ITS Control Center (ICC) for ITS eligible securities.
The specialist shall immediately notify the Floor Trading Committee
Members of his respective Floor of the suspension and trading may be
resumed only at the direction of such Committee members.
* * * * *

para. 4279 Guaranteeing PMP ⁵ on Portion of Multiple
Orders
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\5\ ``PMP'' means Primary Market Protection.
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Rule 5.32(b)(1). When a specialist is representing an order in the
Consolidated Limit Order Book [has an order in his book] and
subsequently guarantees the primary market price on a partial of a
multiple order, if the effective price on the partial is equal to or
through the limit of the order in the Consolidated Limit Order Book
[his book], the following shall apply:
(i) If the effective price on the partial order is equal to the
limit of the order in the Consolidated Limit Order Book [his book], the
specialist shall give up to the order in the Consolidated Limit Order
Book [his book];
(ii) If the effective price on the partial order is through the
limit of the order in the Consolidated Limit Order Book [his book], the
specialist shall fill the order in the Consolidated Limit Order Book
[his book] and record the transaction when a price through the limit
appears on the tape, after which when the member for whom he guaranteed
the partial reports the execution price on the balance of the multiple
order, the specialist shall complete and record the transaction on the
partial of the multiple order he has guaranteed.
Rule 5.32(b)(2). No change.
Rule 5.32(b)(3). When a specialist is requested to execute on a PMP
basis all or part of a multiple order, he shall notify all other PCX
[the] specialists [on the other Floor] registered to trade that issue
if technically possible prior to relinquishing part of the order to
other markets.
Rule 5.32(b)(4). No change.
* * * * *

para. 4287 Specialists Placing Orders in [Own Book] the
Consolidated Limit Order Book for Own Account

Rule 5.33(b). No specialist may place orders in the Consolidated
Limit Order Book [his own book] for any account in which he or his firm
or any participant therein is directly or indirectly interested, except
in special situations (e.g., when rights or arbitrage is involved) in
which the Floor Trading Committee grants such permission on specific
issues.

[para. 4289 Specialist's Own Orders in Other Specialist Book
Prohibited

Rule 5.33(c). No specialist on one Floor may place orders for any
account in which he or his firm or any participant therein is directly
or indirectly interested in the book of the specialist on the other
Floor in any security in which he is registered as specialist.]

para. 4291 Specialist Options

[Rule 5.33(d)] Rule 5.33(c). No change.

para. 4293 Specialist Joint Accounts

[Rule 5.33(e)] Rule 5.33(d). No change.

para. 4295 Specialist--Puts--Calls

[Rule 5.33(f)] Rule 5.33(e). No change.

[para. 4297 Specialist Stopping Stock for His Own Account

Rule 5.33(g). A specialist may stop stock in his own book for his
own account only under the following conditions:
(1) When he is making the highest bid or the lowest offer if the
difference between the bid and offer is more than one applicable
trading differential, he may ``stop'' stock for his own account in his
own book up to 50% of the number of shares bid for or offered in his
book.]

para. 4299 Effecting Executions of Stop Orders Held by Specialists

[Rule 5.33(h)] Rule 5.33(f). No specialist shall make a transaction
for his own account in a stock in which he is registered that would
result in putting into effect any stop order he may have in the
Consolidated Limit Order Book; [on his book;] provided, however, a
specialist may be party to the election of a stop order when (a) his
bid or offer, made with the approval of a Floor Official, has the
effect of bettering the market, and (b) he guarantees that the stop
order will be executed at the same price as the electing sale.
* * * * *

Minor Rule Plan

Rule 10.13(a)-(h) No change.

(i) Minor Rule Plan: Equity Floor Decorum and Minor Trading Rule
Violations

(1)-(12) No change.
(13) Specialist kept an order in the Manual-Ex Window of P.COAST
for more than two minutes (and there is no applicable exemption to this
requirement under Rule 5.25(g)(1)).
* * * * *

(k) Minor Rule Plan: Recommended Fine Schedule

(i) No changes.

(iii) Equity Floor Decorum and Minor Trading Rule Violation \3\

(1)-(12) No change.
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\3\ Fines for multiple violations of Equity Floor Decorum and
Minor Trading Rules are calculated on a running two-year basis,
except that violations denoted with an asterisk are calculated on a
running one-year basis.

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No. of Violations Fine Amount
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*(13) Specialist kept an order in the 1-5................................ Official Warning
Manual-Ex Window of P/COAST for more
than two minutes (and there is no
applicable exemption to this
requirement under Rule 5.25(g)(1)).
6-10............................... $50
11+................................ $100
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[[Page 22891]]

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 Exchange 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 Exchange 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
a. Background. The Exchange is proposing to change its rules to
implement a CLOB for orders for equity securities that are entered into
the Exchange's P/COAST \6\ trading system. The CLOB has been designed
to facilitate the execution of customer orders in time priority
pursuant to Exchange Rules.\7\
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\6\ P/COAST, the ``Pacific Computerized Order Access System,''
is the Exchange's communication, order routing and execution system
for equity securities. It operates on a dual processing system, with
mainframe computers in San Francisco and Los Angeles. The system
allows trading to be integrated from two separate trading floors.
See PCX Rule 5.25.
\7\ See PCX Rule 5.8(c).
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The Exchange currently operates two equity trading floors, one in
San Francisco and one in Los Angeles. For most of the equity securities
traded on the Exchange, there are two Registered Specialists
continuously making two-sided markets. The Exchange disseminates a
consolidated best bid and offer reflecting orders held by both
specialists as well as any interest of the specialists for their own
proprietary accounts.
The Exchange route orders to a specialist in one city or the other
based on arrangements that the specialists have previously made with
firms that send orders to the Exchange. For orders for which neither
specialist has made specific arrangements with the firm sending the
order, the Exchange will generally assure that the orders are
transmitted to the two specialists on an alternating basis (e.g., the
first order goes to Specialist A, the next order to Specialist B, the
next to Specialist A, and so on).
Prior to the CLOB's implementation, if an incoming limit order was
sent through the P/COAST system, it would either be placed in a
specialist's limit order book or be executed by the specialist who
received the order. If a specialist in one city received an order, and
if a specialist in the other city held a limit order with time priority
that matched against the newly received order, the specialists would be
responsible for assuring that the two orders were executed in
accordance with PCX's priority rules.\8\
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\8\ See PCX Rules 5.30(b)-(c). Rule 5.30(b) provides that
specialists registered in the same security which is traded on both
floors are responsible for establishing a unified opening sale in
such security. Moreover, throughout each trading session the
specialists must stay in contact with one another to ensure that
they maintain fair, orderly and integrated markets in such
securities. Rule 5.30(c) provides that whenever a specialist's
market or the market on his respective floor equals or betters a
competitive market, he will immediately inform the specialist on the
other floor, if technically possible.
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The Exchange developed the CLOB as part of its continuing effort to
enhance communication between PCX's two trading floors. All round-lot
orders sent to the Exchange through the P/COAST system are initially
displayed to the specialist designated to receive them (based on prior
arrangements or designation on an alternating basis). Limit orders that
are not immediately executed by the designated specialist will be
maintained in the CLOB, subject to the exceptions discussed below.
Orders in the CLOB continue to be represented by the designated
specialist. The CLOB eliminates the need for each specialist to
manually match incoming orders against limit orders with priority that
are represented by another specialist.
b. Order Handling Under the CLOB. 1. Overview. Under the P/COAST
system, all incoming orders in an equity security are specified for
representation by one of the specialists in that issue, and appear on
that specialist's computer screen on the automatic-execution (``auto-
ex'') window for up to 15 seconds. When market or marketable limit
orders appear on the auto-ex window, the specialist will have 15
seconds to move the order to the manual-ex window, where the specialist
may improve the execution price.\9\ If the specialist does not move the
order to the manual-ex window within 15 seconds, the order, in most
cases, will automatically execute against any limit orders in the CLOB
that are at or better than the National Best Bid or Offer (``NBBO'')
according to price and time priority.\10\ If there are no limit orders
in the CLOB at the NBBO, then the order may execute against a
specialist's proprietary quote at the NBBO. A specialist may also cause
an incoming market or marketable limit order to execute immediately
against a limit order in the CLOB, without waiting for 15 seconds to
pass.\11\
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\9\ The practice of moving orders to the manual-ex window, and
proposed rule changes associated with that practice, are discussed
below.
\10\ Generally, if executing an order at the NBBO would result
in a double-uptick, double-downtick, new high for the day, or new
low for the day, the P/COAST system will send the order to the
specialist's manual-ex window for further handling, instead of
automatically executing the order at the NBBO. The system will not
prevent a specialist from then manually executing the order at the
NBBO in those circumstances.
The P/COAST system also uses a ``background execution
parameter'' that allows the specialist to program the system to
execute all market and marketable limit orders that are smaller than
a certain designated size, at the disseminated market price, without
first being displayed for price improvement. This feature is
typically used for very small orders (generally, those under 100
shares). Currently, the size of the background parameter can only be
activated for all securities at a given specialist post and cannot
be activated security-by-security. Orders smaller than the
background execution parameter will receive an automatic execution
at the NBBO, even if that would result in a double-uptick, double-
downtick, new high for the day, or new low for the day.
\11\ The specialist is also able to cause a market or marketable
limit order to execute against orders in the CLOB while
simultaneously preventing an execution against the specialist's
proprietary account. For example, if there are orders in the CLOB to
buy 800 shares at $60, and orders to buy 200 shares at $59\15/16\,
and a market order to sell 1,000 shares is entered, the specialist
can cause the orders in the book at $60 to match against the
incoming order to sell, with the remainder of the incoming order
(200 shares) sent to the manual-ex window, without causing an
execution against the specialist's proprietary account.
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Non-marketable limit orders (i.e., orders to buy that are priced
below the national best offer and orders to sell that are priced above
the national best bid) that arrive through the P/COAST system \12\ will
move from the auto-ex window into the CLOB after 15 seconds unless the
specialist executes the order or moves it to the computer screen's

[[Page 22892]]

manual-execution (``manual-ex'') window for further handling.\13\
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\12\ Although most orders arrive in the Exchange through the P/
COAST system, some orders are sent to floor brokers on the Exchange.
Floor brokers currently may enter these orders into the CLOB from a
workstation at the floor broker's booth. Because the CLOB has not
yet been developed to fully accommodate the processing of manual
orders received by floor brokers, the system has limitations that
make it difficult for floor brokers to track orders and receive
reports on them. The PCX is currently implementing a systems change
to facilitate the entry and processing of manual limit orders in the
CLOB. The change will allow floor brokers to track their orders more
efficiently and to receive reports on their orders directly from the
system. The Exchange anticipates that the systems change will be
implemented by the end of April 1999. The Exchange currently does
not require floor brokers to place limit orders in the CLOB,
however.
\13\ A specialist's handling of non-marketable limit orders in
the manual-ex window is discussed in more detail below.
Motreover, specialists may reject limit orders that appear
clearly erroneous. For example, if the last sale is 122, an order to
trade at 22 could be rejected, If an order has been rejected, then
depending on the entering firm's previous instructions to the
Exchange, the order will be routed: (a) to the contra specialist
(i.e., the other specialist in that issue); (b) to the firm that
entered the order; or (c) to the Exchange's P/COAST Service Center.
If a specialist is in the process of executing an order, the
specialist may reject a subsequent request to ``cancel'' or ``CFO''
(``cancel former order'') that order.
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2. Execution of Incoming Market Orders. The CLOB's automatic
execution feature executes incoming market orders in the following
manner. Assume that Specialist A and Specialist B are both representing
non-marketable limit orders in the CLOB to buy XYZ stock at $20, which
is the national best bid, and further assume that the orders were
entered in the following sequence: one order for Specialist A (100
shares), one order for Specialist B (100 shares), and ten orders for
Specialist A (100 shares per order), so that the two specialists are
collectively representing 12 orders to buy 1,200 shares of XYZ stock.
If an incoming market order to sell 2,000 shares of stock is received
for representation by Specialist A, that order will be displayed for 15
seconds on Specialist A's auto-ex window, giving Specialist A the
opportunity to improve the price, and then will be executed in time
priority sequence against the various orders in the CLOB--i.e., it
will first execute against the first order being represented by
Specialist A, then against the order being represented by Specialist B,
and finally, against the 10 orders being represented by Specialist A.
The remaining 800 shares would either be executed at $20, against
Specialist A's proprietary account, or be placed in Specialist A's
manual-ex window for further handling. If the remainder of the order is
placed in Specialist A's manual-ex window, it may be executed against
other orders that may be in the CLOB at a lower price (or prices), if
that lower price now constitutes the NBBO.
3. Manual Execution of Limit Orders. Once a limit order is in the
CLOB, the specialist who represents it may manually execute it through
the specialist's Limit Order Book Window. The specialist may do this
if, for example, there is a trade on the primary market at the limit
order price. The P/COAST system will notify both PCX specialists in an
issue of the first print on the primary market that occurs at a price
equal to the limit price of an order (or orders) in the CLOB. It will
also notify both PCX specialists of the first print from another market
that trades through the PCX market. If a specialist decides to execute
a ``limit alert'' \14\ at a price based on an execution in the primary
market, the CLOB will assure that the order (or orders) will be
executed in accordance with time priority. For example, assume that
Specialist A and Specialist B are both representing orders to buy XYZ
stock at $20, and those orders were entered in the following sequence:
one order for Specialist A, one order for Specialist B, and ten orders
for Specialist A. If a print at $20 occurs on the primary market and
Specialist A attempts to execute all limit orders in his or her custody
to buy XYZ stock at $20, the CLOB will allow the first order to be
executed, but will prevent the next 10 orders from also being executed
simultaneously because the order held by Specialist B has time
priority. If Specialist B manually executes the order with priority
that he or she is representing from the limit order book, prior to
Specialist A's execution of the ``limit alert,'' Specialist A would
then be permitted to execute simultaneously all of the other orders at
that price. However, Specialist A would immediately receive a CLOB
``violation'' message that Specialist B had executed an order out of
time priority sequence. If that occurs, Exchange Surveillance personnel
would receive a report that this time or price priority violation had
occurred.\15\
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\14\ A ``limit alert'' is a proxy that groups together all
orders in the CLOB that are then being represented by a specialist
at a given price. A specialist who executes a ``limit alert'' will,
in effect, be attempting to execute all of the limit orders covered
by the proxy, without committing a priority violation. Upon the
execution of the ``limit alert,'' the CLOB will only allow the
execution of orders that may be executed without causing a priority
violation to occur. If there are unexecuted limit orders remaining
in the CLOB at the same price, the specialist who executed the limit
alert will be so notified.
\15\ Out of priority executions are further discussed below.
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4. Opening of Trading. At the opening of trading, all market orders
that a specialist is representing are executed at the opening price on
the primary market. In addition, the P/COAST system electronically
checks the limit order file and executes all buy orders priced above
the primary market opening price and all sell orders priced below the
primary market opening price. These orders are executed at the opening
price on the primary market. The system also provides a limit alert to
advise the specialists that there are limit orders in the book priced
equal to the opening price on the primary market.
c. Manual Handling of Orders. The manual-ex window of P/COAST
provides specialists with flexibility that is needed in the special
handling of customer orders. Specialists may place orders in the
manual-ex window for a number of reasons. For instance, doing so allows
the specialist greater flexibility in providing price improvement for
customer orders and conducting price discovery in other markets when
handling market orders on the PCX. Placing an order on the manual-ex
window also allows the specialist to continue to work in order that
cannot be placed in the CLOB. The practice also allows the specialist
to process orders with special instructions from the customer.
The P/COAST system automatically routes certain types of incoming
orders from the auto-ex window to the manual-ex window for manual
handling. These include:
(a) Marketable limit orders whose execution would result in a
double-uptick (or double-downtick),\16\ or a new high (or new low) for
the day (but only if the firm that entered the order has specifically
requested that such executions do not occur on their orders); \17\
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\16\ A ``double-uptick'' on the PCX means that a trade has been
executed on the PCX at a price that is more than one trading
differential away from the last print on the primary market. For
example, if the last execution price on the primary market is $20,
then a double uptick would occur on the PCX if an order were
executed on the PCX at $20 1/8, because currently, the minimum
trading differential in 1/16. Conversely, a trade on the PCX at 19
7/8 would be a ``double-downtick'' if the last execution price on
the primary market is $20.
\17\ When orders are automatically sent to the manual-ex window
for one of these reasons, a message is sent to the customer stating
that the customer is guaranteed to receive a certain price or
better.
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(b) Orders that cannot be placed in the book at all (e.g., market,
marketable limit, market-on-close, fill or kill, or sell-short at the
market);
(c) Market and marketable limit orders that have been partially
executed from the auto-ex window (but limit orders in the book that
receive a partial execution will not go to the manual-ex window because
no orders in the book can go to the manual-ex window); and
(d) Large orders, for more than a number of shares that has been
designated by the specialist.\18\
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\18\ The P/COAST system accepts all orders for 10,099 shares or
less. The system also provides automatic executions of all market
orders for 1,099 shares or less, although order flow providers may
set higher parameters for the automatic execution of market orders
they send. All non-marketable limit orders, including those over the
size designated by an order flow provider, are routed to the CLOB
upon time-down or acceptance by the specialist. If an incoming
market or marketable limit order exceeds the automatic execution
parameter set by an order flow provider, the order will be routed
automatically, upon time-down or acceptance, to the specialist's
manual-ex window.
---------------------------------------------------------------------------

At times, a specialist may place a limit order that would match or
improve

[[Page 22893]]

the NBBO, into the manual-ex window, rather than placing it into the
CLOB. The specialist may do this when conducting price discovery. If
the price of a stock is changing rapidly during a busy market, it may
be unclear at the time the order is entered what the true market really
is. A specialist may not want to execute the order until those
conditions have changed, so that the specialist can determine the best
price. A specialist may manually change the PCX quote to reflect the
limit order. Alternatively, in the course of conducting price
discovery, the specialist may lay off a limit order of equal size onto
the primary market, in which case the initial limit order would not be
reflected in the Exchange''s disseminated quote, but should be
reflected in the quote on the primary market.
Exchange rules currently do not require that orders in the manual-
ex window to executed within a set period of time. In fact, certain
types of orders cannot be placed in the book and, unless executed, will
remain in the manual-ex window throughout the trading day. However, the
Exchange evaluates specialists on their ``turnaround time'' and the
amount of time during which they ``hold orders without action.'' \19\
Specialists are subject to remedial action by the Equity Allocation
Committee if they have substandard scores on their quarterly
performance evaluations.\20\
---------------------------------------------------------------------------

\19\ See PCX Rule 5.37(a).
\20\ See PCX Rule 5.37(g).
---------------------------------------------------------------------------

To assure that orders do not remain in the manual-ex window for
undue periods of time, the Exchange is proposing to adopt new Rule
5.25(g)(1) stating that an order may remain in the manual-ex window for
a maximum of two minutes, unless:
(a) The order is designated: (i) market-on-close; (ii) all-or-one;
(iii) a ``tick sensitive'' order (including buy minus, sell plus, sell
short, or sell short exempt); (iv) stop; or (v) stop limit;
(b) Execution of the order would result in a double-uptick (or
double-downtick) or would result in a new high (or new low) price for
the day;
(c) The specialist stops the order;\21\ or
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\21\ The term ``stop'' refers to the practice in which a
specialist guarantees that an order will receive a specific price or
better. At a minimum, the order must receive a price equal to the
NBBO at the time the specialist received the order for execution;
however, the specialist may also provide an improved price. If an
order has been stopped, the customer must always receive the better
of: (a) the current NBBO or (b) the stop price. At the PCX when a
specialist stops an order, a message is automatically sent to the
customer stating that the customer is guaranteed to receive a
specific price (i.e., the stopped price) or better. In addition, at
the PCX, if an order has been stopped, it must be executed by the
end of the trading day.
---------------------------------------------------------------------------

(d) There are extraordinary market conditions or systems problems.
If an order remains in the manual-ex window for more than two
minutes, Exchange staff will be altered and will follow up with the
specialist. If there is no immediate resolution, Surveillance staff
will follow up with the specialist. In any event, a specialist who
violates the two minute limit will first be warned and subsequently
fined.\22\ An order may not remain in a specialist's manual-ex window
after the close of a trading day under any circumstances. At the close
of trading, the P/COAST system notifies the PCX customer service staff
of any orders that are remaining in any specialists' manual-ex windows,
and the staff will then notify the specialist so that appropriate
action can be taken. If there is a rare circumstance in which an order
remains in a specialist's manual-ex window after such notification, due
to oversight or error, P/COAST will purge the order from the manual-ex
window (but will retain a record of it within the system).
---------------------------------------------------------------------------

\22\ Specifically, the Exchange is proposing to modify its Minor
Rule Plan to add new Rule 10.13(i)(13) to the list of rules eligible
for adjudication pursuant to PCX Rule 10.13. The violation will be
codified as: ``Specialist kept an order in the Manual-Ex Window of
P/COAST for more than two minutes (and there is no applicable
exemption to this requirement under Rule 5.25(g)(1)).'' The Exchange
is also proposing to modify its Recommended Fine Schedule to add the
following sanctions for violations of this provision: For the first
five violations, official warnings will be issued; for the sixth
through tenth violations, a fine of $50 (per violation); and for
eleven or more violations, a $100 fine (per violation). Fines for
multiple violations will be calculated on a running one-year basis.
---------------------------------------------------------------------------

d. Contra-Specialist Interaction with Orders. 1. Incoming Market
and Marketable Limit Orders. If an incoming market or marketable limit
order arrives on a specialist's auto-ex window at a time when the
contra specialist is representing an order in the CLOB with priority,
the contra specialist will receive a ``shadow'' notification of the
entry of the new order on the contra specialist's window. Although the
P/COAST system does not permit the contra specialist to interact
directly with the new order, the ``shadow'' message will serve to
notify the contra specialist of the potential execution against the
order with priority that he or she is representing. The shadow message
will disappear from the specialists' auto-ex window after either a 15-
second timedown occurs or the specialist interacts to delete the
message. If an order is taken into the manual-ex window, no shadow
message is generated.\23\ However, if the receiving specialist executes
the order out of time priority sequence, both the contra specialist and
the Exchange's Surveillance Department will be notified of the priority
violation.
---------------------------------------------------------------------------

\23\ Modifying P/COAST to allow the contra specialist to view
orders whenever they are in the receiving specialist's manual-ex
window would not be practical due to technology constraints.
Specifically, there is a difficulty in maintaining synchronization
between the shadow message and the original order due to executions,
cancellations and modifications to the order that may occur while it
is in the manual-ex window. Accordingly, as an alternative to such a
modification of P/COAST, the Exchange intends to place a limit on
the amount of time certain orders may remain in the manual-ex
window, as discussed above.
---------------------------------------------------------------------------

2. View of CLOB. The CLOB's Limit Order Display Widow allows
specialists to view summaries of limit orders residing in the CLOB.
Currently, a specialist can view limit orders that the contra
specialist represents only to the extent they are priced at or better
than the primary market. The PCX intends to effect a systems change
\24\ to allow all specialists in an issue to view summaries of all
orders in the CLOB via the Limit Order Display Window.
---------------------------------------------------------------------------

\24\ The Exchange intends to implement all of the system changes
referred to in this filing within one year from the date that the
Commission approves this filing.
---------------------------------------------------------------------------

3. Executing Orders in CLOB. The CLOB does not currently permit a
specialist unilaterally to execute an order being represented by a
contra specialist. If a specialist seeks to execute an order
represented by the contra specialist, the specialist must contact the
contra specialist (generally by telephone) and vocalize a bid or offer.
The contra specialist may then execute one or more orders on the other
specialist's behalf by typing in that specialist's acronym and pressing
the ``execute'' key. The Exchange's ``firm quote'' rule would require
the contra specialist to effect an execution for the other specialist's
account upon that other specialist's request.\25\
---------------------------------------------------------------------------

\25\ See PCX Rule 5.8(c).
---------------------------------------------------------------------------

The Exchange intends to modify P/COAST to allow a specialist to
have direct electronic access to orders represented by a contra
specialist. The change will allow the specialist to send an electronic
order to the contra specialist that may execute against any order being
represented by the contra specialist. Once an order is sent, the contra
specialist will be notified electronically. The order that has been
sent will be executed after a 15-second time-down, unless the contra
order has already been executed. If the order that has been sent is not
executed, it will expire after the 15-second time-down

[[Page 22894]]

and the specialist who entered the order will be notified
electronically.
e. Out of Priority Executions. The P/COAST system has been designed
to prevent orders from being executed out of time priority sequence, or
in cases where they are not electronically prevented, to report the
violation to the contra specialist and the Exchange's Surveillance
Department. Specifically, if either specialist elects manually to
execute a limit order out of priority sequence, the Exchange's
Surveillance Department will receive a report of the time or price
priority violations. The contra specialist will also receive a report
of the violation, if the contra specialist is representing a limit
order that had priority over an executed limit order.
The CLOB currently has a ``global execution'' feature that allows a
specialist to execute multiple orders simultaneously, including all
orders at a specific price that the specialist is representing.
However, the Exchange intends to modify its existing ``global
execution'' feature so that its use will not result in multiple
executions that are out of priority sequence. The P/COAST system also
currently has a function (the ``Control Execute E'' function) that
allows a specialist to execute a manual order ahead of an order in the
CLOB that does not have priority. It was designed, initially, to
provide specialists with greater flexibility to execute orders when
there are system problems and errors to be resolved. The Exchange
surveils all use of the function to detect any priority rule
violations. The Exchange now believes that the function is superfluous
and intends to disable it.
With the change to the Global Execution function and the
elimination of the Control-E function, specialists will be unable to
execute individual orders in the CLOB out of priority sequence, and
will be unable to execute orders for their own accounts ahead of orders
in the CLOB. If there is a limit order in the CLOB with priority, the
modified system will not allow another order in P/COAST to be executed
ahead of it.
In rare circumstances, some orders in the P/COAST system can be
executed out of priority sequence, but only if there are no orders with
priority in the CLOB. If multiple orders are being represented by one
or more specialists in the auto-ex or manual-ex windows, they may not
be executed in the same sequence in which they were received, although
they will generally be executed within seconds of one another.
The Exchange notes that whenever orders in P/COAST are executed out
of priority sequence, a surveillance report will be generated (although
this may depend on certain time parameters). Moreover, to prevent such
out-of-priority executions from occurring in the first place, the
Exchange is proposing to modify P/COAST to provide a shadow message to
a specialist whenever an order is taken into a contra specialist's
manual-ex window. Currently, the contra specialist receives a shadow
notification when the other specialist receives an order in his or her
auto-ex window that could execute against a limit order with priority
in the CLOB that the contra specialist is representing.
Moreover, the Exchange believes that specialists currently have
little or no incentive to use their manual-ex windows to hide orders
from their contra specialists, and that there are financial incentives
for not doing so. For example, assume the NBBO is 19\7/8\-20\1/8\. If
Specialist A is representing a limit order to buy stock at $20 but does
not quote it and places it in the manual-ex window, and if Specialist
B, in the meantime, executes a sell order in the same stock at 19\7/8\.
Specialist A will be obligated to execute the buy limit order and can
only cover the position at a worse price.\26\
---------------------------------------------------------------------------

\26\ The Exchange acknowledges that the Commission's ``Display
rule,'' 17 CFR 240.11Ac1-4, requires PCX specialists to ``publish
immediately'' certain bids and offers as specified in subsection
(b)(1)(i)-(ii) of that Rule.
---------------------------------------------------------------------------

f. Impact of OptiMark. In January 1999, the Exchange implemented
the PCX Application of the OptiMark System.\27\ Orders in the CLOB may
be placed in the OptiMark System for a potential match against an
OptiMark profile. If an order in the CLOB matches against an OptiMark
profile, then the Exchange anticipates that in most instances, the
response will occur in less than 3 seconds. The system has been
designed so that in no event will an order be delayed for more than 12
seconds.
---------------------------------------------------------------------------

\27\ See generally Securities Exchange Act Release No. 39086
(September 17, 1997), 62 FR 50036 (September 24, 1997); see also
Securities Exchange Act Release No. 40551 (October 14, 1998), 63 FR
56282 (October 21, 1998) (order approving PCX rule requiring PCX
specialists to ensure that their best bids and offers will be
represented in the OptiMark System).
---------------------------------------------------------------------------

g. Emergency Deactivation of CLOB. The CLOB has been designed to
allow Floor Operations staff to deactivate the combined book
functionality for the entire Exchange. This feature is intended to be a
systems safeguard. The Exchange does not anticipate deactivating the
CLOB in the absence of highly unusual circumstances such as a disaster
or other situation where the Exchange's mainframe computers go out of
synchronization.
H. Rule Text Changes. The Exchange is proposing to modify the text
of the rules on equities trading in several respects so that they will
be consistent with the operation of the CLOB. First, the proposal would
codify new PCX Rule 5.25(g), entitled ``Consolidated Limit Order
Book,'' which provides that incoming Equity orders entered into the
Exchange's P/COAST trading system will be maintained in and executed
through the CLOB, that incoming market and marketable limit orders are
immediately executed against orders in the CLOB based on price and time
priority once they have been displayed for possible price improvement,
and that incoming orders other than market and marketable limit orders
will be maintained in the CLOB, but represented by a particular PCX
specialist.
Second, the Exchange is proposing to change several rules by adding
references to the CLOB in place of references to individual
specialist's books.\28\ For example, while Rule 5.33(b) currently
refers to placing orders in a specialist's book, the Exchange is
proposing to change it so that it refers to placing orders in the CLOB.
---------------------------------------------------------------------------

\28\ These include amendments to PCX Rule 5.8(a) (priority rules
applicable to orders received from the other floor for entering in
the specialist's book and order handing procedure for situations
where a security is traded on both floors); Rule 5.8(c) (general
rule on priority of bids and offers); Rule 5.29(d) (rule on
disclosure of information respecting orders in a specialist's
custody); Rule 5.31(b)(1) (procedures to follow when a specialist
suspends trading of a security); Rule 5.32(b)(1) (procedure for when
a specialist has on order in the book and guarantees the primary
market price on a partial of a multiple order); Rule 5.33(b)
(prohibition of specialists' placing orders in the book for accounts
in which they or their firms are interested); Rule 5.33(g)
(condition under which specialists may stop stock for their own
accounts); and Rule 5.33(h) (prohibition on specialist making a
transaction for its own account that puts into effect a stop order
in the book).
---------------------------------------------------------------------------

Third, the Exchange is proposing to eliminate certain references in
the rules to ``Floors'' to make those rules consistent with the
operation of the CLOB.\29\ For example, in Rule 5.8(a) the Exchange is
replacing the phrase ``where a security is traded on both floors'' with
the phrase ``where a security is traded by more than one specialist.''
Likewise, the phrase ``regardless of the floor'' in Rule 5.8(c) would
be eliminated as superfluous. These changes are being proposed to
clarify that the location of orders will be

[[Page 22895]]

in the CLOB rather than on a particular floor.
---------------------------------------------------------------------------

\29\ These include amendments to Rule 5.8(a); Rule 5.8(c); Rule
5.29(d); Rule 5.30(b) (specialist's duty to coordinate markets);
Rule 5.31(b)(1)-(2); and Rule 5.32(b)(3) (confirmation price when a
specialist guarantees Primary Market Protection on a portion of
multiple orders).
---------------------------------------------------------------------------

Fourth, the Exchange is proposing to eliminate Rule 5.30(c), which
provides that whenever a specialist's market or the market on his
respective floor equals or betters a competitive market, that
specialist will immediately inform the specialist on the other floor,
if technically possible. PCX believes that this rule is unnecessary
because the CLOB allows specialists to view orders being represented by
the contra specialist.
Fifth, the Exchange is proposing to replace the text of Rule
5.30(d), which currently requires a specialist to notify the specialist
on the floor it has received an order so that the receiving
specialist's order can have standing on the other specialist's
floor.\30\ As modified, proposed Rule 5.30(d)(1) would provide that
specialists holding ``manual orders''--meaning orders provided to the
specialist by a floor broker--must notify other specialists trading the
same security to obtain standing with the other specialists. Proposed
Rule 5.30(d)(2) would provide that a specialist may not execute orders
at or through (inferior to) the limit price of orders in the CLOB or
other limit orders in P/COAST that another specialist is representing
(i.e., orders in the other specialist's manual-ex window or auto-ex
window), without those limit orders first being filled. Proposed Rule
5.30(d)(3) would provide that if a specialist representing manual
orders or orders in P/COAST fails to notify the contra specialist of
such orders, and the contra specialist executes a transaction at or
through the limit price of those orders, the specialist who failed to
notify the contra specialist will be required to execute those orders.
A specialist will be deemed to have notified the contra specialist of
orders in P/COAST if they are being represented in the CLOB.
---------------------------------------------------------------------------

\30\ As currently written, the rule also provides that if the
specialist on one floor fails to notify the specialist on the other
floor of orders in his book and if transactions take place on the
other floor at or through the limit price of such orders, the
specialist failing to notify the specialist on the other floor will
be responsible for an execution of the orders in his book.
---------------------------------------------------------------------------

Sixth, the Exchange is proposing to eliminate Rule 5.33(c), which
provides that no specialist on one floor may place orders for any
account in which he or his firm or any participant therein is directly
or indirectly interested in the book of the specialist on the other
floor in any security in which he is registered as specialist. The
Exchange believes that this rule is overly broad and inconsistent with
the Exchange's proposal, discussed above, to permit specialists to send
orders that would execute against orders being represented by the
contra specialists after a 15-second time-down. The Exchange also
believes that this rule is unnecessary because PCX Rule 4.5 prohibits
specialists from placing orders in the book ahead of customer orders.
Finally, the Exchange is proposing to eliminate Rule 5.33(g), which
provides that a specialist may stop stock in his own book for his own
account only when he is making the highest bid or the lowest offer and
if the difference between the bid and offer is more than one applicable
trading differential, in which case he may stop stock for his own
account in his own book up to 50 percent of the number of shares bid
for or offered in his book. The Exchange believes that this rule is
both inconsistent with the operation of the CLOB and currently serves
on legitimate purpose.
(2) Basis
The Exchange believes the proposed rule change is consistent with
Section 6(b) of the Act,\31\ in general, and furthers the objectives of
Section 6(b)(5),\32\ in particular, in that it is designed to perfect
the mechanisms of a free and open market, to promote just and equitable
principles of trade, to facilitate transactions in securities, and in
general, to protect investors and the public interest. Specifically,
the proposal is intended to promote just and equitable principles of
trade by facilitating the execution of customer orders promptly and in
order of priority. The proposal will facilitate transactions in
securities by automating the trading process for specialists, in
general, and by eliminating the need for PCX specialists to manually
match incoming orders against limit orders with priority that are
represented by another specialist. The proposal will protect investors
and the public interest by ensuring that their orders will be processed
efficiently, in accordance with Exchange rules, and in accordance with
the needs and expectations of PCX customers. Finally, the proposal will
ensure that PCX members will be appropriately disciplined for
violations of PCX rules, as required by Section 6(b)(6) of the Act.\33\
---------------------------------------------------------------------------

\31\ 15 U.S.C. 78f(b).
\32\ 15 U.S.C. 78f(b)(5).
\33\ 15 U.S.C. 78f(b)(6).
---------------------------------------------------------------------------

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.

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

Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve such proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.

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, 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 the PCX. All submissions should
refer to File No. SR-PCX-99-06 and should be submitted by June 25,
1999.

[[Page 22896]]

For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\34\
---------------------------------------------------------------------------

\34\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-10671 Filed 4-27-99; 8:45 am]
BILLING CODE 8010-01-M

Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Pacific Exchange, Inc. Relating to a Consolidated Limit Order Book for Equity Securities

Federal Register Citation

Suggested Web Citation