Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Pacific Exchange, Inc. Relating to Market Maker Surcharges

[Federal Register Volume 64, Number 154 (Wednesday, August 11, 1999)]
[Notices]
[Pages 43805-43807]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-20633]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41699; File No. SR-PCX-99-15]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to Market Maker 
Surcharges

August 3, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act''),\1\ notice is hereby given that on June 
1, 1999, the Pacific Exchange, Inc. (``PCX'' or ``Exchange'') filed 
with the Securities and Exchange Commission (``Commission'' or ``SEC'') 
the proposed rule change as described in Items I, II, and III below, 
which Items have been prepared by PCX. On June 25, 1999, and July 16, 
1999, the PCX filed with the Commission Amendment Nos. 1 and 2, 
respectively, to the proposed rule change.\2\ The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ In Amendment No. 1, the Exchange removed a provision that 
permitted the Options Floor Trading Committee (``OFTC'') to delegate 
responsibility and corrected a typographical error. See letter from 
Michael D. Pierson, Director, Regulatory Policy, PCX, to Michael A. 
Walinskas, Associate Director, Division of Market Regulation 
(``Division''), Commission, dated June 24, 1999 (``Amendment No. 
1''). In Amendment No. 2, the Exchange corrected a typographical 
error. See letter from Michael D. Pierson, Director, Regulatory 
Policy, PCX, to Michael A. Walinskas, Associate Director, Division, 
Commission dated July 15, 1999 (``Amendment No. 2'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The PCX is proposing to amend its rules to adopt a one-year pilot 
program under which the Exchange will impose a fee on Market Makers for 
contracts traded by Market Makers in particular option issues. The fee 
will be used to reduce order book execution charges on the PCX. Below 
is the text of the proposed rule change. Proposed new language is in 
italic.
* * * * *

RULE 16.1

RATES AND CHARGES

Market Maker Surcharge for Customer Rate Reduction

    Rule 16.1(a) Definitions
    (1) Resident Market Maker. A Resident Market Maker in a particular 
issue of options is a Market Maker who transacted at least 80% of his 
or her market maker contracts in option issues traded in the trading 
crowd where the particular option issue is traded in the prior calendar 
month.
    (2) Standard OBO Rate. The Standard OBO Rate is any rate for Order 
Book Official (``OBO'') floor brokerage established by the Exchange for 
the particular equity option issue traded on the Exchange Floor, other 
than pursuant to this Rule.
    (3) Standard Market Maker Fees. Standard Market Maker Fees are the 
total market maker fees established by the Exchange for the particular 
option issue other than any fees implemented pursuant to this Rule.
    (4) Market Maker Surcharge. The Market Maker Surcharge is the 
amount of the fee, not to exceed 25 cents per contract, that the 
Exchange may impose on Market Makers for a particular issue of option 
pursuant to this Rule that is in addition to the Standard Market Maker 
Fees for the option issue.
    (b) Generally.
    (1) The Options Floor Trading Committee (``OFTC'') may impose a 
Market Maker Surcharge for transactions in a particular issue of 
options, which Surcharge will be imposed on a per contract basis for 
every contract traded by every Market Maker, whether in-person or by 
order, in that option issue during the period for which the Market 
Maker Surcharge is in effect.
    (2) In imposing the fee, the OFTC will consider the vote of the 
Resident Market Makers for a particular option issue, as described in 
paragraph (d) of this Rule. In addition, the OFTC will consider the 
views of any Market Maker in favor of or opposed to the recommended 
Surcharge or in favor of some other Surcharge amount. The OFTC will 
provide notice of its meeting schedule for the consideration of the 
Market Maker Surcharge and the deadline for the submission of other 
materials for its consideration. The OFTC will determine the manner in 
which it will review the submitted materials and whether it will allow 
personal appearances before the OFTC. A decision of the OFTC may be 
appealed to the Exchange's Board of Appeals Committee pursuant to Rule 
11; however, the Surcharge will be

[[Page 43806]]

effective until the matter has completed the Exchange's review process. 
The OFTC through authority delegated by the Board of Governors will 
submit a rule filing pursuant to Section 19(b)(3) of the Exchange Act 
before the implementation of any new Surcharge or any change in the 
Surcharge or change in the OBO rate made pursuant to this Rule.
    (3) The Market Maker Surcharge will be used to reimburse the 
Exchange to the extent the OFTC reduces the OBO brokerage rate 
applicable to the particular option issue below the standard OBO Rate 
pursuant to paragraph (g) of this Rule. Any amount remaining after the 
Exchange has been reimbursed will be refunded to each Market Maker who 
paid the Surcharge in that issue (on a pro rata basis). The Market 
Maker Surcharge generally will be assessed after the end of the month 
in which transactions on which the Market Maker Surcharge was based 
occurred.
    (c) Time Period. The Market maker Surcharge generally will be 
instituted for a minimum period of one month.
    (d) Vote to Recommend a Market Maker Surcharge Amount.
    (1) Any Resident Market Maker may recommend a Market Maker 
Surcharge amount by the Friday prior to the vote or by any other time 
and date required by the OFTC. The vote of the Resident Market Makers 
to recommend the Surcharge will take place at the trading post where 
the applicable option issue is traded on the Tuesday of expiration week 
for equity options, or on any other day selected by the OFTC. The OFTC 
must provide 24 hour notice of the time and date of the vote to the 
trading crowd if the vote is to be held at a different time or on a 
different day. The OFTC will determine how the vote will be conducted. 
Any Resident Market Maker personally present at the trading post when 
the vote is conducted may vote on the amount of the Surcharge to be 
recommended. The Order Book Official at the particular trading post 
will conduct the vote.
    (2) Each Resident Market Maker's vote will be weighted equally.
    (3) Any Surcharge amount that receives a majority of the votes cast 
will be the Surcharge recommended to the OFTC. If any Surcharge amount 
does not receive a majority on the first ballot, the OBO may conduct 
subsequent ballots with the proposed Surcharges received the most votes 
or may solicit Resident Market Makers for other proposed Surcharge 
amounts.
    (c) Option Issues. The OFTC may specify those option issues on 
which a Surcharge may be assessed pursuant to paragraph (b) of this 
rule. In no event may the OFTC permit a Surcharge to be assessed on an 
issue that is not also listed for trading on at least one other options 
exchange. In addition, the Surcharge may not be assessed for an option 
issue that has been allocated to a Lead Market Maker.
    (f) Book Brokerage Rates. The OFTC may reduce the Exchange's OBO 
Rate for a particular option issue below the Standard OBO Rate upon a 
recommendation of the Resident Market Makers pursuant to the terms of 
the vote in paragraph (d). In determining to reduce the OBO brokerage 
rate, the OFTC will consider not only the vote of the Resident Market 
makers, but also the views of any other Floor Broker or Market Maker 
who submits views to the OFTC pursuant to the published schedule for 
such submissions. Notice of the hearing, governance of the hearing, and 
all appeal rights will be the same as those set forth in paragraph 
(b)(ii) of this Rule. If the OFTC determines to reduce the OBO 
brokerage rate below the Standard OBO Rate, the Exchange will make the 
appropriate filing as required by the Exchange Act. To the extent the 
OFTC reduces the OBO brokerage rate below the Standard OBO Rate, any 
Market Maker Surcharge will be sued to reimburse the Exchange for the 
difference pursuant to paragraph (b)(iii). If the Exchange determines 
on its own initiative, otherwise than pursuant to this Rule, to lower 
the Standard OBO Rate for a particular equity option issue, the Market 
Maker Surcharge will not be used to reimburse the Exchange for such 
reduction.
    (g) Pilot Program. This Rule will be in effect as a pilot program 
until one year from [date of SEC approval of this Rule.]
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis or, the Proposed Rule Change

    In its filing with the Commission, PCX included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. PCX has prepared summaries, set for in Sections A, B, 
and C below, of the most significant aspect of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Background. Many options traded on the PCX are traded in crowds 
where the quotes are established by competing Market Makers.\3\ In the 
PCX's competing market maker crowds, the agency function is performed 
by OBOs, who are PCX employees, and Floor Brokers. An OBO maintains the 
limit order book in reach option issue. Only non-broker/dealer customer 
orders may be placed with an OBO.\4\ Orders that cannot be placed with 
an OBO must be manually represented in the trading crowd. Other 
exchanges, such as the American Stock Exchange and Philadelphia Stock 
Exchange, have a specialist system whereby specialists can serve both 
the agency and principal functions. At the Chicago Board Options 
Exchange (``CBOE''), certain issues are traded by Designated Primary 
Market Makers (``DPMs''), who can also serve both functions.\5\
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    \3\ Other options on the PCX are traded in a Lead Market Maker 
(``LMM'') system. The LMM functions in approved option issues as a 
market and, for those LMMs participating in the LMM Book Program, in 
the place of the Order Book Official (``OBO''). See PCX Rule 6.82; 
Securities Exchange Act Release No. 40548 (October 14, 1998) 63 FR 
56283 (October 21, 1998). This proposal will apply to option issues 
traded by market maker trading crowds, but will not apply to issues 
traded by LMMs.
    \4\ See PCX Rule 6.52(a).
    \5\ The proposal is similar to a recent CBOE rule change. See 
Securities Exchange Act Release No. 41121 (February 26, 1999) 64 FR 
11523 (March 9, 1999). At the CBOE, like the PCX, some, but not all 
option issues are traded by market maker trading crowds (and are not 
traded under the DPM or LMM system).
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    As a result of the differences between competing market maker 
crowds and specialist and DPM systems, the OBO's rates at the PCX 
compete with rates charged by specialists and DPMs at other exchanges 
with respect to orders that can be placed with an OBO. The Exchange 
notes that specialists and DPMs can reduce their book execution rates 
to attract order flow and can offset such reductions through revenue 
they earn from the principal part of their business. Because the PCX's 
non-LMMs (who cannot represent agency orders) lack the flexibility over 
pricing enjoyed by specialists and DPMs at other exchanges, the PCX 
developed the current proposal to allow the PCX and its member firms to 
better compete with other exchanges in order book rates.
    General Description of the Proposal. The Exchange is proposing a 
new PCX Rule 16.1 that would allow the

[[Page 43807]]

Exchange to impose a fee on Market Makers (``Surcharge'') for contracts 
traded by Market Makers in a particular option issue. This fee, not to 
exceed $0.25 per contract,\6\ will be collected by the Exchange and 
will be used to reimburse the Exchange to the extent the OBO brokerage 
rate is reduced if such reduction is based upon a recommendation of the 
Resident Market Makers.\7\ Any remaining amount of the Surcharge 
collected sill then be refunded to each Market Maker who paid the 
Surcharge (on a pro rata basis). The proposed Surcharge would allow the 
PCX to compete with other exchanges based on the respective fee each 
exchange charges a firm to execute an order on the limit order book.
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    \6\ Bids and offers in options series trading below $3 are 
expressed in sixteenths of a dollar, i.e., $0.0625. Because standard 
option contracts have a multiplier of 100 (i.e., they represent 
interest in 100 shares of the underlying security), the value of the 
minimum spread between any option contract listed on the Exchange 
would be $6.25 ($0.0625 times 100). Options priced over $3 have a 
minimum spread of one eighth of a dollar (12.50 value for the 
minimum spread). Thus, the 25-cent cap on the Surcharge will ensure 
that it remains far below the minimum quote increment for options 
trade on the PCX.
    \7\ The proposed defines a ``Resident Market Maker'' as someone 
who transacted at least 80% of his or her market maker contracts in 
option issues traded in the trading crowd in the prior calendar 
month. If the Exchange decides on its own initiative to reduce the 
OBO rate for a particular option issue, then the Surcharge would not 
be used to reimburse the Exchange.
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    How the Surcharge Will be Determined. Under proposed PCX Rule 16.1, 
the OFTC,\8\ under authority delegated to it by the PCX's Board of 
Governors, will determine the issues option for which the Surcharge 
would be assessed as well as what that Surcharge, if any, will be.\9\ 
Any Resident Market Maker can recommend a Surcharge amount. All 
Residents Market Makers then vote on the recommended amounts of the 
Surcharge, with each person having an equal vote. Any amount that 
receives a majority of the votes is the Surcharge amount that is 
recommended to the OFTC, which then decides the actual Surcharge. In 
reaching its decision, the OFTC must consider the vote of the Resident 
Market Makers and the views of any Market Maker in favor of or opposed 
to the recommended Surcharge.\10\ The OFTC is not bound, however, to 
follow the Resident Market Makers' recommendation. The OFTC is free to 
impose a different Surcharge than the one recommended or to impose no 
Surcharge at all. Any Market Maker may appeal the decision of the OFTC 
to the Exchange's Appeals committee pursuant to PCX Rule 11.7. The 
Surcharge will remain in effect until the appeal has been decided.
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    \8\ Generally, the OFTC consists of 14 members who trade on the 
Options Floor. OFTC members that would be impacted by the Surcharge 
would be required to recuse themselves from that vote.
    \9\ The proposal is limited, however, to option issues that are 
multiply traded, and does not include LMM option issues. As of May 
28, 1999, approximately 800 standard equity options are traded on 
the PCX, and of those, approximately 100 would be eligible for 
participation in this pilot program.
    \10\ The OFTC must give notice of its meeting schedule for the 
consideration of the Surcharge and the deadline for the submission 
of other matierals for its consideration.
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    Once the OFTC determines to implement a Surcharge and change the 
OBO fee, it will file a rule proposal with the Commission pursuant to 
Section 19(b)(3)(A) under the Act. After determining to impose or amend 
a Surcharge, the OFTC will notify the PCX Board of Governors at the 
meeting following the determination. Any Surcharge to be paid by the 
Market Makers would be in effect for at least one month to avoid 
disrupting normal Exchange billings and accounting procedures.
2. Statutory Basis
    The PCX believes the proposed rule change is consistent with 
Section 6(b) \11\ of the Act, in general, and furthers the objectives 
of Section 6(b)(5) \12\ in particular, because it is designed to 
facilitate transactions in securities, perfect the mechanism of a free 
and open market and a national market system, and to protect investors 
and the public interest.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

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

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

    Within 35 days of the 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 the 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 at the 
Commission's Public Reference Room. Copies of such filing also will be 
available for inspection and copying at the principal office of PCX. 
All submissions should refer to File No. SR-PCX-99-15 and should be 
submitted by September 1, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-20633 Filed 8-10-99; 8:45 am]
BILLING CODE 8010-01-M