[Federal Register Volume 61, Number 198 (Thursday, October 10, 1996)]
[Notices]
[Pages 53247-53253]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-26013]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37780; File No. SR-PSE-96-03]
Self-Regulatory Organizations; Pacific Stock Exchange, Inc.;
Order Approving and Notice of Filing and Order Granting Accelerated
Approval of Amendment Nos. 1 and 2 to Proposed Rule Change Relating to
the Lead Market Maker Program
October 3, 1996.
I. Introduction
On January 16, 1996, the Pacific Stock Exchange, Inc. (``PSE'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposal relating to changes to its Lead Market Maker (``LMM'')
Program. The proposed rule change was published for comment in the
Federal Register on March 18, 1996.\3\ The Exchange filed an amendment
(``Amendment No. 1'') \4\ to its proposal on August 11, 1996. The
Exchange filed a second amendment (``Amendment No. 2'') \5\ to its
proposal on September 26, 1996. No comments were received on the
proposed rule change. This order approves the Exchange's proposal as
amended.
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\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 36952 (March 11,
1996), 61 FR 11072.
\4\ Amendment No. 1 provides further justification and rationale
for the PSE's proposed changes to the LMM Rule. Amendment No. 1 also
provides revised language to the proposed Rule 6.82 changes. Letter
from Michael D. Pierson, Senior Attorney, Regulatory Policy, PSE, to
Michael A. Walinskas, Senior Special Counsel, Office of Market
Supervision, Division of Market Regulation, Commission, dated August
9, 1996.
\5\ Amendment No. 2, like Amendment No. 1, provides further
justification and rationale for the PSE's proposed changes to the
LMM Rule and provides revised language to the proposed Rule 6.82
changes. Letter from Michael D. Pierson, Senior Attorney, Regulatory
Policy, PSE, to Janet Russell-Hunter, Special Counsel, Office of
Market Supervision, Division of Market Regulation, Commission, dated
September 26, 1996.
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II. Description of the Proposal
PSE Rule 6.82 (``LMM Rule'') sets forth the basic rules and
procedures applicable to LMMs and the LMM Program.\6\ The Exchange
proposes to modify Rule 6.82 by adding several new substantive
provisions and by restructuring the rule and clarifying some of its
existing provisions. The purpose of the proposal is to enhance the LMM
Program and to clarify and streamline the LMM Rule. The proposed
changes include, more specifically, the following:
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\6\ The LMM Rule was adopted in January 1990 as a pilot program.
See Securities Exchange Act Release No. 27631 (January 17, 1990), 55
FR 2462. The pilot program most recently was extended to September
30, 1997. See Securities Exchange Act Release No. 37767 (September
30, 1996).
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1. Current PSE Rule 6.82(c)(6) provides that LMMs are guaranteed
50% participation in transactions occurring at their disseminated bids
and offers in their allocated issues. The Exchange is proposing to
create an exception to this provision.\7\ Specifically, with regard to
multiply-traded issues, the proposed rule will provide that if the
average daily trading volume in an issue reached 3,000 contracts at the
Exchange for three consecutive months, and if (i) in the case of an
issue traded by two options exchanges, the Exchange's share of the
total multi-exchange customer trading volume in the issue drops from
above 70% to below 70%, or (ii) in the
[[Page 53248]]
case of an issue traded by three or more options exchanges, the
Exchange's share of the total multi-exchange customer trading in the
issue drops from above 45% to below 45%, the Options Allocation
Committee shall evaluate the LMM's performance in that issue, and,
based on that evaluation, may reduce the LMM's guaranteed participation
in the issue from 50% to 40%. See proposed Rule 6.82(d)(2)(A)-(B).
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\7\ Current Rule 6.82(b)(3)(iii) provides that, subsequent to
appointment of an issue to an LMM, the issue may be reassigned to
the market maker system, pursuant to subsection (b)(7), once trading
volume in the issue reaches an average daily volume of 3,000
contracts at the Exchange for four consecutive months, immediately
preceded by an Exchange average of 75% of the total multi-exchange
trading volume for three consecutive months. The Exchange is
proposing to delete this provision and modify it as discussed below.
It should be noted that both the provision being deleted and the one
replacing it are permissive, not mandatory. See Amendment No. 1,
supra note 4.
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This proposed change is intended to give discretion to the Options
Allocation Committee to reduce an LMM's guaranteed participation when
trading volume levels are sufficiently high and the individual
situation warrants such action. In making these determinations, the
Options Allocation Committee would consider the factors specified in
proposed Rule 6.83(e)(4) regarding evaluation of LMMs, including, among
other things, consideration of the LMM's evaluation conducted pursuant
to Options Floor Procedure Advice (``OFPA'') B-13, and the LMM's
compliance with Exchange rules, including, but not limited to, Rules
6.32 through 6.40 and Article XI, Section 2 of the Exchange
Constitution. The proposal would prompt the Options Allocation
Committee to review the performance of LMMs when issues they trade have
substantial increases in order flow.\8\
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\8\ Amendment No. 1, supra note 4.
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These new provisions assure LMMs that they will continue to retain
some guaranteed participation as long as their performance is adequate.
Thus, they serve as incentives to attract and keep qualified LMMs who
will participate in the LMM Program and offer competitive markets and
services. With respect to issues traded only on the Exchange, the
Exchange believes that the Options Allocation Committee should have the
flexibility to reduce an LMM's guaranteed participation in a high-
volume issue from 50% to 25% if it finds, based upon review of an LMM's
performance, that that issue has reached a high level of trading volume
for reasons other than those for which the LMM is responsible.\9\
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\9\ Amendment No. 1, supra note 5.
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With respect to multiply-traded issues, the proposal would allow
the Options Allocation Committee to take action in situations where an
issue becomes heavily traded at the Exchange, but the Exchange begins
to lose a certain share of order flow to a competing exchange.\10\ In
such situations, if the Options Allocation Committee finds that the LMM
was responsible for the loss of order flow, it would have the ability
to encourage better performance by reducing an LMM's guaranteed
participation.\11\
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\10\ Id.
\11\ The Options Allocation Committee could, of course, also
reallocate the issue to another LMM or to the trading crowd pursuant
to Rule 6.82(f)(1)(A) if the individual situation warranted such
action.
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The Exchange has selected the 40% and 25% figures (rather than
other figures) because they take into account what the Exchange
believes to be an appropriate balance of the factors that would be
considered by the Options Allocation Committee in deciding whether to
reduce an LMM's guaranteed participation. These factors include
compensation to the LMM for taking on the responsibilities of an
LMM,\12\ and the amount of guaranteed participation necessary for the
LMM to compete in multiple trading.\13\
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\12\ See Rule 6.82(c).
\13\ The proposed reductions in guaranteed participation to 25%
in exclusively-traded issues and to 40% in multiply-traded issues
are based on the assumption that in multiply-traded issues, the LMM
requires greater participation to compete for order flow with order
exchanges.
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With regard to the proposed change in the number of months (from
four to three) that must pass before an LMM's guaranteed participation
may be reduced, the Exchange seeks to accelerate the review process so
that appropriate action may be taken more quickly.
2. Commentary .02 to Rule 6.82 currently provides that for an LMM
to be used in any options class opened for trading at the Exchange
before January 1, 1990, such option class must have an average monthly
contract volume for the previous six-month period that ranks that class
in the bottom 20% of class activity for the options floor. It further
provides that any dually-traded options class whose daily contract
volume for the previous calendar year falls below 70% of the total
multi-exchange volume and any options class subject to reallocation
pursuant to OFPA B-13 may be converted to the LMM Program at the
discretion of the Exchange. The Exchange is proposing in Amendment No.
1 to eliminate Commentary .02 because the Exchange believes that all
issues traded in the options floor should be eligible for trading under
the LMM Program.\14\ The Exchange believes that Commentary .02 is
unnecessarily restrictive. To the extent that it precludes LMMs from
trading high volume issues, the Exchange believes that it is
unwarranted based on the Exchange's experience with several high-
volume, multiply-traded issues that are, and have been, successfully
traded under the LMM Program. The Exchange believes that there may be
situations, other than those where reallocation currently is
permissible, where reallocation to an LMM of a non-multiply-traded
issue would be appropriate (e.g. where a trading crowd voluntarily
requests an issue to be reallocated and an LMM offers to make better
markets and to provide better customer service than any other applicant
for the issue). Furthermore, the Exchange asserts that the current
restrictions place the PSE at a competitive disadvantage to other
exchanges. See e.q. CBOE Rule 8.80(a).\15\
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\14\ Amendment No. 1, supra note 4.
\15\ Amendment No. 2, supra note 5.
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The Exchange also is proposing to delete the reference to
Commentary .02 in Rule 6.82(a)(2) because, under the proposal,
Commentary .02 will be deleted.\16\
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\16\ Id.
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3. Under the proposal, if an issue is reallocated from an LMM to a
market maker trading crowd, the market quality and service provided by
the crowd must equal or better that previously provided or guaranteed
by the LMM. Otherwise, the Options Allocation Committee may determine
that the issue revert to the LMM system. See proposed Rule 6.82(f)(2).
4. The proposal would allow the Options Appointment Committee to
designate a cooperative of market makers to act as an LMM in an issue
provided the market makers in the cooperative together maintain a cash
or liquid asset position in the amount required for LMM's, set forth in
current Rule 6.82(c)(8).\17\ A cooperative would consist usually of two
or three Exchange members who must be registered as market makers. They
may not, however, have ``financial arrangements'' with one another as
defined in PSE Rule 6.40, which restricts such members from trading in
the same trading crowd.\18\ This provision further states that
violations of the Exchange Constitution and Rules committed by a market
maker cooperative that is not registered as a broker-dealer may render
each market maker thereof personally liable for
[[Page 53249]]
disciplinary sanctions for such violations.\19\
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\17\ Under the proposal, current Rule 6.82(c)(8) will be
renumbered as Rule 6.82(c)(11) and will continue to require that an
LMM maintain a cash or liquid asset position in the amount of
$100,000 or in an amount sufficient to assume a position of 20
trading units of the security underlying the option the LMM has been
allocated, whichever amount is greater.
\18\ The PSE recently amended its Rule 6.40, Financial
Arrangements of Options Floor Members (formerly, Financial
Arrangements of Market Makers) in Securities Exchange Act Release
No. 37543, (August 8, 1996), 61 FR 42458. See also Discussion
section, infra. at notes 39-42 and accompanying text.
\19\ See proposed Rule 6.82(a)(3).
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The Exchange believes that such cooperatives will serve a useful
function by allowing for greater liquidity in an LMM issue together
with greater accountability and service to customers than might
otherwise be provided if only one member served as LMM in that
issue.\20\
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\20\ Amendment No. 1, supra note 4.
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The Exchange believes that it is appropriate to allow such
cooperatives to serve as LMMs so long as the capital requirements and
customer service requirements of the LMM Rule are met, and the trading
restrictions on members with financial arrangements are satisfied. If
trading conditions were to become unduly complicated, however, the
Options Allocation Committee could rectify the situation by disallowing
more than one member to serve as LMM in that issue.\21\
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\21\ Id.
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5. The Exchange proposes that in the absence of extraordinary
circumstances, as determined by the Options Allocation Committee, no
LMM may be allocated more than 10% of the number of all option issues
traded on the Options Floor. See proposed Rule 6.82(e)(3). The purpose
of this proposed change is to reduce the Exchange's risk in the event
that a member fails or a market break occurs and a number of option
issues would then be required to be reallocated.\22\
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\22\ Id.
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6. The Exchange proposes to replace references to the LMM
Appointment Committee in the current rule with references to either the
Options Allocation Committee or the Options Appointments Committee. See
passim. When Rule 6.82 first was adopted in 1990, it provided for the
LMM Appointment Committee to administer virtually all of the provisions
of the LMM Rule.\23\ In June 1992, however, the Commission approved an
Exchange proposal that, among other things, eliminated the LMM
Appointment Committee, whose functions were assumed by the Options
Allocation Committee and the Options Appointment Committee.\24\ The
current proposal conforms Rule 6.82 to Rules 11.10(a) and 11.10(c).\25\
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\23\ See Securities Exchange Act Release No. 27631, supra note
6.
\24\ See Securities Exchange Act Release No. 20843 (June 19,
1992), 57 FR 28889 (approving File No. SR-PSE-92-07); see also PSE
Rule 11.10(a) (Options Appointment Committee), Rule 11.10(c)
(Options Allocation Committee), and OFPA B-13 (Evaluations of
Options Trading Crowd Performance).
\25\ Amendment No. 1, supra note 4.
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Currently, and as specified in the rule change proposal, the
Options Appointment Committee is responsible for ``qualifying'' LLMs,
i.e., approving their registration as LMMs based on capital
requirements (and other factors). The Options Allocation Committee
currently is responsible for allocating option issues to LMMs,
evaluating LMM performance, and, if necessary, reallocating issues
traded by LMMs. In addition, the Exchance notes that the Market
Performance Subcommittee of the Options Floor Trading Committee
currently is responsible for evaluating the performances of LMMs on a
case by case basis when relevant issues arise, and making
recommendations to the Options Allocation Committee on those
issues.\26\
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\26\ Id.
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7. The proposal specifies that each LMM must designate an approved
LMM to act as a substitute LMM (in case the designated LMM is unable to
perform its duties), and notify Book Staff of such designation. See
proposed Rule 6.82(c)(5). The term ``substitute LMM'' refers to a
member who agrees to act for an LMM on a temporary basis when the
registered LMM is unable to be present throughout a trading day.
Substitute LMMs, agree to assume all of the registered LMM's duties as
LMM. They must previously have been approved by the Options Appointment
Committee and must currently meet all other requirements of the LMM
Rule, including capital requirements.\27\
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\27\ Id.
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8. Rule 6.82(b)(8) currently provides that if an issue is
reallocated pursuant to subsection (b)(7), the LMM shall receive an
award of compensation based upon time of service, performance, capital
commitment, and trading volume in the subject option issue. It further
provides that this award shall not exceed two years. The Exchange
proposes to change the term ``shall'' in that provision to ``may.'' See
proposed Rule 6.82(f)(3). The Exchange believes that situations may
arise where an issue is reallocated and the LMM should not be entitled
to any compensation (e.g., due to lack of performance). Given that the
current rule is sufficiently vague that its requirements could be
satisfied by providing an LMM with nominal compensation, the Exchange
believes that the proposed change is relatively insignificant.\28\
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\28\ Id.
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In addition, in Amendment No. 1, the Exchange is proposing to
change the reference to subsection (f)(2) contained in subsection
(f)(4) to a reference to subsection (f)(1), because the Exchange notes
that an award of compensation may be appropriate in any of the
circumstances set forth in subsection (f)(1). The Exchange notes that
under Amendment No. 1, subsection (f)(2) will be deleted.
9. The Exchange proposes to simplify the current provisions
concerning appeals from Options Allocation Committee or Options
Appointment Committee decisions so that in all cases such appeals are
governed by Rule 11,\29\ and, during such appeals, the Options
Allocation Committee shall appoint an interim LMM or trading crowd
until such appeal has been resolved. See proposed Rule 6.82(g). The
Exchange believes that such decisions are not disciplinary in nature
and that such appeals are more properly addressed by Rule 11 relating
to appeals of committee decisions, rather than Rule 10, which relates
to appeals of disciplinary decisions.
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\29\ PSE Rule 11 concerns generally committees of the Exchange.
PSE Rule 11.7 concerns hearings and review of committee action.
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10. The proposal would remove a provision requiring that LMM issues
be traded in an area of the trading floor that is separate from other
issues. See current Rule 6.82(a)(2). The Exchange does not believe that
segregated areas for market maker and LMM trading posts should be
required because the integration of LMMs with market maker trading
crowds allows for greater competition and liquidity. In addition, with
the limited amount of space on the trading floor, the Exchange needs
maximum flexibility when it is necessary to move an issue to a new
location on the floor. The Exchange also intends to allow individual
members to trade issues as LMMs while continuing to trade other issues
as market makers in various locations on the floor.\30\
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\30\ Amendment No. 1, supra note 4.
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11. Proposed Rule 6.82(c)(2) states that each LMM is obligated to
honor guaranteed markets, including markets required by Rule 6.86 \31\
and any better market pledged during the allocation process. The term
``better market pledged'' refers to the market depth or width that an
applicant for a new issue agrees to provide if the Options Allocation
Committee allocates that issue to that applicant. The Options
Allocation Committee considers such pledges when choosing among
applicants for allocations of new option issues. The rule change merely
[[Page 53250]]
reinforces the obvious requirements that LMMs must honor those
pledges.\32\
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\31\ PSE Rule 6.86 states that non-broker-dealer customer orders
are entitled to a guaranteed minimum of twenty option contracts at
the bid or offering prices being disseminated at the time the order
is represented at the designated trading post.
\32\ Amendment No. 1, supra note 4.
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12. The Exchange proposes to replace existing language in Rule
6.82(b)(10), which currently states that the ``Committee'' \33\ may
perform all functions of the Market Performance Committee of the Board
of Governors under the PSE rules with respect to review and evaluation
of the conduct of LMMs in the classes of their LMM appointment.
Instead, proposed Rule 6.82(e)(4) states that the Options Allocation
Committee shall monitor and evaluate the performance of LMMs with
regard to quality of markets. This will continue to be done at lease
semiannually. In reviewing and evaluating an LMM`s performance, the
Options Allocation Committee will consider, among other things, OFPA B-
13, and the LMM's compliance with Exchange rules, including, but not
limited to, Rules 6.32 through 6.40 and Article XI, Section 2 of the
Exchange Constitution. The Exchange notes that the reference to the
Market Performance Committee should be deleted because that entity has
been replaced by the Exchange's Board Oversight Committee.\34\
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\33\ Securities Exchange Act Release No. 30843, supra note 24.
\34\ Amendment No. 1, supra note 4.
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13. Rules 6.82(b)(4) and (b)(9)(ii) currently provide that an LMM
who is the subject of ``Committee'' \35\ review in connection with the
termination of an LMM appointment will be advised of the review and,
upon receipt of such notification, shall have ten (10) business days in
which to submit a written statement for the consideration of the
Committee, and that formal rules of evidence do not apply to these
proceedings.\36\
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\35\ Securities Exchange Act Release No. 30843, supra note 24.
\36\ Amendment No. 1 supra note 4.
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The Exchange proposes to delete this provision on the ground that
it unnecessarily restricts the Options Allocation Committee, which may
need to act promptly in reallocating issues, or the Options Appointment
Committee, which may need to act quickly in disqualifying an LMM. The
Exchange believes that these committees ought to have the ability to
reallocate issues or disqualify LMMs in the normal course of business,
and that no special procedures should be required, as is the case with
virtually all other actions of committees.
14. In Amendment No. 1, the Exchange is proposing to modify Rules
6.82(b)(3) and 6.82(c)(13) so that members will be required to notify
the Exchange, rather than specific committees (as stated in the
original proposal), when certain events occur (i.e. notice of an LMM's
resignation or notice of a material financial, operational or personnel
change to the LMM). The Exchange believes that this change will make
administration of the relevant rule provisions more efficient. The
Exchange also is proposing to eliminate the phrase ``as determined by
the Options Appointment Committee'' from the text of proposed Rule
6.82(f)(1)(B) because under that rule, determinations may be made
either by the Options Appointment Committee or the Options Allocation
Committee, depending upon the issue or circumstances. The Exchange will
assure that any such notices will be forwarded to the appropriate
Committee.
15. Rule 6.82(b)(7)(ii) currently provides that the use of an LMM
in a particular option may be discontinued if ``it is * * * determined,
considering all the facts and circumstances, that the trading in a
particular option class would be better accommodated by the
introduction of, or return to, the market maker system without an LMM.
An LMM so affected shall be required to terminate his appointment in no
fewer than three (3) business days subsequent to his receipt of written
notice from the Exchange.'' The Exchange believes, based on its
evaluation of the LMM Program over the past several years, that this
vague provision is unnecessary for the operation of the LMM
Program.\37\
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\37\ Id.
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16. In Amendment No. 1, the Exchange is proposing to modify OFPA B-
13 to provide expressly that all of the rules and procedures applicable
to the semiannual evaluations of options trading crowd performance will
also apply to evaluations of LMM performance. This change would codify
an existing practice of the Options Allocation Committee. As stated in
the rule change, trading crowds are compared with other trading crowds
and LMMs are compared with other LMMs for determining which trading
crowds and which LMMs rank in the bottom 10% of the floor, thereby
subjecting them to the remedial action specified in subsection (a) of
OFPA B-13. In addition, the Exchange is proposing to modify subsection
(i) of OFPA B-13 so that appeals of remedial action taken by the
Options Allocation Committee will be governed by Rule 11.7 (``Hearing
and Review of Committee Action''), rather than by Rule 10.11(d), which
relates to appeals of disciplinary decisions.
17. The Exchange is proposing to eliminate the requirement in
current Rule 6.82(c)(3) that the LMM disclose to the trading crowd the
elements of any formula the LMM uses for automatically updating market
quotations. The Exchange believes that this provision is unnecessary
because the Exchange has a longstanding policy that any member who
wants to know what formula is being used for automatically updating
quotations in an issue can simply ask the Order Book Official, and he
or she will provide the information to that member. The Exchange
believes that this policy improves upon the existing rule, which is not
specific as to when, or to whom the formula must be disclosed.
18. In Amendment No. 2, the Exchange is proposing to strike the
words ``dually-traded or'' from Rule 6.82(d)(2)(A) because they are
superfluous.\38\ The Exchange also is replacing the term ``exclusively-
traded'' in proposed Rule 6.82(d)(2)(B) with the term ``non-multiply-
traded.''\39\ Finally, the Exchange proposes to restructure the rule,
eliminate superfluous provisions, and make other revisions that would
clarify the current text of the Rule. See passim.
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\38\ Amendment No. 2, supra note 5.
\39\ Id.
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III. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, with Section 6(b)(5) of the Act, in that the proposal is
designed to protect investors and the public interest. The Commission
finds generally that the proposed changes to the PSE's LMM Program may
continue to enhance the market making mechanism at the PSE, thereby
improving the market for listed options on the Exchange. Specifically,
the Commission finds as follows:
1. The Commission believes that the Exchange's proposal to provide
the Options Allocation Committee with the discretion to reduce an LMM's
guaranteed participation in a dually- or multiply-traded issue from 50%
to 40%, and, in a non-multiply-traded issue, from 50% to 25%, if
certain volume levels are reached, is consistent with the Act.
The Commission agrees with the Exchange that once sufficient volume
in an LMM issue has been developed it may be appropriate to undertake
such action. The Commission also notes that with respect to multiply-
traded issues,
[[Page 53251]]
the Exchange proposal would provide for such reductions only if the
Exchange's share of trading volume fell below certain thresholds. The
Commission notes that in making the determination whether to reduce an
LMM's guaranteed participation, the Options Allocation Committee will
consider factors such as the LMM`s evaluation conducted pursuant to
OFPA B-13, and the LMM's compliance with Exchange rules, including, but
not limited to, Rules 6.32 through 6.40 and Article XI, Section 2 of
the Exchange Constitution.\40\ The Commission also notes that these
provisions are permissive, not mandatory.
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\40\ Amendment No. 1, supra note 4.
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The Commission finds that the distinction the Exchange makes
between multiply-traded issues and non-multiply-traded issues is
reasonable. As noted by the Exchange, this distinction, is intended to
provide an LMM with greater participation for multiply-traded issues,
given that it will be competing for order flow with other exchanges. As
further noted by the Exchange, when an issue traded only on the
Exchange reaches a high level of trading volume, there should be
flexibility to reduce the LMM's guaranteed participation where the
issue has reached high trading volume for reasons other than those
attributable to LMM performance.
The Commission also finds that the change from four to three as the
number of months that must pass before an LMM's guaranteed
participation may be reduced is reasonable given that it will permit
appropriate action to be taken more quickly.
2. Commentary .02 to Rule 6.82 currently restricts the use of an
LMM to various options classes. The Exchange is proposing to make all
issues traded on the options floor eligible for the LMM Program. The
Commission notes that in the original proposal for the LMM Program, the
Exchange made eligible new options classes, and those with
comparatively low volume.\41\ The Exchange believes that Commentary .02
is unnecessarily restrictive based on its successful experience trading
several high-volume, multiply-traded issues in the LMM Program. The
Commission finds that it is appropriate to open the LMM Program to all
issues traded on the options floor because the broadening of the LMM
Program may enhance the market making mechanism on the Exchange,
thereby improving the markets for all listed options on the Exchange.
Specifically, the Commission believes that expanding the LMM Program
may improve the Exchange's market making capabilities by encouraging
long-term commitments to options classes.
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\41\ Securities Exchange Act Release No. 27631, supra note 6.
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The Commission notes that the pilot LMM Program recently was
extended for another year, and will expire in September 1997.\42\ In
approving the modification to the LMM Program making all option issues
eligible, the Commission notes, however, that before the LMM Program
can be approved on a permanent basis, or further extended, the Exchange
must provide the Commission with an updated report on the operation of
the LMM Program.\43\ When the Commission receives this report, it will
consider the impact of this modification in deciding whether to approve
the LMM Program on a permanent basis, or to further extend it.
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\42\ Securities Exchange Act Release No. 37767, supra note 6.
\43\ Id.
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3. The Commission believes that, if an issue is reallocated from an
LMM to a market maker trading crowd, it is reasonable that the Exchange
require that the market quality and service equal or better that
previously provided or guaranteed by the LMM. The Commission notes that
under the proposal the Options Allocation Committee is not required to
reallocate the issue to the LMM system. The Commission believes that it
is consistent with the Act to allow the Options Allocation Committee to
take such action because it should result in options being reallocated
in a manner designed to achieve improved market quality and service.
4. The Commission believes that the Exchange's proposal to allow
the Options Appointment Committee to designate a cooperative of market
makers to act as an LMM in an issue is consistent with the Act. The
Exchange states that it believes that such cooperatives should serve to
increase liquidity in an LMM issue and provide for better service to
customers than might otherwise exist. In addition, PSE Rule 6.40 should
address concerns that may exist that a market maker cooperative might
dominate the market in a given issue.\44\ Rule 6.40 provides that a
member with a ``financial arrangement'' \45\ with another member may
not bid, offer, and/or trade in the same trading crowd at the same time
in the absence of an exemption from the Options Floor Trading
Commission.\46\ The Commission expects that, as would generally be the
case, in determining whether a market maker cooperative should to
receive an exemption from the Rule 6.40 restrictions, the Options Floor
Trading Committee will consider the potential for market domination the
market maker cooperative could pose. The Commission notes that, in
addition to a cooperative meeting the Exchange's capital requirements,
each member of a cooperative of market makers that is acting as an LMM
must comply with Rule 15c3-1 under the Act, the net capital rule.\47\
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\44\ The purpose of Rule 6.40 is to prevent market makers who
have financial arrangements with each other from unfairly dominating
the market in any option issues or series. PSE Rule 6.40, Commentary
.01. The Commission recently approved certain changes to PSE Rule
6.40. Securities Exchange Act Release No. 37543, supra note 18.
\45\ PSE Rule 6.40(a), Financial Arrangements Defined.
\46\ PSE Rule 6.40(b)(1). PSE Rule 6.40 formerly imposed a
narrower restriction on market makers with financial arrangements
with floor brokers. Former PSE Rule 6.40, Commentary .01.
\47\ 17 CFR 240.15c3--1.
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5. The Commission finds that the Exchange's proposal to prevent a
single LMM from being allocated more than 10% of the number of option
issues traded on the options floor is consistent with the Act. The
Commission agrees with the Exchange that this provision should help to
address concerns regarding the potential adverse effects on the
maintenance of a fair and orderly market that could arise from a LMM's
insolvency or similar event.
6. The Commission finds that the Exchange's proposal to replace
references to the LMM Appointment Committee that exist in the current
rule with references either to the Options Allocation Committee or the
Options Appointment Committee is appropriate given that the LMM
Appointment Committee no longer exists.\48\ The Commission believes
that this aspect of the Exchange's proposal should add clarity to the
LMM Rule.
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\48\ See Securities Exchange Act Release No. 30843, supra note
24.
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7. The Commission believes that the Exchange's proposed requirement
that each LMM designate an approved LMM to act as a substitute LMM is
reasonable and should serve to benefit the LMM system by ensuring that
the duties of an LMM absent on a particular day nevertheless will be
undertaken by another LMM.
8. The Exchange has proposed to permit, rather than require, the
awarding of compensation to an LMM whose issue is reallocated pursuant
to proposed Rule 6.82(f)(1). The Commission finds that it is
appropriate for the Exchange to determine what compensation, if any, an
LMM should receive in the event of reallocation of an issue.
9. The Commission believes that the Exchange's proposal to have all
appeals
[[Page 53252]]
from Options Allocation Committee or Options Appointment Committee
decisions be governed by Rule 11 rather than Rule 10 is appropriate
given that Rule 10 concerns disciplinary proceedings and appeals,
whereas Rule 11 concerns committees of the Exchange. The Commission
agrees with the Exchange that because decisions of the Options
Allocation Committee and the Options Appointment Committee are not
disciplinary in nature, they more properly are addressed by Rule 11.
10. The Exchange has proposed to remove the provision requiring LMM
issues be traded in an area of the trading floor that is separate from
other issues. The Commission believes that this restriction is not
necessary, and agrees with the PSE that removing it will afford the PSE
increased flexibility in allotting limited space, and similarly will
allow PSE members to trade issues as LMMs while continuing to trade
other issues as market makers.
11. The Commission agrees with the PSE that the provision that an
LMM honor any ``better markets pledged during the allocation process''
reinforces and serves to formalize the implicit requirement that an LMM
honor pledges made during the allocation process, and therefore is
reasonable.
12. The Commission believes that the Exchange's proposal to replace
a reference to ``Committee'' with one to Options Allocation Committee
is appropriate given that ``Committee'' in current Rule 6.82 refers to
the LMM Appointment Committee which no longer exists.\49\ Similarly,
the current reference to Market Performance Committee, now the Board
Oversight Committee, is removed. The Commission believes that both
these changes add clarity to the Exchange's proposal.
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\49\ Id.
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13. The Exchange proposes to remove the current provision that
states that an LMM that is the subject of Committee review in
connection with the termination of an LMM appointment shall have ten
business days in which to submit a written statement for the
consideration of the Committee. The Exchange has stated that this
provision unnecessarily restricts the Options Appointment Committee and
the Options Allocation Committee, which may need to act promptly to
disqualify an LMM or to reallocate issues, as the case may be.
Moreover, the Exchange states that the Options Allocation Committee
should be able to effect reallocation in the normal course of its
business, and that no special procedures should be required, given that
other actions of committees require no such special procedures.
The Commission believes that this aspect of the Exchange's proposal
is appropriate, given that it would allow the Options Appointment
Committee to disqualify an LMM due to a material financial,
operational, or personnel change warranting immediate action, and
furthermore, would permit the Options Allocation Committee to
reallocate issues promptly. A ten day notification period is at odds
with such a need for prompt action. The Commission finds that the
removal of the ten day notice provision is consistent with the Act.
Furthermore, the Commission finds that the elimination of this
provision is consistent with appeals from Options Allocation Committee
or Options Appointment Committee decisions being governed by Rule 11
\50\ concerning committees of the Exchange.
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\50\ See PSE Rule 11.7 (concerning hearings and review of
committee action).
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14. The Commission agrees that requiring members to notify the
Exchange, rather than a specific committee, when certain events occur,
such as notice of an LMM's resignation or notice of a material
financial, operational, or personnel change to the LMM, will make
administration of the relevant rule provisions more efficient. The
Commission also agrees that deletion in Rule 6.82(f)(1)(B) of the
phrase ``as determined by the Options Appointment Committee'' is
appropriate, where determination of whether a material change in the
LMM's operations or status has occurred may be made, depending on the
circumstances, by either the Options Appointment Committee or the
Options Allocation Committee.
15. The Commission believes that the proposal to delete the
provision in current Rule 6.82(b)(7)(ii) requiring an LMM to terminate
his appointment within three business days of written notification by
the Exchange of a determination that trading in a particular option
would be better accommodated by the introduction of, or return to, the
market maker system without an LMM, is appropriate. The Commission
agrees with the Exchange that the provision is vague, and notes that
Rule 6.82 contains more specific provisions for the reallocation of a
particular option of another LMM or to the market maker trading
crowd.\51\
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\51\ See current Rule 6.82(b)(4); proposed Rule 6.82(f).
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16. The Commission believes that the modification of OFPA B-13 to
provide expressly that all of the rules and procedures applicable to
the semiannual evaluations of options trading crowd performance will
also apply to evaluations of LMM performance is appropriate. The
Commission agrees that this modification is appropriate as the
codification of existing practice of the Options Allocation Committee,
and that it creates consistency in the treatment of LMMs and options
trading crowds with respect to evaluations.
The Exchange also is proposing to modify OFPA B-13 so that appeals
of remedial action taken by the Options Allocation Committee will be
governed by Rule 11 rather than Rule 10. The Commission believes this
modification is consistent with the Exchange's proposal that appeals of
decisions from the Options Allocation Committee and the Options
Appointment Committee will be governed by Rule 11 concerning appeals of
committee decisions, rather than Rule 10 concerning appeals of
disciplinary decisions.
17. The Commission finds that the elimination of the requirement to
disclose to the trading crowd the formula used by the LMM to
automatically update market quotations is appropriate in light of the
longstanding Exchange policy, that this information is available upon
request from the Order Book Official. The Commission considers the
provision requiring LMM disclosure of this information therefore to be
superfluous and unnecessary.
18. The Commission finds appropriate the revisions to the proposal
that would strike the words ``dually-traded or'' from Rule
6.82(d)(2)(A) because they are superfluous, and replace the term
``exclusively-traded'' in proposed Rule 6.82(d)(2)(B) with the term
``non-multiply-traded.'' The Committee finds that the other revisions
and restructurings to Rule 6.82 serve to add clarity to the Exchange's
proposal, and therefore are appropriate.
19. The Commission finds good cause for approving Amendment Nos. 1
and 2 to the proposed rule change prior to the thirtieth day after the
date of publication of notice thereof in the Federal Register.
Amendment Nos. 1 and 2 consist of clarifying changes that serve to
strengthen the Exchange's proposal, but do not materially alter the
terms of the proposal as originally described when published for
comment.\52\ Accordingly, the Commission believes there is good cause,
consistent with Sections 6(b)(5) and 19(b)(2) of the Act, to approve
[[Page 53253]]
Amendment Nos. 1 and 2 to the proposal on an accelerated basis.
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\52\ Securities Exchange Act Release No. 36952, supra note 3.
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 1 and 2. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549. Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. Sec. 552, will be available for inspection and
copying in the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of such filing will also be
available for inspection and copying at the principal office of the
PSE. All submissions should refer to File No. SR-PSE-96-03 and should
be submitted by October 31, 1996.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\53\ that the proposed rule change (SR-PSE-96-03), as amended, is
approved.
\53\ 15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\54\
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\54\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-26013 Filed 10-9-96; 8:45 am]
BILLING CODE 8010-01-M
