[Federal Register Volume 63, Number 208 (Wednesday, October 28, 1998)]
[Notices]
[Pages 57721-57726]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-28850]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40577, File No. SR-PSE-97-02]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval to
Amendments 1 and 2 to the Proposed Rule Change by the Pacific Exchange,
Inc., Relating to the Proprietary Hand-Held Terminal Program for Floor
Brokers
October 20, 1998.
I. Introduction
On January 17, 1997, the Pacific Exchange, Inc. (``PCX'' or
``Exchange'') \1\ filed a proposed rule change with the Securities and
Exchange Commission (``SEC'' or ``Commission''), pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \2\ and Rule
19b-4 thereunder,\3\ to adopt Rule 6.89 governing the use by PCX
Members and Member Organizations (``Members'') of proprietary brokerage
order routing terminals (``Terminals'') on the options floor of the
Exchange. On March 30, 1998, and June 5, 1998, respectively, the
Exchange filed Amendments 1 \4\ and 2 \5\ with the Commission.
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\1\ The Exchange changed its name from the Pacific Stock
Exchange to the PCX subsequent to the filing of this proposed rule
change. For record-keeping purposes the file number will remain SR-
PSE-97-02.
\2\ 15 U.S.C. 78s(b)(1).
\3\ 17 CFR 240.19b-4.
\4\ See Letter from Michael D. Pierson, Senior Attorney,
Regulatory Policy, PCX, to David Sieradzki, Attorney, Division of
Market Regulation (``Division''), Commission, dated March 27, 1998
(``Amendment No. 1''). In Amendment No. 1, the Exchange makes three
substantive changes to the proposal. First, the Exchange states that
approval to use Terminals on the floor of the Exchange will not be
granted on an issue by issue basis. Instead, the Exchange will
approve the use of any Terminal system that does not interfere with
any Exchange-sponsored hand-held terminals, POETS, or any other
equipment on the floor. Subject to those conditions, once the
Exchange has approved a Member or Member Firm to use a Terminal, the
approval is not restricted to particular options trading crowds.
Second, the Exchange amends the market making restriction in Section
4(d)(3) to make the definition of market making consistent with the
definition of market making in PCX's Exchange-sponsored hand-held
terminal filing (SR-PCX-97-28) and Section 3(a)(38) of the Act. See
Securities Exchange Act Release No. 39970 (May 7, 1998), 63 FR 26662
(May 13, 1998) and 15 U.S.C. 78c(a)(38). Third, the Exchange removes
provisions designating the proposal as a pilot program. finally, the
Exchange modifies the format of the proposal so that it will be a
change to the text of the Rules of the Exchange, rather than a
written policy.
\5\ See Letter from Michael D. Pierson, Senior Attorney,
Regulatory Policy, PCX, to David Sieradzki, Attorney, Division,
commission, dated June 3, 1998 (``Amendment No. 2''). Amendment No.
2 makes one non-substantive change to the text of the Rule, removing
a reference to the fact that the Exchange intends to roll out its
own brokerage order routing system. In addition, the Exchange
clarified, through an internal cross-reference, that any decision to
terminate approval for a Terminal system under PCX rule 6.89(g)
would be based on the factors set forth in PCX rule 6.89(b).
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Notice of the proposal was published for comment and appeared in
the Federal Register on February 18, 1997.\6\ Two comment letters were
received on the proposed rule change.\7\ The PCX responded to IB's
comment letter.\8\ This order approves the Exchange's proposal,
including Amendments No. 1 and 2 on an accelerated basis.
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\6\ See Securities Exchange Act Release No. 38270 (February 11,
1997), 62 FR 7286 (February 18, 1997).
\7\ Letter from Earl H. Nemser, Managing Director, Interactive
Brokers, LLC (``IB''), to Jonathan G. Katz, Secretary, Commission,
dated March 11, 1997; letter from Earl H. Nemser, The Timber Hill
Group, LLC (``Timber Hill''), to Chairman Levitt, Commissioners
Hunt, Unger, Carey and Johnson, Commission, dated June 8, 1998. In
further support of its March 11 comment letter, on August 15, 1997,
IB supplemented its comment letter with a working paper entitled
``Affirmative Obligations of Market Makers: An Idea Whose Time Has
Passed?'' Letter from Bradford L. Jacobowitz, General Counsel, IB,
to Jonathan G. Katz, Secretary, Commission, dated August 14, 1997.
\8\ Letter from Michael D. Pierson, Senior Attorney, Regulatory
Policy, PCX, to Jonathan G. Katz, Secretary, Commission, dated April
21, 1997.
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II. Description of the Proposal
The Exchange proposes to adopt rules governing Terminals that
Members may use on the options floor of the Exchange. The rules include
specific provisions on Exchange approval of
[[Page 57722]]
Terminals; restrictions on Members' use of Terminals; exchange
inspection and audit; exchange liability; and termination of exchange
approval.
Exchange Approval
Proposed Rule 6.89 specifies that Members must obtain prior
Exchange approval to use any proprietary brokerage order routing
terminals on the options floor. Once the Exchange grants approval to a
Member to use Terminals, the Member may do so in all trading crowds. To
request such approval, Members must submit a letter of application to
the Exchange specifying the make, model number, functions, and intended
use of the equipment, and must also provide additional information upon
the request of the Exchange. The rule further provides that the format
of any orders to be transmitted over the Terminals must also be pre-
approved by the Exchange.
PCX Rule 6.89(b) states that, in considering the approval of an
application, as well as whether a previously issued approval should be
withdrawn, the Exchange will take into account such factors as: (1) the
physical size of the Terminal; (2) space available at the post where
the Terminal is to be used; (3) telecommunication, electrical and radio
frequency requirements; (4) Terminal characteristics and capacity; and
(5) any factors that the Exchange considers relevant in the interest of
maintaining fair and orderly markets, the orderly and efficient conduct
of Exchange business, the maintenance and enhancement of competition,
the ability of the Exchange to conduct surveillance of the use of the
Terminal and the business transmitted through it, the adequacy of
applicable audit trails, and the ability of the Terminal to interface
with other Exchange facilities.
PCX Rule 6.89(c) provides that Members must report to the Exchange
every proposed material change in functionality of a Terminal and every
proposed change in the use of a Terminal. It further provides that
Members must not implement any such proposed changes unless and until
they have been approved by the Exchange, and that Members must also
promptly file with the Exchange supplements to their applications
whenever the information currently on file becomes inaccurate or
incomplete for any reason.
Restrictions on Use of Terminals
PCX Rule 6.89(d) sets forth four restrictions applicable to
Members' use of Terminals on the options floor. The first restriction
is that Members may receive brokerage orders in the trading crowd via
Terminals, but must represent such orders in the trading crowd by open
outcry in a manner that is consistent with Exchange rules.
The second restriction states that when a Member executes an order
that was received over a Terminal, the Member must fill out and time
stamp a trading ticket within one minute of the execution. Exchange
rules on record keeping and trade reporting are unchanged.
The third restriction states that Terminals may be used to receive
brokerage orders only, and that Terminals may not be used to perform a
market making function. it states that any system used by a Member to
operate a Terminal must be separate and distinct from any system that
may be used by a member or any person associated with a Member in
connection with market making functions. It further states that, for
the purpose of this subsection, orders initiated from off the floor of
the Exchange that are not counted as ``Market Maker transactions''
within the meaning of PCX Rule 6.32 and that do not constitute a
Member, on a regular and continuous basis, simultaneously representing
orders to buy and sell options contracts in the same series for the
account of the same beneficial holder shall not be deemed to be a
market making function.
The Exchange believes that if Terminals were permitted to be used
to perform market making functions from off the floor of the Exchange,
it may become undesirable for Exchange market makers to continue to
assume the costs and obligations associated with being a registered
market maker, which in turn could harm the liquidity and quality of the
Exchange's market. The Exchange is particularly concerned that off-
floor market making effectively would establish a market making
structure devoid of affirmative market making obligations that could
result in less deep and liquid markets during periods of market stress,
when off-floor Terminal market makers would not be required to continue
making markets. Moreover, the Exchange believes that surveillance of
market making through the Terminals currently would be particularly
difficult.
The Exchange intends to interpret the term ``market making'' in
accordance with its traditional definition as defined under the Act,
i.e., holding one's self out as being willing to buy and sell a
particular security on a regular or continuous basis.\9\ The definition
of market making would not capture parties who enter orders on one side
of the market, nor would it capture parties who enter two-sided limit
orders on occasion. A party would not be deemed to be engaging in
market making unless it regularly or continuously holds itself out as
willing to buy and sell securities.
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\9\ See 15 U.S.C. 78c(a)(38).
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The fourth restriction in PCX Rule 6.89(d)(4) states that no Member
or any person associated with a Member may use for the benefit of such
Member or any person associated with such Member information about any
brokerage order in the Terminal system until that information has been
disclosed to the trading crowd. Accordingly, prior to acting on
information displayed on a Terminal by placing an order or making or
changing a bid or offer on the Exchange or in any other securities or
futures market to the benefit of the Member, the Member must disclose
information displayed on a Terminal to the trading crowd. The Exchange
believes that this restriction will help to ensure that Members using
Terminals trade on the same terms and conditions as other market
participants and do not receive any trading advantages such as the
ability to interact with orders transmitted through the Terminals
without first disclosing those orders to the trading crowd.
Inspection and Audit
PCX Rule 6.89(e) states that the operation and use of all aspects
of the Terminal and all orders entered through the Terminal are subject
to inspection and audit by the Exchange at any time upon reasonable
notice. It further provides that Members must furnish to the Exchange
such information concerning the Terminal as the Exchange may from time
to time request upon reasonable notice, including without limitation an
audit trail identifying transmission, receipt, entry, execution, and
reporting of all orders. For the purpose of this subsection, a notice
of at least twenty-four hours shall be deemed to be reasonable
(however, shorter periods may be provided in appropriate
circumstances).
Exchange Liability
PCX Rule 6.89(f) states that neither the Exchange nor its
directors, officers, employees or agents shall be liable to a member, a
Member's employees, a Member's customers or any other person for any
loss, damage, cost, expense or liability arising from the installation,
operation, relocation, use of, or inability to use a Terminal on the
floor of the Exchange (including any failure, malfunction, delay,
suspension, interruption, or termination).
[[Page 57723]]
Termination of Approval
PCX Rule 6.89(g) provides that the Exchange may at any time
determine to terminate approvals for the installation and use by
Members of Terminals on the floor of the Exchange or at particular
trading posts, as long as the Exchange gives 30 days notice to such
Member(s). However, any such decision to terminate its approval of the
installation or use of Terminals on the floor of the Exchange must be
based on certain specified factors.\10\ It further provides that a
Member's approval to use a Terminal may also be summarily terminated by
the Exchange, once notice has been provided to the affected Member, if:
(1) any statement by such Member in its application or any supplement
thereto is inaccurate or incomplete; (2) such Member has failed to
comply with any provision of this Rule; or (3) the operation of the
Terminal is causing operational difficulties on the floor of the
Exchange, and the Member has failed to cure the same within seven
calendar days following the giving of notice (or such shorter period of
time as the Exchange may deem appropriate if it determines the
circumstances have created a situation requiring a shorter period). It
states that Members must immediately stop using their Terminals and
must remove such Terminals from the floor of the Exchange upon the
termination of approval pursuant to this subsection, and that nothing
in this subsection shall be construed as a waiver of or limitation upon
whatever right Members may otherwise have to seek appropriate relief
pursuant to PCX Rule 11.\11\
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\10\ These factors include the physical size of the terminal,
space available at the post where the Terminal is to be used,
telecommunication, electrical and radio frequency requirements, and
Terminal characteristics and capacity. See Amendment No. 1, supra
note 4.
\11\ PCX Rule 11.7 provides due process protections for persons
who have been aggrieved by Exchange action. It gives such persons an
opportunity to be heard and to have the complaint reviewed by the
Exchange.
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In its filing, the Exchange noted that, except in certain minor
respects, the proposed Rule is similar to an approved rule change of
the Chicago Board Options Exchange (``CBOE'') relating to the use of
proprietary brokerage order routing terminals on the CBOE floor.\12\
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\12\ See Securities Exchange Act Release No. 38054 (December 16,
1996), 61 FR 67365 (December 20, 1996). The Commission notes that
the CBOE proposal authorized the use of hand-held order routing
terminals in the S&P 500 (``SPX'') crowd to trade SPX options only.
The current PCX filing concernsthe use of Terminals on a floor-wide
basis.
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III. Summary of Comments
A. IB Comment Letter
In its comment letter, IB expressed support for the proposal's aim
to introduce Terminals to the options floor, but objected for several
reasons to the Exchange prohibiting a Terminal from being used to
transmit two-sided orders. IB requested that the Commission, pursuant
to the National Securities Markets Improvement Act of 1996 (``NSMIA''),
``use its * * * exemptive powers and supervisory authority over the
[Exchange] to * * * modify the proposed rule to eliminate unreasonable
restrictions * * * and then to direct its implementation forthwith.''
First, IB argued that Section 105 of NSMIA permits the Commission
to provide an exemption in order to permit the immediate use of hand-
held technology on the PCX options floor, without imposing the
restrictions suggested by the PCX proposal. Second, IB argued that the
Exchange's proposal must be rejected because it does not sufficiently
analyze the proposal's impact on efficiency and competition as required
by Section 106 of NSMIA. Third, IB argued that a floor-wide prohibition
on the use of Terminals for two-sided orders would place an
unreasonable burden on competition. IB noted that, in proposing its
market making restriction, the Exchange improperly relied on the
Commission's approval of the CBOE proposal relating to Terminals used
by the SPX options trading crowd. IB believes that approval of the
restriction for that one options class should not act as a precedent
for a floor-wide policy as proposed by PCX, and should be re-examined
by the Commission. In particular, IB noted the important differences in
the liquidity of the SPX option and the various PCX products. Fourth,
IB argued that the proposed restrictions on two-sided orders must be
rejected because the Exchange did not appropriately assess whether the
restriction's resulting burden on competition was justified as
reasonable and appropriate, and whether the public interest could
otherwise be protected by a more competitive alternative. Fifth, IB
argued that the use of Terminals for two-sided orders would not deprive
market makers of the advantages afforded to them and would not
discourage them from meeting their market making obligations. IB noted
that it believes that as new products are listed on the various
exchanges, market makers will have the financial incentive to continue
to make markets. In addition, IB noted that if the Exchange restricts
the use of Terminals to transmit two-sided orders to the trading floor,
the liquidity of the markets and the investing public will suffer
during periods of market stress. Sixth, IB argued that the Exchange
should have considered less restrictive alternatives such as requiring
non-market makers who use Terminals for the submission of two-sided
orders to assume market maker obligations through the use of Terminals.
Seventh, IB argued that the Exchange should not be (1) permitted to
limit the use of proprietary Terminals when it implements its own
brokerage order routing system; or (2) deny the use of Terminals
summarily,\13\ or on an ``issue-by-issue'' basis without setting out an
objective standard.\14\ IB noted that to develop a proprietary order
routing system requires a large capital investment. Further, IB
believes that by denying the use of Terminals in this manner, the
Exchange discourages development of better systems, deprives the public
of the benefits of market efficiencies created by new technology, is
inconsistent with Commission policy to encourage development of
innovative trading systems and services, and has not been shown to
justify the resulting burdens on competition. Finally, IB argued that
the PCX proposal unnecessarily mandates the manual writing and time
stamping of paper tickets. IB noted that it believes that an electronic
audit trail is more accurate and more efficient than paper tickets and
more consistent with Commission policy and NSMIA.
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\13\ The Commission notes that a member would have the right to
appeal any decision to deny approval to use a Terminal or suspend a
member from using a Terminal pursuant to PCX Rule 11.7, Hearings and
Review of Committee Action.
\14\ See infra note 31.
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B. PCX Response Letter
The PCX response to IB's comment letter stated that without the
market making restriction, an off-floor market maker could avoid all
affirmative market making obligations and have significant trading
advantages over on-floor market makers. Among other things, on-floor
market makers are required to: (1) trade with public customers at the
disseminated best bid or offer,\15\ (2) maintain fair and orderly
markets,\16\ (3) maintain price continuity by dealing from their own
accounts under certain circumstances,\17\ and (4) log on to the
Exchange's Auto-Ex system when circumstances warrant it. In this
context, the Exchange notes that if a market maker had the freedom to
leave
[[Page 57724]]
the floor and perform market making through a Terminal, many would do
so to avoid the obligations of being a market maker. This could
ultimately result in a significant reduction of liquidity on the
Exchange's options trading floor. Accordingly, the Exchange believe
IB's proposal would compromise the continued viability of its markets.
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\15\ See PCX Rule 6.86.
\16\ See PCX Rule 6.37(a).
\17\ See PCX Rule 6.37(b).
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Next, the Exchange contends that allowing off-floor market making
would, in effect, create an entirely new category of floor trader. The
Exchange notes that the IB proposal to allow off-floor market making
was never presented to the Options Floor Trading Committee for
approval. The Exchange also requests that, if the Commission does
approve IB's proposal, that the Commission do so uniformly across
options exchanges to prevent one exchange from being at a competitive
disadvantage to another.
The Exchange also addresses IB's contention that the Exchange
unjustifiably relies on the Commission's prior approval of a similar
CBOE filing that included a market making restriction because the prior
proposal dealt with heavily traded issues while the trading volume on
the PCX is considerably smaller. The Exchange states that ``the
question of whether Terminals should initially be permitted in trading
crowds with low volume or trading crowds with high volume should be
left to the discretion of the [Options Floor Trading Committee], which
is in the best position to make such a determination because of its
diverse composition of industry representatives.''
The Exchange makes several arguments in response to IB's request
that the Commission ``uses its * * * exemptive powers and supervisory
authority over the [Exchange] to * * * modify the proposed rule to
eliminate unreasonable restrictions. First, the Exchange argues that
Congress has not indicated that Section 105 of NSMIA should be used in
the manner that IB suggests. The Exchange believes that Congress
intended that Section 105 be used to allow the exchanges to use
automated trading systems without filing a proposed rule change or that
the exemption refers to the Commission's ability to exempt certain
electronic trading systems from having to be registered under the Act
as national securities exchanges. Second, the Exchange argues that even
if Section 105 were to apply, IB has failed to meet the statutory
requirements that the exemption be ``necessary or appropriate in the
public interest'' and ``consistent with the protection of investors''
because, among other things, it could undermine the Exchange's market
making system and result in less deep and liquid markets. The Exchange
also believes that surveillance would be particularly difficult and
that IB has not met the burden under NSMIA that the exemption be
necessary or appropriate because IB still has the choice of putting a
market maker in the trading crowd. Third, the Exchange notes that the
Commission has yet to use its exemptive authority under Section 105 and
recommends that the Commission use caution before doing so. Fourth, the
Exchange believes that the Commission has previously engaged in a
``rigorous'' analysis of the issues in this matter. Specifically, the
Commission has previously considered comment letters and responses in
connection with similar rule filings of the American Stock Exchange and
the CBOE. Fifth, in response to IB's argument that the Exchange should
not be permitted to limit the use of proprietary Terminals when it
implements its own brokerage order routing system, the Exchange states
that ``as long as an applicant's proprietary trading system does not
cause operational problems on the trading floor, the applicant will not
be arbitrarily denied the privilege of operating its Terminals on the
floor[.]'' Finally, with regard to IB's objection that written, time-
stamped tickets would be required under the rules relating to
Terminals, the Exchange notes that such tickets are needed, at this
time, not only for audit trail purposes, but also for purposes of
verifying compared trades and reconciling uncompared trades.
C. Timber Hill Comment Letter
In its comment letter, Timber Hill urges the Commission to consider
the issue of prohibiting the use of Terminals to perform a market
making function. Timber Hill asserts that, due to the impact of the
proposed market making restriction on competition and the use of
technology, NSMIA requires that the restriction must be supported by an
actual basis in fact, and not merely by possibilities derived from an
outdated theoretical construct. Further, Timber Hill argues that the
Commission should not rely on its prior approval of a similar market
making restriction in a proposal by the CBOE without reanalyzing the
issue in light of NSMIA.
IV. Commission Finding and Conclusions
Section 6(b)(5) of the Act \18\ requires that the rules of an
exchange be designed to prevent fraudulent and manipulative acts and
practices, promote just and equitable principals of trade, remove
impediments to and perfect the mechanism of a free and open market, and
in general to protect investors and the public interest. Section
6(b)(7) of the Act \19\ requires that the rules of an Exchange be in
accordance with Section 6(d) of the Act,\20\ and in general provide a
fair procedure for the disciplining of members and the prohibition or
limitation by an exchange of a person's access to services offered by
the exchange. Section 6(b)(8) of the Act \21\ requires that the rules
of an exchange not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Act. Section
11A(a)(1)(C)(ii) of the Act \22\ states that it is in the public
interest and appropriate for the protection of investors and the
maintenance of fair and orderly markets to assure fair competition
among brokers and dealers. For the reasons set forth below, 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, the
requirements of Sections 6(b)(5), 6(b)(7), 6(b)(8), and 11A(a)(1)(C) of
the Act.\23\
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\18\ 15 U.S.C. 78f(b)(5).
\19\ 15 U.S.C. 78f(b)(7).
\20\ 15 U.S.C. 78f(d). Section 6(d) of the Act, among other
things, requires that an exchange, in any proceeding to determine
whether a member should be disciplined, bring specific charges,
notify such member of and provide him with an opportunity to defend
himself against such charges, and keep a record. Id.
\21\ 15 U.S.C. 78f(b)(8).
\22\ 15 U.S.C. 78k-1(a)(1)(C).
\23\ In approving the proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78f(b). As discussed below, the
proposed rule will likely expedite and make more efficient the
process by which members can receive and execute options orders on
the floor of the Exchange. In addition, the Commission discusses the
proposed rule's effect on competition below.
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The Commission believes that the PCX's proposal should foster
coordination with persons engaged in facilitating transactions in
securities, remove impediments to and perfect the mechanism of a free
and open market, and protect investors and the public interest by
expediting and making more efficient the process by which members can
receive and execute options orders on the floor of the Exchange.
Because Terminals will be allowed to be used by all brokers and dealers
in all trading crowds, provided that they comply with the terms and
conditions as set forth in the proposal, the proposal also will promote
fair competition among brokers and dealers and facilitate transactions
in
[[Page 57725]]
options on the Exchange. Finally, although IB and Timber Hill have set
forth a number of objections to the market making restriction, for the
reasons discussed below, the Commission believes that these objections
have been adequately addressed and finds that the market making
restriction is consistent with the Act.
As described above, PCX Rule 6.89(d)(3) provides that no floor
broker may knowingly use a Terminal, on a regular and continuous basis,
to simultaneously represent orders to buy and sell options contracts in
the same series for the account of the same beneficial holder. The Rule
further provides that if the Exchange determines that a person or
entity has been sending, on a regular and continuous basis, orders to
simultaneously buy and sell option contracts in the same series for the
account of the same beneficial holder, the Exchange may prohibit orders
for the account of such person or entity from being sent through the
Exchange's Member Firm Interface (``MFI'') \24\ for such period of time
as the Exchange deems appropriate.
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\24\ The MFI is an electronic order delivery and reporting
system that allows member firms to route orders for execution by the
automatic execution feature of POETS as well as to route limit
orders to the Options Public Limit Order Book. Orders that do not
reach those two destinations are defaulted to a member firm booth.
MFI also provides member firms with instant confirmation of
transactions to their systems. Member firms may access POETS by
establishing an MFI mainframe-to-mainframe connection.
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The Commission finds that the market making restriction is
consistent with the Act for the following reasons. The Commission
believes that the PCX's restriction on market making through the use of
Terminals has been effected in a clear and reasonable manner that is
not ambiguous or overbroad, and that takes into account regulatory and
market impact concerns, including those relating to quote competition
and price discovery.\25\ Notably, the Exchange's proposal does not bar
all two-sided limit orders. Instead it only restricts the acceptance of
two-sided limit orders placed by the same beneficial holder in the
performance of a market making function. The distinction between market
making and brokerage activity is well established among market
participants. Moreover, the language of PCX Rule 6.89(d)(3) expressly
restricts a floor broker from, on a regular and continuous basis,
simultaneously representing orders to buy and sell options contracts in
the same series for the account of the same beneficial holder, not the
occasional entry of two-sided limit orders. This definition of market
making activity is consistent with the definition of market maker under
the Act, which states that a market maker ``holds himself out as being
willing to buy and sell [a] security for his own account on a regular
or continuous basis.''\26\ Thus, the market making restriction on
Terminal use for routing limit orders is the minimum necessary for the
Exchange to ensure that Terminals are not used for off-floor market
making.
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\25\ Cf., Securities Exchange Act Release No. 25842 (June 23,
1988), 53 FR 24539 (approving certain restrictions on the use of
telephones on the floor of the New York Stock Exchange), aff'd per
curiam, 866 F.2d 47 (2d Cir. 1989).
\26\ 15 U.S.C. 78c(a)(38).
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IB alleges that the market making restriction places an
unreasonable burden on competition. As the Commission has previously
stated in approving market making restrictions similar to that being
adopted by PCX, the Commission does not believe it unreasonable for a
market to determine that the introduction of unregulated market making
through Terminals may undermine its market maker system and potentially
create disincentives for market makers to remain on an exchange trading
floor.\27\ Accordingly, any burden on competition that arguably exists
from PCX's restriction on using Terminals for market making is, in the
Commission's view, justified as reasonable and appropriate to ensure
adequate regulation of the PCX market.\28\
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\27\ See Securities Exchange Act Release No. 38054 (December 16,
1996), 61 FR 67365 (December 20, 1996)(order approving SR-CBOE-95-
48).
\28\ While the Commission recognizes that, as IB contends, there
may be ways to address the regulatory issues presented by off-floor
market making through the use of floor broker hand-held terminals,
the Act does not dictate that any particular approach be taken. The
Commission believes that the manner in which the Exchange has chosen
to address the regulatory issues presented by off-floor market
making reflects the considered judgment of the PCX regarding the
attributes of Exchange membership and the organization of its
trading floor, and is a fair exercise of its powers as a national
securities exchange.
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The Commission also does not believe that restricting market making
activity through Terminals constitutes an unreasonable restriction on
the introduction of new technology onto the floor of the Exchange in
violation of NSMIA, as alleged in the IB and Timber Hill Comment
Letters. The Commission believes that it is within the business
judgment of an Exchange to determine the manner in which new
technologies are introduced onto its trading floor provided that the
limitations do not constitute an unreasonable burden on competition and
are otherwise consistent with the Act.
In addition, the Commission has considered the impact of the
Exchange's market making restriction on efficiency and competition.
While the proposal may impose a burden on competition by limiting how
Terminals may be used on the floor, the Commission does not believe
such burden to be unreasonable. As discussed above, the Commission
believes that the PCX's restriction on market making through the use of
Terminals has been effected in a clear and reasonable manner that is
neither ambiguous nor overbroad, and that takes into account regulatory
and market impact concerns. Further, the Commission notes that the
impact on competition of the current proposal is limited by the fact
that the Exchange's own hand-held order routing terminal program was
approved by the Commission with an identical market making
restriction.\29\ In response to IB's request that the Commission use
its exemptive authority under Section 105 of NSMIA to permit the use of
Terminals for market making, the Commission agrees with the Exchange
that Congress did not intend that Section 105 be used in the manner
that IB suggests. Section 105 of NSMIA states that the Commission ``by
rule, regulation, or order may conditionally or unconditionally exempt
any person, security, or transaction, * * * from any provision or
provisions of this title or of any rule or regulation thereunder[.]''
\30\ The rules IB requests relief from are the rules of the PCX, not
the Act or rules or regulations under the Act. Accordingly, the
Commission does not believe that it is appropriate to grant the relief
IB requests under Section 105 of NSMIA.
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\29\ See Securities Exchange Act Release No. 39970 (May 7,
1998), 63 FR 26662 (May 13, 1998) (order approving SR-PCX-97-28).
\30\ P.L. 104-290; 110 Stat. 3416.
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Further, the Commission believes the PCX has adequately addressed
the other issues raised by IB. First, PCX has amended its proposal so
that under PCX Rule 6.89(g), termination of the Exchange's approval of
Terminals can only occur under certain specified circumstances, rather
than without cause.\31\ In addition, while the Exchange has retained
the right to summarily terminate its approval of a member's Terminal
use, such summary action can also only be taken under certain
[[Page 57726]]
circumstances.\32\ Further, upon either type of termination action, the
PCX proposal provides certain appeal rights of the termination
decision. The Commission believes that the appeal procedures ensure
adequate due process for termination under PCX Rule 6.89, consistent
with Sections 6(b)(7) \33\ and 6(d) \34\ of the Act. In this regard, we
note that a member aggrieved by an Exchange decision to terminate its
prior terminal approval could seek relief pursuant to PCX Rule 11.
These provisions provide specific procedures to seek Exchange hearing
and review for persons aggrieved by actions of the Exchange including
terminating or enforcing the terms of PCX Rule 6.89.\35\
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\31\ The Commission notes that the Exchange, in Amendment No. 1
to the proposed rule change, sets forth objective standards on which
the decision to terminate an approval to use Terminals would be
based and stating that approval to use Terminals would be given on a
floor-wide, rather than on an issue-by-issue basis. See Amendment
No. 1, supra note 4.
\32\ Under PCX Rule 6.89(g), the Exchange can summarily
terminate approval of the use of Terminals when (1) a statement in
the Member's application is inaccurate or incomplete; (2) such
Member has failed to comply with any provision of PCX Rule 6.89; and
(3) the operation of the Terminal causes operational difficulties on
the floor of the Exchange. See Amendment No. 1, supra note 4.
\33\ 15 U.S.C. 78f(b)(7).
\34\ 15 U.S.C. 78f(d).
\35\ See supra note 13.
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With respect to the use of written order tickets, the Exchange has
represented that such tickets are needed, at this time, not only for
audit trail purposes, but also for purposes of verifying compared
trades and reconciling uncompared trades. The Commission believes that
it is reasonable for the Exchange to require the use of written order
tickets for those purposes.
In conclusion, the Commission believes that the proposed rule will
make the process by which members can receive approval for using
Terminals more transparent and fair. In addition, the use of Terminals
should also make options trading on the floor of the Exchange more
efficient. Finally, for the reasons stated above, the Commission
believes that the market making prohibition on the use of the Terminals
adequately balances the potential benefits to be derived from the use
of Terminals with the regulatory issues that are raised in connection
with the potential use of Terminals for market making.
The Commission finds good cause for approving Amendments 1 and 2 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register.
Amendment No. 1 changes the language in proposed Commentary .02 to Rule
6.67 to indicate that orders received through proprietary hand held
terminals will be considered to be in writing for the purposes of PCX
Rule 6.67. Commentary .02, as originally proposed, applied only to
Exchange-Sponsored Terminals. Amendment No. 1 ensures that all hand-
held terminal systems, regardless of whether they are Exchange
sponsored or proprietary will have the same regulatory requirements.
Amendment No. 2 clarifies the proposal to indicate, through an internal
cross-reference, what factors the Exchange will consider when
determining whether or not to revoke approval for the use of a
terminal. As a result, the Commission does not believe that Amendments
1 and 2 raise any new regulatory issues. Accordingly, the Commission
believes there is good cause, consistent with Sections 6(b)(5) and
19(b)(2) \36\ of the Act, to approve Amendments 1 and 2 to the
Exchange's proposal on an accelerated basis.
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\36\ 15 U.S.C. 78f(b)(5) and 78s(b)(2).
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V. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendments 1 and 2 including whether the
amendments are 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. 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 will also be available for inspection and copying at the
principal office of the above-mentioned self-regulatory organization.
All submissions should refer to File No. SR-PSE-97-02 and should be
submitted by November 18, 1998.
In view of the above, the Commission finds that the proposal is
reasonable and is consistent with the Act, and, in particular, Sections
6(b)(5), 6(b)(7), 6(b)(8), and 11A(a)(1)(C)(ii) of the Act.
VI. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\36\ that the proposed rule change (File No. SR-PSE-97-02) is
approved.
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\36\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\37\
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\37\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 98-28850 Filed 10-27-98; 8:45 am]
BILLING CODE 8010-01-M
