[Federal Register Volume 59, Number 210 (Tuesday, November 1, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-27036]
[[Page Unknown]]
[Federal Register: November 1, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34893; File No. SR-Phlx-92-09]
Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change Prohibiting Trading the
Quote Spread on PACE
October 25, 1994.
On April 10, 1992, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to prohibit the use of the Phlx
Automated Communication and Execution System (``PACE'') volume
execution guarantees with offsetting orders in low-volatility, high
volume stocks in order to ``trade the quote spread.'' On April 14,
1994, and June 6, 1994, the Phlx submitted Amendment Nos. 1 and 2,
respectively.\3\
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\1\15 U.S.C. Sec. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1991).
\3\See letters from Gerald D. O'Connell, Vice President, Market
Surveillance, Phlx, to Sharon Lawson, Assistant Director,
Commission, dated April 14, 1994, and June 1, 1994. In Amendment No.
1 the Phlx amended the language of the rule to clarify that three
occurrences of trading the quote spread within one month may
constitute a violation of the rule. In Amendment No. 2 the Phlx (a)
clarified that the three occurrences are meant to be in the same
stock, and (b) changed the word ``may'' to ``will'' constitute a
violation.
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The proposed rule change, as amended, was published for comment in
Securities Exchange Act Release No. 34259 (June 27, 1994), 59 FR 34000
(July 1, 1994). No comments were received on the proposal.
The proposed rule change adopts Commentary .18 to Phlx Rule 229,\4\
which details the execution guarantees due a PACE order. Commentary .18
generally prohibits members from engaging in any established pattern of
trading via PACE to generate short-term trading profits by exploiting
PACE volume execution guarantees.
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\4\See Philadelphia Stock Exchange Rules, Rule 229.
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PACE is the Exchange's automated order routing, delivery and
execution system for equity securities. Pursuant to Phlx Rule 229,
customer orders entered through PACE are entitled to certain execution
guarantees. For example, limit orders for less than 600 shares become
due an execution once an accumulative volume of 1,000 shares of that
security prints at the limit price or better on the New York Stock
Exchange (``primary market guarantee'').\5\
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\5\See Phlx Rule 229, Supplementary Material .10(a).
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As used in the proposed rule change, unjustly exploiting the PACE
volume execution guarantees by trading the quote spread refers to the
practice of placing an order to buy at the primary market's bid price
and simultaneously or shortly thereafter placing an order to sell for a
related account at the primary market's offer price, or vice versa.
This creates the expectation that each of the orders will be elected at
their respective limit prices when the required volume trades on the
primary market. When both orders are filled due to volume guarantees, a
profit is locked-in, equal to the amount of shares multiplied by the
quote spread less commissions. This profit can be made within minutes
after the orders are placed and without any quote change in the stock.
This practice usually is most successfully undertaken with respect to
low-volatility, high-volume stocks, because the bid-ask spread for
these stocks is often narrow and static.
For the reasons described below, the Commission believes that the
proposed rule change is consistent with the Act, and the rules and
regulations thereunder applicable to a national securities exchange,
and in particular Section 6(b).\6\ Specifically, the Commission
believes the proposal is consistent with the Section 6(b)(5)
requirements that the rules of an exchange be designed to promote just
and equitable principles of trade, to prevent fraudulent and
manipulative acts, and, in general, to protect investors and the public
in that it prevents the misuse of the Exchange's execution guarantees
available through PACE.\7\
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\6\15 U.S.C. Sec. 78f(b) (1988).
\7\See generally Securities Exchange Act Release No. 33678, 59
FR 10192 (March 3, 1994), in which the Commission approved a NYSE
proposed rule change prohibiting certain abusive uses of that
Exchange's odd-lot order execution system. The prohibited uses were
not consistent with the traditional odd-lot investing practices of
smaller investors for which the odd-lot order execution system was
developed.
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The Commission believes the use of the PACE system as proscribed in
the proposal is inappropriate and inconsistent with PACE's functioning
as a small order execution system. Automated order routing and
execution systems were described in general in the Report of the
October 1987 Market Break.\8\ The Report stated that these systems
provide the primary means of executing the vast majority of small-sized
trades both for listed and OTC stocks, and that, with the exception of
program trades, most of these trades are for retail customers.
According to the Report, small order routing and execution systems are
designed to receive smaller sized orders electronically from broker-
dealers and route them to the appropriate stock exchange floor for
automatic execution or for manual handling by the specialist. The
Exchange's PACE system is one of these systems. The Commission
believes, therefore, that PACE was intended to facilitate execution of
small orders, and not to force Phlx specialists to trade at the inside
primary market quote with traders trying to get the advantage of the
spread without taking any risk.
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\8\Division of Market Regulation of the Securities and Exchange
Commission, Report of the October 1987 Market Break (February 1988)
(``Report'').
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The Commission also believes that trading the quote spread as
proscribed in the proposal potentially can result in misleading market
information with respect to the level of bona fide investment interest
in the subject stocks. Using PACE to trade the quote spread could
potentially disadvantage other market participants by ultimately
reducing liquidity. Moreover, this type of trading is unfair to the
PACE specialists, who are not obligated to trade at the same prices as
the primary market, but who have agreed that for small, retail orders,
they will provide primary market price guarantees.
The Commission further believes the Exchange has adequately
identified in the proposal the violative trading activity and what
constitutes an established pattern of violative trading. The proposal
makes clear that three occurrences of proscribed trading in the same
security within a one-month period constitute an established pattern in
violation of Rule 229. Because the rule excludes from its coverage
random or inadvertent violations, the Commission believes that the Phlx
has reasonably tailored and defined its prohibition.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\9\ that the proposed rule change (SR-Phlx-92-09) is approved.
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\9\15 U.S.C. Sec. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\10\
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\10\17 CFR 200.30-3(a)(12) (1991).
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Jonathan G. Katz,
Secretary.
[FR Doc. 94-27036 Filed 10-31-94; 8:45 am]
BILLING CODE 8010-01-M
