[Federal Register Volume 59, Number 220 (Wednesday, November 16, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-28216]
[[Page Unknown]]
[Federal Register: November 16, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34946; File No. SR-PSE-94-18]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Pacific Stock Exchange, Inc., Relating to the Expansion
of the Exchange's Auto-Ex System Capacity to 20 Contracts
November 7, 1994.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ on June 20, 1994, the
Pacific Stock Exchange, Inc. (``PSE'' or ``exchange'') submitted to the
Securities and Exchange Commission (``SEC'' or ``Commission'') a
proposed rule change to amend PSE Rule 6.87, ``Automatic Execution
System,'' to allow the Options Floor Trading Committee (``OFTC'') to be
authorized to increase, on an issue-by-issue basis, the size of the
equity option orders that may be eligible to be executed through the
Exchange's Automatic Execution System (``Auto-Ex'') up to a maximum of
20 contracts.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
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The proposal was published for comment in Securities Exchange Act
Release No. 34702 (September 22, 1994), 59 FR 49729 (September 29,
1994). The Commission received one comment letter on the proposal,\3\
in addition to the PSE's response to the letter.\4\
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\3\See Letter from Jeffery C. Hauke, JMD Trading Co., to the
Commission, dated September 12, 1994 (``September 12 Letter''). In a
subsequent letter, the commenter clarified that his comments are
applicable to File No. SR-PSE-94-18 rather than to File No. SR-PSE-
94-19. See Letter from Jeffery C. Hauke, JMD Trading Co., to the
Commission, dated October 10, 1994.
\4\See Letter from David P. Semak, Vice President, Regulation,
PSE, to Jonathan G. Katz, Secretary, Commission, dated October 31,
1994 (``October 31 Letter'').
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The Auto-Ex system, a feature of the PSE's Pacific Options Exchange
Trading System (``POETS''), permits eligible market or marketable limit
orders sent from member firms to be executed automatically at the
displayed bid or offering price. Participating market makers are
designated as the contra side to each Auto-Ex order.\5\ Participating
market makers are assigned by Auto-Ex on a rotating basis, with the
first market maker selected at random from the list of signed-on market
makers. Auto-Ex preserves public Limit Order Book (``Book'') priority
in all options. If Auto-Ex determines that the Book price is at or
better than the market quote, the Auto-Ex order is executed against the
Book. Automatic executions through Auto-Ex are currently available for
public customer orders of 10 contracts or less in all series of options
traded on the PSE's options floor.
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\5\The Commission recently approved an Exchange proposal setting
forth certain standards for market makers participating on Auto-Ex.
The standards include restrictions on the number of Auto-Ex trading
posts at which market makers may participate and mandatory log-on
requirements to assure that market makers do not withdraw from the
system during volatile market conditions. See Securities Exchange
Act Release No. 32908 (September 15, 1993), 58 FR 49076 (September
21, 1993).
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The Exchanges proposes to amend PSE Rule 6.87 to increase the
maximum size of equity option orders eligible for Auto-Ex and to
provide the OFTC with the authority to designate such changes on an
issue-by-issue basis. Under the proposal, the OFTC is authorized to
increase the size of orders eligible for an execution on Auto-Ex to a
size of up to 20 contracts without separate approval from the
Commission.\6\ The PSE states that the proposed rule change is designed
to enhance the Exchange's ability to compete for options order flow.
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\6\The Commission recently approved an Exchange proposal to
allow the OFTC to increase the size of Auto-Ex-eligible orders in
one or more classes of multiple traded equity options to the extent
that other options exchanges permit such larger-size orders to be
entered into their own automated execution systems. The rule
provides that if the OFTC intends to increase the Auto-Ex size
eligibility pursuant to the rule, the Exchange will submit a
proposed rule change to the Commission pursuant to Section
19(b)(3)(A) under the Act. See securities Exchange Act Release No.
34131 (May 27, 1994), 59 FR 29316 (June 6, 1994).
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The PSE believes that any implementation of the proposal by the
OFTC will not impose any significant additional burdens on the
operation and capacity of the POETS system in general or on the Auto-Ex
system in particular. In that regard, the Exchange has submitted a
separate capacity statement to the Commission setting forth the basis
for this contention.\7\ The exchange also represents that the OFTC will
determine that adequate market making capacity exists prior to
increasing Auto-Ex order size eligibility. The OFTC will make such a
determination notwithstanding the fact that floor officials may require
market makers who are members of a trading crowd to which a particular
option class is assigned to log onto Auto-Ex in the event that there is
inadequate participation in that options class.
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\7\See Letter from Michael D. Pierson, Senior Attorney, PSE, to
Richard L. Zack, Branch Chief, Options Regulation, Commission, dated
December 20, 1993 (File No. SR-PSE-93-26).
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The PSE believes that the proposal is consistent with Section 6(b)
of the Act, in general, and with Section 6(b)(5), in particular, in
that it is designed to facilitate transactions in securities and to
promote just and equitable principles of trade.
As noted above, the Commission received one comment letter
concerning the proposal.\8\ In his September 12 Letter, the commenter
argues that the proposal violates certain provisions of the Exchange's
Certificate of Incorporation. Specifically, the commenter states that
floor brokers in the trading crowd have no opportunity to participate
in trades that are eligible for automatic execution through Auto-Ex
unless they ``book'' their orders. Notwithstanding this, because
certain types of orders, such as contingent orders and spreads, cannot
be placed on the book, book orders represented in the crowd are not
eligible for execution against orders entered through Auto-Ex.
Therefore, the commenter believes that as a member of the Exchange, he
should have an equal opportunity to participate in trades that occur on
the Exchange floor. Finally, the commenter questions why the semi-Auto-
Ex function, which would solve his concerns, has not been utilized on
the PSE.
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\8\See September 12 Letter, supra note 3.
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On October 31, 1994, the PSE submitted a letter responding to the
comment letter.\9\ In its October 31 Letter, the PSE states that the
Commission has approved automatic execution systems on other options
exchanges and, in approving POETS, has concluded that POETS provides
substantial benefits to public customers. In addition, the Exchange
argues that providing floor brokers with the opportunity to participate
in all trades on the Exchange floor would require the elimination of
Auto-Ex, which would be inconsistent with the Commission's
determination to give priority to small public customer orders and
would place the PSE at a competitive disadvantage with the other
options exchanges. In response to the commenter's statement about semi-
Auto-Ex, the PSE notes that the semi-Auto-Ex feature of POETS has never
been implemented and that the Exchange continues to study the software
and precise mechanism necessary to implement semi-Auto-Ex. Finally, the
PSE argues that POETS and Auto-Ex has been approved previously by the
Commission, and therefore that the arguments raised by the commenter
are untimely.
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\9\See October 31 Letter, supra note 4.
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The Commission has considered carefully the opinions of the
commenter and the PSE and finds, for the following reasons, 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. Specifically, the Commission finds that the
proposal is consistent with Section 6 and Section 11A of the Act.\10\
The Commission continues to believe that the development and
implementation of Auto-Ex provides for more efficient handling and
reporting of orders in PSE equity options through the use of new data
processing and communications techniques, thereby improving order
processing and turnaround time. The Commission believes that Auto-Ex
has benefitted public customers by ensuring that a POETS order will be
executed at the current disseminated quotation, and by allowing small
public customer orders to receive immediate executions and nearly
instantaneous confirmations of orders.\11\ Accordingly, the Commission
believes that expanding the eligibility of Auto-Ex to public customer
orders of up to 20 contracts for all PSE-traded equity options is
consistent with Section 6(b)(5) in that it will extend the benefits of
automatic execution in equity options to a greater number of public
customer orders while continuing to ensure adequate limit order
protection.
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\10\15 U.S.C. 78f and 78k-1 (1988).
\11\See Securities Exchange Act Release No. 32703 (July 30,
1993), 58 FR 42117 (August 6, 1993) (order approving File No. SR-
PSE-92-37) (``POETS Approval Order''). The Commission believes that
the rationale in the POETS Approval Order supporting approval of
Auto-Ex applies equally to the current proposal, and incorporates
that rationale into the current discussion.
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In regard to the commenter's specific concern, the Commission
previously has approved small order execution systems for option
exchanges. For all of these systems, the Commission has found that
interaction with the limit order book was sufficient to provide limit
order protection. Merely increasing the size of Auto-Ex eligible orders
to 20 contracts does not change the character of Auto-Ex orders
sufficiently to warrant a reexamination of whether Auto-Ex orders
should interact with trading crowd orders. Orders of 20 contracts or
less are still small sized orders, and truly large orders will continue
to interact with the trading crowd.
In addition, the Commission believes that the proposal will
facilitate transactions in securities and promote competition among
options markets by placing the PSE in an equal competitive posture with
the other options exchanges when competing for order flow in equity
options. In this regard, the Commission notes that the American Stock
Exchange's and the Chicago Board Options Exchange's automatic execution
systems both have Commission approval to accommodate public customer
equity option orders of up to 20 contracts, and that the Philadelphia
Stock Exchange's automatic execution system has Commission approval to
accommodate public customer equity option orders of up to 25
contracts.\12\ Accordingly, the Commission believes that the PSE's
proposal is consistent with the Act because it eliminates constraints
in the PSE's rules that restrict the Exchange's ability to compete for
order flow in equity options. The Commission believes that enhanced
competition among the exchanges for options order flow, in turn, should
benefit public investors and the public interest.
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\12\See Securities Exchange Act Release Nos. 32906 (September
15, 1993) 58 FR 49345 (September 22, 1993) (order approving File No.
SR-PHLX-92-38); 28411 (September 6, 1990), 55 FR 49345 (September
13, 1990) (order approving File Nos. SR-CBOE-89-27 and 89-29); and
24899 (September 10, 1987), 52 FR 35012 (September 16, 1987) (order
approving File No. SR-Amex-87-21).
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Finally, the Commission believes, based on representations by the
Exchange, that expanding the order eligibility size of Auto-Ex to 20
contracts for all equity options will not expose the PSE's options
markets or equity markets to risk of failure or operational break-down.
The Exchange also states that the OFTC will determine that adequate
market making capacity exists prior to increasing the order size
eligibility for any issue pursuant to the proposal.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\13\ that the proposed rule change (SR-PSE-94-18) is approved.
\13\15 U.S.C. 78s(b)(2). (1982).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\14\
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\14\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-28216 Filed 11-15-94; 8:45 am]
BILLING CODE 8010-01-M
