02-31401. Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by the Pacific Exchange, Inc. Regarding Market Maker Quoting Obligations

December 4, 2002.

Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”),^[1] and rule 19b-4 thereunder,^[2] notice is hereby given that on August 7, 2002, the Pacific Exchange, Inc. (“PCX” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in items I, II, and III below, which items have been prepared by the Exchange. On November 8, 2002, the Exchange submitted Amendment No. 1 to the proposed rule change.^[3] The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

The Exchange proposes to adopt PCX rules 6.37(a)(5) and 6.37(c)(4), and amend commentary .05 to PCX rule 6.37 to require options market makers to vocalize a legal-width, two-sided market for a minimum of 10 contracts whenever a floor broker enters a trading crowd and calls for a market in an option series that is one of the 120 most actively traded equity options.^[4]

The text of the proposed rule change appears below. New text is in italics.

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Text of the Proposed Rule Change

Pacific Exchange, Inc.; Rules of the Board of Governors

¶4935 Obligations of Market Makers

Rule 6.37(a)—No change.

(b) Appointment as a Primary Market Maker.—No change.

(1)-(4)—No change.

(5) Whenever a Floor Broker enters a trading crowd and calls for a market in a particular option series, each Market Maker present at the trading post will be obligated to vocalize a two-sided, legal-width market (pursuant to rule 6.37(b)(1)) for a minimum of 10 contracts. This obligation only applies to:

(A) Market Makers who have executed a transaction in the issue, but not those who have been assigned contracts by the Order Book Official pursuant to Commentary .05, on the day of the Floor Broker's call for a market or on the previous business day;

(B) Option issues that are ranked in the 120 most actively traded equity options based on the total number of contracts traded nationally as reported by the Options Clearing Corporation. For each current month, the Exchange's determination of whether an equity option ranks in the top 120 most active issues will be based on volume statistics for the one month of trading activity that occurred two months prior to the current month;

(C) Non-broker-dealer orders; and

(D) Series not designated as LEAPS (pursuant to rule 6.4).

(c) In Classes of Option Contracts Other Than Those to Which Appointed.—No change.

(1)-(3)—No change.

(4) Whenever a Floor Broker enters a trading crowd and calls for a market in a particular option series, each Market Maker present at the trading post will be obligated to vocalize a two-sided, legal-width market (pursuant to rule 6.37(b)(1)) for a minimum of 10 contracts. This obligation only applies to:

(A) Market Makers who have executed a transaction in the issue, but not those who have been assigned contracts by the Order Book Official pursuant to Commentary .05, on the day of the Floor Broker's call for a market or on the previous business day;

(B) Option issues that are ranked in the 120 most actively traded equity options based on the total number of contracts traded nationally for a specified month based on volume as reported by the Options Clearing Corporation. For each current month, the Exchange's determination of whether an equity option ranks in the top 120 most active issues will be based on volume statistics for the one month of trading activity that occurred two months prior to the current month;

(C) Non-broker-dealer orders; and

(D) Series not designated as LEAPS (pursuant to rule 6.4).

(d)-(f)—No Change.

Commentary .01-.04—No Change.

Commentary .05—Whenever a Floor Broker enters a trading crowd and calls for a market in any class and series at that post, each Market Maker present at the post where the option is traded is obligated, at a minimum, to make a market for one contract except as provided for in rule 6.37(b)(5) and rule 6.37(c)(4), at the established price. In addition, the Options Floor Trading Committee may determine that Market Makers in trading crowds shall increase the depth of their markets as set forth in Options Floor Procedure Advice B-12. In the event a Floor Broker is unable to satisfy his order from bids and offers given in the crowd, the Order Book Official may assign one contract to every Market Maker present within the primary zone to assist the Floor Broker in satisfying his order. If a Market Maker at the post either bids lower or offers higher than the established market, such Market Maker shall be obligated to trade one contract at the price quoted by the Market Maker.

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

In its filing with the Commission, PCX included statements concerning the purpose of, and basis for, the proposed rule change, as amended, and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in item III below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements.

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

1. Purpose

The Exchange proposes to modify PCX rule 6.37 to provide that, subject to certain conditions, whenever a floor broker enters a trading crowd and calls for a market, certain market makers present at the trading post will be obligated to vocalize a two-sided, legal-width market for a minimum of 10 contracts. This obligation would apply to: (a) Market makers who have executed a transaction in the issue, but not those who have been assigned contracts by the Order Book Official pursuant to PCX rule 6.37, commentary .05, on either the day of the floor broker's call for a market or on the previous business day;^[5] (b) option issues that are ranked in the top 120 most actively traded equity options; (c) non-broker dealer orders; and (d) series not designated as LEAPS.^[6] The proposed rule change would apply to market makers regardless of whether the issue is included in their primary appointment zones.

The Exchange would determine whether an equity option ranks in the top 120 most active, nationally-traded issues, based on volume statistics reported by the Options Clearing Corporation.^[7] The list of designated issues will be based on volume statistics for trading activity that occurred two months prior to the current month. For example, February's list of top 120 issues will be based on December's volume, March's list of top 120 issues will be based on January's volume, and so forth. Thereafter, the Exchange will continue to designate the top 120 issues based on a two-month lag time. The Exchange intends to notify its Members of the issues that are designated to be in the top 120 via a regulatory bulletin that will be published at the beginning of each month.

The Exchange represents that the proposed rule change is intended to enhance the quoting obligations of Exchange market makers. Currently, when floor brokers enter a trading crowd and request a market, market makers are only required to make a market for one contract.^[8] The Exchange believes that the proposed rule change will also provide greater depth and liquidity to the marketplace, and will therefore benefit the public.

2. Statutory Basis

The Exchange believes that the proposed rule change, as amended, is consistent with section 6(b) of the Act,^[9] in general, and furthers the objectives of section 6(b)(5) of the Act,^[10] in particular, in that it is designed to promote just and equitable principles of trade, to prevent fraudulent and manipulative acts and practices, and to protect investors and the public interest.

B. Self-Regulatory Organization's Statement on Burden on Competition

PCX does not believe that the proposed rule change, as amended, would impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.

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

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

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

Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding, or (ii) as to which the Exchange consents, the Commission will:

(A) By order approve such proposed rule change, as amended; or

(B) Institute proceedings to determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as amended, is consistent with the Act. Specifically, the Commission solicits comments on whether the proposal would have a detrimental effect on competition and liquidity on the Exchange. The Commission notes that the proposal to increase the quote size obligations for Top 120 options would apply to all market makers that have executed a trade on the same or previous day that a floor broker requests a market in a particular Top 120 option. The Commission understands that PCX market makers have continuous market making obligations in those options for which they have a primary appointment.^[11] In addition, the Commission understands that PCX market makers are permitted to make markets in option issues that are outside of their primary appointment.^[12] Accordingly, the Commission questions whether the proposal to increase market makers' quote size obligations would discourage some market makers from executing transactions in option issues that are outside of their primary appointment.

Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room. Copies of the filing will also be available for inspection and copying at the principal offices of the Exchange. All submissions should refer to File No. SR-PCX-2002-55 and should be submitted by January 3, 2003.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[13]

Jill M. Peterson,

Assistant Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See letter from Steven B. Matlin, Senior Counsel, PCX, to Nancy J. Sanow, Assistant Director, Division of Market Regulation (“Division”), Commission, dated November 7, 2002 (“Amendment No. 1”). In Amendment No. 1, the Exchange amended the proposed rule change by: (i) Changing the quotation minimum from 20 contracts to 10 contracts; (ii) adding an exception for market makers where a transaction occurs as a result of being assigned contracts by the order book official; (iii) making technical corrections to the rule text; and (iv) offering a basis for requesting accelerated effectiveness for the proposal.

4.  Subject to the conditions set forth in proposed PCX rule 6.37(b)(5)(A)-(D).

5.  See Amendment No. 1.

6.  See PCX rule 6.4.

7.  The Exchange notes that it intends to use the same procedure for designating the top 120 activity traded issues that it currently uses in designating such issues for purposes of its “shortfall fee.” See Securities Exchange Act Release No. 45351 (January 29, 2002), 67 FR 5631 (February 6, 2002) (SR-PCX-2001-51).

8.  See PCX rule 6.37, commentary .05.

9.  15 U.S.C. 78f(b).

10.  15 U.S.C. 78f(b)(5).

11.  See PCX rule 6.37(b). See also PCX rule 6.35.

12.  See PCX rule 6.37(c).

13.  17 CFR 200.30-3(a)(12).