[Federal Register Volume 59, Number 105 (Thursday, June 2, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-13344]
[[Page Unknown]]
[Federal Register: June 2, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34109; File No. SR-Phlx-93-29]
Self-Regulatory Organizations; Order Approving and Notice of
Filing and Order Granting Accelerated Approval of Amendment No. 1 to a
Proposed Rule Change by the Philadelphia Stock Exchange, Inc., Relating
to Enhanced Specialist Participation in Parity Options Trades.
May 25, 1994.
On August 9, 1993, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') filed with 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
proposed rule change relating to enhanced specialist participation in
parity options trades. Notice of the proposal appeared in the Federal
Register on September 20, 1993.\3\ One comment letter was received
opposing the proposed rule change,\4\ to which the Phlx responded.\5\
On April 19, 1994, the Exchange filed Amendment No. 1.\6\ 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 (1992).
\3\See Securities Exchange Act Release No. 32891 (September 14,
1993), 58 FR 48921.
\4\See Letter from Jay Mizrahi, General Partner, P.J. Shoreline
Securities (``Shoreline''), to Jonathan Katz, Secretary, Commission,
dated December 16, 1993 (``Shoreline Securities Letter'').
\5\See Letter from William Uchimoto, Vice President and General
Counsel, Phlx, to Sharon Lawson, Assistant Director, Office of
Derivatives and Equity Oversight (``ODEO''), Division of Market
Regulation (``Division''), Commission, dated February 23, 1994
(``Phlx Response Letter'').
\6\On April 19, 1994, the Exchange filed Amendment No. 1 to the
proposed rule change to specify that: (1) The Exchange's Allocation,
Evaluation and Securities Committee (``Committee'') may only extend
the proposed six month Enhanced Parity Split (as defined herein) for
one additional six month period; and (2) the Enhanced Parity Split
cannot cause a customer order to receive a smaller participation as
a result of this rule than any other crowd participant, including
the specialist. Further, Amendment No. 1 clarifies that (1) a ``New
Unit'' would be any new equity options specialist unit approved by
the Exchange on or after June 16, 1993; (2) a `New Options Class''
is any class of options listed for trading by the Exchange on or
after June 16, 1993; and (3) the Enhanced Parity Split may be
granted for a New Options Class after the initial six month period
has expired as long as the New Options Class is assigned to the New
Unit while it is still entitled to receive the Enhanced Parity Split
pursuant to the proposed rule change on the first New Options Class
it commenced trading. See Letter from Michele Weisbaum, Associate
General Counsel, Phlx, to Michael Walinskas, Branch Chief, ODEO,
Division, Commission, dated April 19, 1994 (``Amendment No. 1'').
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Description of Proposal
In order to encourage the registration with the Exchange of New
Units,\7\ the Exchange proposes to add now Commentary .17 to Rule 1014.
Specifically, the proposal would enable New Units trading New Options
Classes,\8\ to execute 50% of the contracts in transactions where the
New Unit is on parity with one registered options trader (``ROT''), and
40% of the contracts in a transaction where the New Unit is on parity
with two or more ROTs (``Enhanced Parity Split''); provided, however,
that no customer order which is on parity may receive a smaller
participation than any other crowd participant, including the
specialist.\9\
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\7\See Amendment No. 1, supra note 6.
\8\id.
\9\In such cases, the specialist may waive the Enhanced Parity
Split. Telephone conversation between Michele Weisbaum, Associate
General Counsel, Phlx, and Brad Ritter, Attorney, ODEO, Division,
Commission, on May 20, 1994.
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A New Unit can be formed by current ROTs and/or specialists as long
as a new broker-dealer firm is established. Because the proposal will
be limited to New Options Classes, options classes that are leased or
otherwise transferred from an existing specialist to a New Unit, or
that were listed on the Exchange prior to June 16, 1993, and which are
assigned to a New Unit, and not covered by the proposed rule.
The Enhanced Parity Split would be effective for a period of six
months from the commencement of trading by the New Unite of its first
New Options Class.\10\ Furthermore, the Committee may extend the
Enhanced Parity Split for one additional six month period upon petition
by the New Unit and a determination by the Committee that such
extension is consistent with the promotion of just and equitable
principles of trade and the public interest.\11\ The Enhanced Parity
Split will also be applicable to any additional New Options Classes
that are assigned to a New Unit, provided that at the time such classes
are assigned, the New Unit is still entitled to receive the Enhanced
Parity Split on the first New Options Class it commenced trading
pursuant to this rule.\12\ The Committee may terminate any extension of
the Enhanced Parity Split if the Committee determines that such action
is consistent with the promotion of just and equitable principles of
trade and the public interest.\13\
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\10\On August 17, 1992, the Exchange filed a similar proposal
pursuant to which all specialists would have received the enhanced
parity split contained in this proposal. See File No. SR-Phlx-92-19.
The Exchange has withdrawn that proposal. See Letter from Keith
Kessel, Phlx, to Brad Ritter, Attorney, Office of Derivatives
Regulation, Division of Market Regulation, Commission, dated
December 2, 1993. On February 28, 1994, the Exchange filed another
proposal which provides for a different form of enhanced parity
participation for existing specialist units and for New Units that
become ineligible for the Enhanced Parity Split pursuant to this
proposal. See Securities Exchange Act Release No. 33935 (April 20,
1994), 59 FR 22038 (April 28, 1994) (notice of File No. SR-Phlx-94-
12). If approved, the enhanced parity participation for specialists
proposed in File No. SR-Phlx-94-12 would not be available to New
Units that are eligible for the Enhanced Parity Split pursuant to
this proposal. Telephone conversation between Michele Weisbaum,
Associate General Counsel, Phlx, and Brad Ritter, Attorney, ODEO,
Division, Commission, on April 20, 1994.
\11\See Amendment No. 1, supra note 6.
\12\Once granted, the Enhanced Parity Split on additional New
Options Classes assigned to a New Unit may remain in effect for up
to one year as provided herein even though the Enhanced Parity Split
on the first New Options Class assigned to the New Unit terminates
during that time period. Id.
\13\The Exchange represents that a New Unit will need the
initial six month period in order to establish a trading record in
the New Options Class. If, however, the New Unit's performance
during the initial six month period is substandard, the Committee
may reallocate the particular options class to another specialist
pursuant to Phlx Rule 511. See Letter from William Uchimoto, General
Counsel, Phlx, to Richard Zack, Branch Chief, ODEO, Division,
Commission, dated January 5, 1994.
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Comment Letter
The Comment letter received opposing the proposed rule change made
several arguments as to why the proposed rule change is
inappropriate.\14\ The commenter first argues that the Exchange has no
evidence that granting an Enhanced Parity Split to New Units will in
any way benefit Phlx public customers. In fact, the letter argues that
the proposed rule is anti-competitive and will ultimately harm public
customers by acting as a disincentive for ROTs to make competitive
markets, thus removing liquidity from the market. Shoreline believes
that price competition is restricted whenever the specialist is granted
a benefit not available to the ROTs in the crowd. Shoreline also argues
that there is no evidence that the Enhanced Parity Split will encourage
New Units to make tight and liquid markets, as the Phlx claims.
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\14\See Shoreline Securities Letter, supra note 4.
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The commenter's next argument is that the proposed rule allows, but
does not require, the New Unit to invoke the Enhanced Parity Split.
Shoreline believes that this further harms ROTs because there may be
instances where ROTs are forced to accept a greater percentage of an
undesirable trade than they would if the New Unit is required to accept
the Enhanced Parity Split.
Shoreline also argues that by allowing existing specialists and
ROTs to form New Units, the proposal does not serve its stated purpose,
which is to encourage the formation and registration with the Exchange
of new specialist units.
Finally, the commenter argues that the Phlx has provided no
specific criteria for maintaining or revoking the Enhanced Parity Split
with respect to a particular New Options Class. Shoreline believes that
if the Enhanced Parity Split is to be offered to New Units, the
Committee should have objective standards to apply in making a
determination of whether to extend the Enhanced Parity Split for the
allowed additional six month period.
Phlx Response
The Phlx refutes the arguments raised by Shoreline.\15\ First, the
Phlx believes that the proposal will in fact add liquidity to the
market, thus directly benefiting public customers. The Phlx believes
the proposal will attract new specialist units to the Exchange and will
encourage these New Units to make tight markets in New Options Classes
in order to attract order flow to the Exchange. The Phlx argues that
because every newly listed options class is subject to multiple
listings, disincentives are created which discourage specialist units
from acting as specialists for those new classes of options. The Phlx
believes that the Enhanced parity Split will counteract these
disincentives by offering New Units a direct benefit if they are able
to attract order flow to the Exchange. The Exchange believes the New
Units will be able to attract this order flow, and thus capitalize on
the Enhanced Parity Split, only if they maintain tight markets in the
New Options Classes. As a result, the Phlx believes that public
customers will directly benefit from the proposed rule change.
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\15\See Phlx Response Letter, supra note 5.
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The Phlx also disagrees with Shoreline's contention that any
enhanced split is anti-competitive. First, the Enhanced Parity Split is
available to any market making firm that is willing to establish a New
Unit. Secondly, the proposal does not impact parity splits on existing
options classes or New Options Classes traded by existing specialist
units. Finally, a market maker can always establish priority in a trade
by improving the market or by being the first in establishing a market
that would otherwise be on parity.
In response to the commenter's claims that market makers are
unfairly disadvantaged by this proposal, the Phlx makes several
arguments. First, the Phlx states that the claims that market makers
will be hampered in hedging trades where they improve the market does
not take into account the possibility that the market maker may be able
to hedge by improving both sides of the market or by utilizing another
options series for purposes of hedging. Additionally, the proposal does
not impact in any manner the ability of a market maker to hedge an
options position with underlying stock. Further, the Phlx argues that
specialists have responsibilities and are subject to certain costs that
market makers do not have, such as, updating and disseminating quotes,
reflecting all market interest in the displayed quotes, and the fixed
staffing cost committed to market making in a particular issue whether
it is active or not. In order to attract specialist units to the
Exchange who are willing to accept these responsibilities, the Phlx
believes it is necessary to provide specialists with some benefits that
are not available to ROTs. The Phlx believes that any negative impact
to ROTs that may be caused by this proposal is more than offset by the
benefit to the Exchange and its customers of attracting New Units to
the Exchange.
The Phlx also refutes the commenter's claim that ROTs are further
harmed because the New Unit is not required to invoke the Enhanced
Parity Split. The Phlx argues that because specialists and ROTs both
desire to buy at the bid and sell at the ask, there should be few
undesirable trades where the specialist would not find it desirable to
invoke the Enhanced Parity Split. As a result, the Exchange believes
that any negative impact on the ROTs as a result of the permissive
nature of the rule will be de minimis.
Finally, the Phlx argues that because the Enhanced Parity Split can
apply to a New Options Class for at most one year, the Exchange does
not believe that detailed evaluative criteria for use in awarding or
removing the Enhanced Parity Split will be particularly effective or
necessary. The Exchange believes that by the time that the New Unit
establishes a trading history which can be reviewed and evaluated, the
Enhanced Parity Split will probably have lapsed. Even without such
criteria, however, the Phlx notes that the Committee has the ability to
review the performance of a New Unit and to remove the Enhanced Parity
Split at the end of the initial six month period, or in more egregious
cases, to reallocate an options class for inadequate specialist
performance.
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, the requirements of section 6(b)(5)\16\ in that the
proposal is designed to promote just and equitable principles of trade,
to remove impediments to and perfect the mechanism of a free and open
market, and protect investors and the public interest. Specifically,
the Commission finds that the proposal may serve to remove impediments
to and perfect the mechanism of a free and open market by encouraging
the creation of New Units and by encouraging those New Units to
maintain tight markets for New Options Classes in order to attract
order flow to the Exchange. The Commission believes the proposed rule
change is a reasonable attempt by the PHlx to enhance the ability of
New Units to compete for order flow in the environment of multiply-
traded options classes. In addition, the protection of investors and
the public interest is maintained because the Committee can refuse to
extend the Enhanced Parity Split for an additional six months if the
performance of the New Unit does not warrant an extension. Further, the
proposed rule change provides the Enhanced Parity Split cannot
disadvantage a public customer order that is on parity with a New
Unit.\17\
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\16\15 U.S.C. 78f(b)(5) (1988).
\17\See Amendment No. 1, supra note 6.
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The Commission agrees with the Exchange that in order to attract
order flow to the Exchange, the Phlx needs to be able to attract and
retain well capitalized specialist units that are willing to trade New
Options Classes, as well as existing options classes. Further, the
Commission disagrees with the commenter that the proposed rule change
will disadvantage public customers. On the contrary, the proposed rule
change eliminates any direct injury to public customers by providing
that customer orders on parity may not receive a smaller participation
than any other crowd participant, including the specialist.\18\
Furthermore, because the proposal may serve to add liquidity to the
market by encouraging New Units to maintain tight markets in order to
attract order flow to the Exchange, the Commission believes that public
customers could benefit from the proposed rule change.\19\ Accordingly,
the Commission believes there is no evidence to support a conclusion
that the proposed rule change will disadvantage public customers.
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\18\The specialist may waive the Enhanced Parity Split in these
circumstances. See supra note 9.
\19\The Commission notes that contrary to the commenter's
contention, ROTs may in fact benefit from the Enhanced Parity Split
if the New Units are successful in attracting order flow to the
Exchange.
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The Commission also acknowledges that specialists have
responsibilities that ROTs do not have and that these responsibilities
have certain costs associated with them, such as the staff costs
associated with continually updating and disseminating quotes. As a
result, the Commission believes it is reasonable for the Exchange to
grant certain advantages, such as the Enhanced Parity Split, to New
Units in order to encourage New Units to register as specialists for
New Options Classes. Accordingly, as long as these advantages do not
unreasonably restrain competition and do not harm investors, the
Commission believes that the granting of such benefits to specialists
is within the business judgment of the Exchange. Therefore, even though
the proposed rule change could arguably have some negative impact on
ROTs, for the reasons stated above, the Commission believes the
proposal is consistent with the Act.\20\
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\20\Further, the Commission disagrees with the commenter that
ROTs may be disadvantaged by the fact that New Units are not
required to accept the Enhanced Parity Split in those instances
where it applies. In those cases where a New Unit determines to
waive the Enhanced Parity Split, the Exchange's normal parity rules
will apply and the ROTs involved will be no worse off than they
would on any other parity trade.
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Finally, the Commission agrees with the Phlx that the lack of
quantifiable standards for the Committee to apply in determining
whether to extend the Enhanced Parity Split for an additional six month
period does not make the proposal unreasonable. Even if the Phlx
proposed such standards, some time period would be necessary in order
for the New Unit to establish a trading history in the New Option Class
in order for such a review to have any validity. In addition, the
Committee still will review the performance of the New Unit in
determining whether to extend the Enhanced Parity Split for an
additional six months for particular New Options Classes. Because the
Enhanced Parity Split can be in effect for at most one year for each
New Options Class, the Commission believes that the lack of such
standards does not prevent a finding that the proposal is consistent
with the Act.
The Commission finds good cause for approving Amendment No. 1 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register. First,
Amendment No. 1 limits to one year the maximum time period during which
the Enhanced Parity Split can exist with respect to any New Options
Class and provides that the proposed rule cannot disadvantage customer
orders. The purpose of the Enhanced Parity Split is to encourage New
Units to maintain tight spreads in New Options Classes, which is a
benefit to investors. The Commission believes that providing such an
incentive to specialists is appropriate for New Options Classes for the
period during which the market for such options classes is being
established as long as safeguards exist to ensure that customers are
not harmed. As a result, the Commission believes these amendments
accomplish these goals consistent with the Act. Secondly, Amendment No.
1 also clarifies certain aspects of the proposed rule change. The
Commission believes that these amendments strengthen the proposed rule
change by minimizing any confusion that may arise as to the
applicability of the rule. As a result, the Commission believes it is
consistent with section 6(b)(5) of the Act to approve Amendment No. 1
to the Phlx's proposal on an accelerated basis.
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 1 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW., Washington, DC 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 in the Commission's Public
Reference Section, 450 Fifth Street, NW., Washington, DC. Copies of
such filing will also be available for inspection and copying at the
principal office of the Exchange. All submissions should refer to File
No. SR-Phlx-93-29 and should be submitted by June 23, 1994.
It is therefore ordered, pursuant to section 19(b)(2) of Act,\21\
that the proposed rule change (SR-Phlx-93-29) is hereby approved, as
amended.
\21\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.\22\
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\22\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-13344 Filed 6-1-94; 8:45 am]
BILLING CODE 8010-01-M
