01-13882. Self-Regulatory Organizations; Order Approving a Proposed Rule Change by the Pacific Exchange, Inc. Concerning Financial Arrangements of Options Floor Members

May 25, 2001.

I. Introduction

On July 12, 2000, pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) ^[1] and Rule 19b-4 thereunder,^[2] the Pacific Exchange, Inc. (“PCX” or “Exchange”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) a proposed rule change to eliminate PCX Rule 6.40, which pertains to financial arrangements of options floor members, and to adopt supplemental rules on options floor members who are trading for the same joint account.^[3] The PCX submitted Amendment No. 1 to the proposed rule change on November 29, 2000.^[4] The proposed rule change, as amended, was published for comment and appeared in the Federal Register on December 22, 2000.^[5] The Commission received no comments on the proposal. This order approves the PCX's proposed rule change, as amended.

II. Description of the Proposal

The PCX proposes to eliminate PCX Rule 6.40, which currently prohibits options floor members with financial arrangements from trading in the same trading crowd unless they have received either a short-term or a long-term exemption from the Options Floor Trading Committee.

The PCX proposes to replace PCX Rule 6.40 with PCX Rule 6.84(h), which governs options floor trading for joint accounts. Proposed subsection (h)(1) of PCX Rule 6.84 states that a joint account may be simultaneously represented in a trading crowd only by participants who are trading in person. It further provides that orders for a joint account may not be entered in a trading crowd in which a participant of the joint account is trading in person for the joint account. If no participant is trading in person in the trading crowd for the joint account, then a floor broker may represent orders in the trading crowd on behalf of the joint account as long as the same option series is not concurrently represented by more than one floor broker.

Proposed subsection (h)(2) of PCX Rule 6.84 provides that market makers may alternate trading in-person between their individual and joint accounts while in the trading crowd. It further provides that market makers who alternate trading between accounts must ensure that while trading the joint account another participant does not enter orders through a floor broker for the joint account in the same trading crowd.

Proposed subsection (h)(3) of PCX Rule 6.84 provides that before beginning trading on behalf of a joint account, participants in the joint account are responsible for determining whether any floor brokers are representing orders in the same trading crowd on behalf of the same joint account.^[6]

Proposed subsection (h)(4) of PCX Rule 6.84 provides that floor brokers may not represent a joint account of which they are a participant.

Proposed subsection (h)(5) of PCX Rule 6.84 provides that market makers who are trading in person in a trading crowd may not enter orders with a floor broker either for joint accounts in which they are participants or for their individual accounts.

Proposed subsection (h)(6) of PCX Rule 6.84 provides that the following trades are prohibited: (a) Trades between a joint account participant's individual account and a joint account in which that person is a participant; (b) trades between two joint accounts having common participants; and (c) trades in which the buyer and seller are representing the same joint account and are on opposite sides of the transaction.

PCX Rule 6.85 currently provides that a market maker and a floor broker who represents orders on behalf of the market maker may not be represented at a trading post concurrently. This principle against dual representation of a market maker account has been extended to cover joint accounts, as currently provided in PCX Rule 6.84, Commentary .04.^[7] The Exchange is now proposing to adopt supplemental procedures that apply to situations where a joint account is being concurrently represented by more than one market maker representative, and to situations where a joint account is being represented by a floor broker.^[8]

Finally, the Exchange is proposing to make technical changes to PCX Rule 4.18 and PCX Rule 6.84 by removing cross-references to PCX Rule 6.40.

III. Discussion

The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules thereunder applicable to a national securities exchange, particularly section 6(b)(5) of the Act.^[9]

PCX Rule 6.40 restricts PCX floor members who have financial arrangements with each other from trading in the same trading crowd at the same time in the absence of an exemption. The purpose of PCX Rule 6.40 is to prevent market makers who have financial arrangements with each other from unfairly dominating the market in any option class or series.

The Commission finds that it is appropriate for the PCX to eliminate PCX Rule 6.40 and to adopt new provisions under PCX Rule 6.84 imposing trading restrictions on PCX members who trade on behalf of the same joint account. The revisions to PCX Rule 6.84 specify the circumstances when orders may be entered or represented in a trading crowd on behalf of a joint account, and also prohibit certain trades between joint accounts. Moreover, the new provisions of PCX Rule 6.84 govern the practice of market makers alternating trading between their individual and joint accounts. Finally, as the PCX points out, PCX Rule 6.37(c)(2) precludes market makers, individually or as a group, from dominating the market irrespective of whether the parties have a financial arrangement with each other.

In view of the foregoing, the Commission believes that the elimination of PCX Rule 6.40, in conjunction with the codification of new paragraph (h) of PCX Rule 6.84, should help assure an appropriate balance between the need to impose reasonable trading restrictions for joint account participants and the need to allow PCX members flexibility to participate in trading crowds. Accordingly, the Commission finds that the PCX's proposal is designed to promote just and equitable principles of trade, to facilitate transactions in securities, to remove impediments to and perfect the mechanism of a free and open market, and to protect investors and the public interest, as specified in section 6(b)(5) of the Act.^[10]

IV. Conclusion

It Is Therefore Ordered, pursuant to section 19(b)(2) of the Act,^[11] that the proposed rule change (File No. SR-PCX-00-21) is approved.^[12]

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

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  The PCX subsequently submitted the text of the proposed rule change language properly formatted for publication in the Federal Register. The reformatted version did not contain any substantive changes to the proposed rule change language. See letter dated November 1, 2000, from Michael D. Pierson, PCX, to Kelly Riley, Division of Market Regulation, SEC.

4.  Letter dated November 29, 2000, from Michael D. Pierson, PCX, to Nancy J. Sanow, Assistant Director, Division of Market Regulation, SEC.

5.  Securities Exchange Act Release No. 43714 (December 12, 2000), 65 FR 80970 (December 22, 2001).

6.  Cf. PCX Rule 6.85, Commentary .01 (similar requirement applicable to market makers).

7.  Commentary .04 of PCX Rule 6.84 provides:

Any order of a joint account participant, which is executed by a Floor Broker, shall be in accordance with procedures set forth in Rule 6.85, except that the joint account trading number with its alpha identification should appear in the ‘executing firm’ area. Additionally, a joint account participant may not bid, offer, purchase, sell, or enter orders in an option series in which a Floor Broker holds an order on behalf of the joint account or for the proprietary account of another participant in the joint account. Orders of joint account participants in a particular option series may not be concurrently represented by one or more Floor Brokers.

8.  The Exchange believes that these procedures are substantially the same as those set forth in Regulatory Circular RG-98-94 of the Chicago Board Options Exchange (Joint Account Participant Trading in Equity Options) (September 9, 1998), CCH ¶5291.

9.  15 U.S.C. 78f(b)(5).

10.  15 U.S.C. 78f(b)(5).

11.  15 U.S.C. 78s(b)(2).

12.  In approving the proposal, the Commission has considered the rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 17 CFR 200.30-3(a)(12).

13.  17 CFR 200.30-3(a)(12).