[Federal Register Volume 59, Number 134 (Thursday, July 14, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17096]
[[Page Unknown]]
[Federal Register: July 14, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34338; File Nos. SR-PSE-93-19]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment Nos. 2 and 3 to Proposed Rule Change by the Pacific Stock
Exchange, Inc. Relating to Extension of Market Maker Margin and Capital
Treatment to Certain Market Maker Orders Entered From Off the Trading
Floor
July 8, 1994.
On August 13, 1993, as amended on March 28, 1994, April 21, 1994,
and May 6, 1994, the Pacific Stock Exchange, Inc. (``PSE'' or
``Exchange'') filed with 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 proposal to extend market maker capital and margin
treatment to orders entered by PSE market makers from off the Exchange
floor, provided that at least 80% of their total transactions on the
Exchange are executed in person and not through the use of orders. In
addition, the proposal requires that all off-floor orders for which a
market maker receives market maker treatment be consistent with a
market maker's duty to maintain fair and orderly markets and, in
general, be effected for the purpose of hedging, reducing the risk of,
or rebalancing open positions of the market maker. The PSE originally
proposed requiring that 75% of a market maker's total transactions on
the PSE be executed on the PSE's floor. In addition, the original
proposal did not contain any reference to market making obligations.
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\1\15 U.S.C. 78s(b)(1) (1984).
\2\17 CFR 240.19b-4 (1993).
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The original proposal was published for comment in Securities
Exchange Act Release No. 32958 (September 24, 1993), 58 FR 51661
(October 4, 1993). No comments were received on the proposal. This
order approves the PSE's proposal, as amended.\3\
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\3\On March 28, 1994, the PSE amended its proposal to change
references in PSE Rule 6.32, Commentary .02 from ``Commentary
.07(A)'' to ``Commentary .07'' and to change the phrase ``set forth
in'' to ``provided in'' (``Amendment No. 1''). Amendment No. 1 is
technical in nature and makes no substantive changes. On April 21,
1994, the PSE amended its proposal to provide that 80%, rather than
75%, of a market maker's total transactions on the PSE be executed
in person on the PSE's floor (``Amendment No. 2''). In addition,
Amendment No. 2 states that the off-floor orders for which a market
maker receives market-maker treatment shall be consistent with a
market maker's duty to maintain fair and orderly markets and in
general shall be effected for the purpose of hedging, reducing the
risk of, or rebalancing open positions of the market maker. By a
letter dated May 6, 1994, the PSE deleted a provision that provided
that market makers who elected to enter orders from off the
Exchange's floor but failed to meet the 80% requirement would be
subject to the sanctions provided in PSE Rule 6.37, ``Obligations of
Market Makers,'' Commentary .07. See Letter from Michael Pierson,
Senior Attorney, Market Regulation, PSE, to Yvonne Fraticelli, Staff
Attorney, Options Branch, Division of Market Regulation
(``Division''), Commission, dated May 6, 1994 (``Amendment No. 3'').
Instead, under Amendment No. 3, market makers who fail to comply
with the proposal's requirements will be subject to disciplinary
proceedings under PSE Rule 10. By a letter dated June 13, 1994, the
Exchange indicated that it plans to issue a circular to its members
describing the proposal and emphasizing the importance of monitoring
off-floor trading activity. See Letter from Michael D. Pierson,
Senior Attorney, Market Regulation, PSE, to Yvonne Fraticelli, Staff
Attorney, Options Branch, Division, Commission, dated June 13, 1994
(``June 13 Letter'').
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Currently, under PSE Rule 6.32, ``Market Maker Defined,'' only
transactions initiated on the PSE's floor count as market maker
transactions. Thus, only on-floor market maker transactions qualify for
favorable capital and margin treatment under the PSE's rules, even if
such orders are entered to adjust or hedge the risk of positions of the
market maker that result from his on-floor market making activity.\4\
The PSE states that because a market maker cannot effectively adjust
his positions or engage in hedging or other risk limiting opening
transactions from off the Exchange floor without incurring a
significant economic penalty, PSE market makers must either be
physically present on the floor at all times while the market is open,
or face significant risks of adverse market movements during those
times when they must necessarily be absent from the trading floor. The
PSE argues that by imposing costs on certain hedging or risk-adjusting
transactions of market makers, the PSE's current rules may prevent
market makers from effectively discharging their market making
obligations and expose them to unacceptable levels of risk.
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\4\Questions of margin and capital treatment do not arise in
connection with closing transactions initiated from off the floor,
since they only reduce or eliminate existing positions.
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The Exchange states that its proposal is designed to accommodate
the occasional needs of PSE market makers to adjust or hedge options
positions in their market maker accounts at times when they are not
physically present on the trading floor, without diluting the
requirement that the trading activity of market makers must fulfill
their market making obligations and must contribute to the maintenance
of a fair and orderly market on the Exchange.
Currently, under PSE Rule 6.35, ``Appointment of Market Makers,''
Commentary .03, all PSE market makers are obligated to effect not less
than 75% of their contract volume in their appointed classes of
options. In addition, under PSE Rule 6.37, Commentary .07, PSE market
makers are required to effect not less than 60% of their total
transactions in person on the trading floor and not by entry of orders.
The PSE proposes to amend Exchange Rule 6.32, ``Market Maker Defined,''
Commentary .02, to allow market makers who elect to meet a more
stringent in-person requirement to receive market maker margin and
capital treatment for opening transactions executed through off-floor
orders. Specifically, the PSE proposes to amend PSE Rule 6.32 to allow
market makers to elect to receive market maker treatment for off-floor
opening transactions if the market maker, in addition to satisfying all
of the other existing obligations imposed on market makers, executes at
least 80% of his total transactions for any calendar quarter in person
and not through the use of orders. In addition, the off-floor orders
for which a market maker receives market maker treatment shall be
consistent with a market maker's duty to maintain fair and orderly
markets and in general shall be effected for the purpose of hedging,
reducing risk of, rebalancing or liquidating open positions of the
market maker.\5\
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\5\See Amendment No. 2, supra note 3.
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PSE market makers who elect market maker treatment for off-floor
opening transactions but fail to satisfy the proposal's requirements,
including the 80% in-person requirement, will be subject to full
disciplinary proceedings under Chapter 10 of the PSE's rules.\6\ Under
PSE Rule 10.1, ``Disciplinary Jurisdiction,'' the Exchange may impose
appropriate discipline for violations of the Act and the Exchange's
rules, including expulsion, suspension, limitation of activities,
functions, and operations, suspension or bar from association with a
member or member organization, fine, censure, or any other fitting
sanction.
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\6\See Amendment No. 3, supra note 3.
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The PSE believes that the amended proposal presents a more
appropriate and realistic treatment of market maker transactions
initiated from off the trading floor than what is provided for under
existing Exchange Rule 6.32. The PSE believes that extending favorable
margin and capital treatment for off-floor transactions only to those
market makers who submit to an 80% in-person requirement should have
the effect of increasing the extent to which market maker transactions
contribute to liquidity and to the maintenance of fair and orderly
markets on the PSE by providing for a greater degree of in-person
trading by market makers and by enabling market makers to better manage
the risk of their market making activities.
The PSE believes that the proposal is consistent with Section 6(b)
of the Act, in general, and furthers the objectives of Section 6(b)(5),
in particular, in that it will promote the maintenance of fair and
orderly markets on the PSE and will contribute to the protection of
investors and the public interest.
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, with the requirements of Section 6(b)(5) in that the
proposal is designed to promote just and equitable principles of trade
and to protect investors and the public interest.\7\ In addition, the
Commission finds that the proposal is consistent with the requirement
under Section 11(a) of the Act that a member's transactions not be
inconsistent with the maintenance of fair and orderly markets.\8\
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\7\15 U.S.C. 78f(b)(5) (1982).
\8\15 U.S.C. 78k (1982).
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The Commission believes that the proposal is a reasonable effort by
the PSE to accommodate the needs of PSE market makers to effect off-
floor opening transactions while maintaining the requirement under PSE
Rule 6.37(a) that market makers' transactions constitute a course of
dealings reasonably calculated to contribute to the maintenance of a
fair and orderly market. Specifically, in order to qualify for market
maker treatment for off-floor orders, the proposal requires a market
maker to execute at least 80% of his total transactions for any
calendar quarter in person and not through the use of orders. In
addition, the proposal states that the off-floor orders for which a
market maker receives market maker treatment shall be consistent with a
market maker's duty to maintain fair and orderly markets and in general
shall be effected for the purpose of hedging, reducing risk of,
rebalancing or liquidating open positions of the market maker. The
Commission believes that these requirements, taken together, will help
to ensure that all market maker transactions continue to contribute to
the maintenance of a fair and orderly market while, at the same time
enabling market makers to better manage the risk of their market making
activities.
Under the current requirements, market makers who adjust existing
positions for hedging purposes while not physically present on the
floor cannot receive market maker margin treatment for such orders
under any circumstances and must decide whether to close out their
positions or place an order in a customer margin account requiring 50%
margin. While the Commission believes that this may not be an
unreasonable result in many cases, the Commission believes that the PSE
has set forth a reasonable proposal that permits market maker treatment
for certain off-floor orders under very limited circumstances that
ensure that such orders must contribute to the maintenance of fair and
orderly markets and require market makers to comply with a heightened
80% in person trading requirement.
By requiring both more stringent in person trading requirements and
that off-floor opening transactions be effected only for the purpose of
hedging, reducing the risk of, rebalancing or liquidating open
positions, the proposal should help to ensure the stability and
orderliness of the PSE's markets.
The Commission expects the PSE to closely monitor those market
makers electing to receive market maker treatment for certain off-floor
orders as provided under the proposal to ensure that they are meeting
the in person trading requirements in addition to the other market
making obligations required under the proposal. The PSE has represented
that market makers who choose to receive favorable margin and capital
treatment under the proposal but fail to satisfy the proposal's
requirements will be subject to full disciplinary proceedings under
Chapter 10 of the PSE's rules. As noted above, the sanctions possible
under Chapter 10 include expulsion, suspension, limitation of
activities, functions, and operations, fine, censure, being suspended
or barred from being associated with a member or any other fitting
sanction. The Commission expects the Exchange to impose strict
sanctions for violations of the rule, particularly in cases of
egregious or repeated failures to comply with the rule's
requirements.\9\
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\9\The PSE plans to distribute a circular to its membership
describing the rule change and emphasizing the importance of
monitoring off-floor trading activity. See June 13 Letter, supra
note 3.
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Finally, the Commission notes that the staff of the Board of
Governors of the Federal Reserve System (``Board'') has issued a letter
raising no objection to the Commission's approval of an identical
proposal by the Chicago Board Options Exchange, Inc. (``CBOE''),\10\
based on the Commission's belief that the off-floor transactions of
CBOE market makers under the proposal are designed to contribute to the
maintenance of a fair and orderly market and are consistent with the
obligations of a specialist under section 11 of the Act.\11\
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\10\See File No. SR-CBOE-93-19.
\11\See Letter from Scott Holz, Senior Attorney, Board, to
Howard Kramer, Associate Director, Division, Commission, dated March
9, 1994.
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The Commission finds good cause for approving Amendment Nos. 2 and
3 prior to the thirtieth day after the date of publication of notice of
filing thereof in the Federal Register. Amendment No. 2, which
increases the in-person requirement from 75% to 80% and requires a
market maker's off-floor transactions to be effected for the purpose of
hedging, reducing risk of, rebalancing or liquidating open positions,
limits the likelihood of abuse of the proposed rule change by limiting
its availability to market makers who enter 80% of their orders in
person on the PSE's floor and by requiring that the off-floor orders
have a legitimate market making purpose. Moreover, the PSE's Amendment
No. 2 is identical to Amendment No. 1 to the CBOE's proposal. The
CBOE's Amendment No. 1 was published for comment in the Federal
Register and the Commission received no comments on the CBOE's
amendment.\12\ The PSE's Amendment No. 3, which provides for full
disciplinary proceedings for failures to comply with the proposal's
requirements, is consistent with the CBOE's proposal and should help to
ensure compliance with the requirements of the proposed rule. As a
result, the Commission believes that good cause exists for approving
Amendment Nos. 2 and 3 on an accelerated basis.
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\12\See Securities Exchange Act Release No. 33853 (April 1,
1994), 59 FR 16869 (April 8, 1994) (File No. SR-CBOE-93-19).
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Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 2 and 3. 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 at 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 above-mentioned
self-regulatory organization. All submissions should refer to the file
number in the caption above and should be submitted by August 4, 1994.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
\13\ that the proposed rule change (File No. SR-PSE-93-19), as amended,
is hereby approved.
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\13\15 U.S.C. 78s(b)(2) (1982).
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. 94-17096 Filed 7-13-94; 8:45 am]
BILLING CODE 8010-01-M
