[Federal Register Volume 64, Number 131 (Friday, July 9, 1999)]
[Notices]
[Pages 37185-37187]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-17418]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41588; File No. SR-Phlx-98-56]
Self-Regulatory Organizations; Philadelphia Stock Exchange Inc.;
Order Approving Proposed Rule Change Relating to the Enhanced Parity
Split Pilot Program for Equity and Index Option Specialists, and the
Adoption of an Enhanced Parity Split for Specialists That Develop and
Trade New Products
July 1, 1999.
I. Introduction
On December 28, 1998, the Philadelphia Stock Exchange, Inc.
(``Exchange'' or ``Phlx'') submitted to 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 seeking to extend and receive
permanent approval of the Exchange's enhanced parity split pilot
program for Exchange specialists in equity and index options (``Pilot
Program'').\3\ In addition, the Exchange proposed to amend Exchange
Rule 1014(g), ``Equity Option and Index Option Priority and Parity,''
and its corollary Option Floor Procedure Advice B-6 to provide an
enhanced parity split for Exchange specialists that develop and trade
new products.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Exchange Rule 1014(g)(ii), ``Two for-one Enhanced
Specialist Participation.''
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In the release published for comment in the Federal Register on
January 12, 1999, the Commission gave accelerated approval to the
Exchange's request that the Pilot Program be extended for a six-month
period ending June 30, 1999, or until the Commission approves the
Exchange's request for permanent approval of the Pilot Program,
whichever occurred first.\4\ The Commission did not receive any comment
letters with respect to the proposal. This order permanently approves
the Pilot Program and the Exchange's proposal to establish an enhanced
parity split for Exchange specialists that develop and trade new
products.
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\4\ Securities Exchange Act Release No. 40876 (Dec. 31, 1998),
64 FR 1849 (Jan. 12, 1999).
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II. Description of the Proposal
A. Permanent Approval of the Pilot Program
The Exchange seeks permanent approval of the Pilot Program for
Exchange specialists in equity and index options. The Commission first
approved the Pilot Program on August 26, 1994,\5\ to provide Exchange
specialists in equity options with an enhanced participation in
``parity trades,'' or trades where orders compete at the same price.\6\
While a parity trade is generally divided evenly among the crowd
participants on parity, the enhanced participation gives the specialist
a greater share of the trade than he would normally receive.
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\5\ See Securities Exchange Act Release No. 34606 (Aug. 26,
1994), 59 FR 45741 (Sep. 2, 1994). The Pilot Program was initially
approved for a one year period ending August 26, 1995.
\6\ According to Exchange Rules 119 and 120, when bids and
offers are made simultaneously, or when it is impossible to
determine clearly the order of time in which they were made, all
such bids and offers shall be on parity. For example, suppose that a
floor broker holding a sell order for 10 Jan XYZ call options
announces his order to the crowd. In response, three crowd
participants might simultaneously bid to buy the 10 Jan XYZ call
options at the same price. Because these three simultaneous bids are
competing at the same price, the bids are on parity.
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On November 30, 1994, the Commission approved the Exchange's
proposal to expand the Pilot Program to include index option
specialists.\7\ The Pilot Program was later revised on March 1, 1995,
with respect to situations where less than three controlled accounts
are on parity with the specialist.\8\ The Pilot Program was
subsequently renewed without change on three occasions \9\ and later
was extended and expanded so that the enhanced parity split applies to:
(i) All index options; (ii) all new option classes allocated to a
specialist during the year; and (iii) 50% of a specialist's equity
option issues, which issues are designed by the specialist and approved
by the Exchange's Allocation, Evaluation, and Securities Committee.\10\
In addition, the Pilot Program was revised to permit specialists to
revise the list of eligible
[[Page 37186]]
options (i.e., the designated equity options for which the specialist
is entitled to receive the enhanced parity split) on a quarterly basis,
rather than annually.
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\7\ Securities Exchange Act Release No. 35028 (Nov. 30, 1994),
59 FR 63151 (Dec. 7, 1994).
\8\ Securities Exchange Act Release No. 35429 (Mar. 1, 1995), 60
FR 12802 (Mar. 8, 1995).
\9\ Securities Exchange Act Release Nos. 36122 (Aug. 18, 1995),
60 FR 44530 (Aug. 28, 1995); 37524 (Aug. 5, 1996), 61 FR 42080 (Aug.
13, 1996); and 38924 (Aug. 11, 1997), 62 FR 44160 (Aug. 19, 1997).
\10\ Securities Exchange Act Release No. 39401 (Dec. 4, 1997),
62 FR 65300 (Dec. 11, 1997). The Exchange maintains a separate,
permanent enhanced parity split program for new specialist units
that trade newly listed options. See Exchange Rule 1014(g)(iii),
``New Unit/New Option Enhanced Specialist Participation,'' and
Securities Exchange Act Release No. 34109 (May 25, 1994), 59 FR
28570 (June 2, 1994).
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The Exchange now seeks permanent approval of the Pilot Program. The
Pilot Program works as follows: when an equity or index option
specialist is on parity with one controlled account \11\ and an order
for more than five contracts comes into the crowd, the specialist will
receive 60% of the contracts and the controlled account will receive
40%. When the specialist is on parity with two controlled accounts and
the order is for more than five contracts, the specialist will receive
40% of the contracts and each controlled account will receive 30%. When
the specialist is on parity with three or more controlled accounts and
the order is for more than five contracts, the specialist will be
counted as two crowd participants when allocating the contracts. In any
of these situations, if a customer order is on parity, the customer
will not be disadvantaged by receiving a lesser allotment than any
other crowd participant, including the specialist. Thus, a customer on
parity is assured a minimum participation that is equal to the
participation of the specialist.\12\
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\11\ A controlled account is defined as ``any account controlled
by or under common control with a member broker-dealer.'' Customer
accounts, which include discretionary accounts, as defined as all
accounts other than controlled accounts. See Exchange Rule
1014(g)(i).
\12\ For example, if a customer is on parity with a specialist
and two controlled accounts for a 10 contract order, the
specialist--and therefore the customer also--would be entitled to
receive 4 contracts (40%).
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The application of this enhanced parity split is mandatory.
Therefore, with respect to any equity or index option transaction that
implicates the enhanced parity split, the specialist is required to
accept the preferential allocation and may not decline the enhancement.
If an equity or index option trade is on parity, but not subject to the
enhanced parity split (i.e., the trade is for five or less contracts),
the Exchange specialist is required to allocate the contracts according
to the Exchange's priority and parity rules.\13\
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\13\ See Exchange Rule 119, ``Precedence of Highest Bid,'' and
Exchange Rule 120, ``Precedence of Offers at Same Price.''
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At the request of the Commission, the Exchange prepared a report
(``Report'') discussing whether the: (i) Pilot Program has generated
any evidence of any adverse effect on competition or investors, in
particular, or the market for equity or index options, in general; (ii)
Exchange has received any complaints, either written or otherwise,
concerning the operation of the Pilot Program; and (iii) Exchange has
taken any disciplinary action against, or commenced any investigations,
examinations, or inquires concerning the operation of the Pilot
Program, as well as the outcome of any such matter.
The Exchange incorporated the findings of its Report into the
proposed rule change filing. According to the Exchange, its regulatory
personnel have not observed during the past year evidence of any
adverse effects on competition, investors, or the market for equity or
index options. As to the second issue, the Exchange has not received
any complaints, either orally or in writing, from investors or Exchange
members regarding the Pilot Program. Finally, regarding disciplinary
actions, investigations, examinations or inquires, the Exchange reports
that it did not commence any investigations relating to the Pilot
Program this past year.
B. Adoption of Enhanced Parity Split for Specialists That Develop and
Trade New Products
The Exchange separately proposes to adopt an enhanced parity split
for Exchange specialists that develop and trade new products (``New
Products Split''). The Exchange stated that the New Products Split is
intended to encourage specialist units to develop and trade new
products, and to provide liquidity in such products, thereby attracting
order flow to the Exchange. The exchange believes that the proposal
balances the competing interests of specialists and Registered Option
Traders (``ROTs''), while encouraging specialists to take an active
role in supporting and marketing a new product, both important
activities in a competitive environment.
Under the proposed New Products Split, when the specialist is on
parity with three or more controlled accounts in the crowd, the
specialist will receive 40% of the contracts and the controlled
accounts will receive the remaining 60%. When the specialist is on
parity with less than three controlled accounts in the crowd, the
specialist will receive 60% of the contracts and the controlled
accounts will receive 40%. In either of these situations, if a customer
order is on parity, the customer may not receive a lesser allotment
than any other crowd participant, including the specialist.
The Exchange indicated that the New Products Split would be limited
to new products developed and traded by the same specialist unit.
Therefore, if one specialist unit develops a new product but another
specialist unit is allocated specialist privileges in that same new
product,\14\ the specialist unit trading the new product would not be
entitled to the New Products Split. The Exchange's Options Committee
will be responsible for determining whether a specialist ``developed''
a new product.
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\14\Allocation determinations are governed by Exchange Rules
500-526.
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III. Discussion
For the reasons discussed below, the Commission finds that the
proposed rule change is consistent with the Act and the rules and
regulations under the Act applicable to a national securities exchange.
In particular, the Commission believes the proposed rule change is
consistent with the Section 6(b)(5)\15\ requirements that the rules of
an exchange be designed to promote just and equitable principles of
trade, prevent fraudulent and manipulative acts and practices, and
protect investors and the public interest.\16\ The Commission also
finds that the proposal may serve to remove impediments to and perfect
the mechanism of a free and open market by helping the Exchange to
attract and retain specialist units, and offer new products to the
investing public.
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\15\ 15 U.S.C. 78f(b)(5).
\16\ In approving this proposed rule change, the Commission has
considered the proposal's impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f).
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Generally, a parity trade is divided evenly among the crowd
participants on parity. However, the Pilot Program and the New Products
Split would provide Exchange specialists with an enhanced participation
in parity trades. The enhancement would give the specialist a greater
share of the trade than he would normally receive.
The Pilot Program gives an equity or index option specialist 60% of
the contracts when he is on parity with one controlled accounts and the
order is for more than five contracts. When the specialist is on parity
with two controlled accounts and the order is for more than five
contracts, the specialist will receive 40% of the contracts. When the
specialist is on parity with three or more controlled accounts and the
order is for more than five contracts, the specialist will be counted
as two crowd participants when allocating the contracts.
The New Products Split would give an eligible specialist (i.e., a
specialist who developed a new product and to whom the new product is
allocated) 40% of the contracts in the new product when the specialist
is on parity with three or more controlled accounts in the crowd. When
the specialist is on parity with less than three controlled accounts
[[Page 37187]]
in the crowed, the specialist will receive 60% of the contracts. Under
the Pilot Program and the New Products Split, if a customer order also
is on parity, the customer may not receive a lesser allotment than any
other crowd participant, including the specialist.
The Commission recognizes that the purpose of the enhanced parity
split is to encourage specialists to make deep and liquid markets in
order to attract order flow to the Exchange. The Commission has
previously noted that specialists have responsibilities that other
crowd participants do not share, such as the staff costs associated
with continually updating and disseminating quotes.\17\ As a result,
the Commission believes it is reasonable for the Exchange to grant
certain advantages to specialists, such as the enhanced parity split,
to attract and retain well capitalized specialists at the Exchange. 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, in general, is within the business
judgment of the Exchange.
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\17\ See, e.g. Securities Exchange Act Release No. 35177 (Dec.
29, 1994), 60 FR 2419 (Jan. 9, 1995).
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The Commission believes that the proposal will encourage
specialists to make deep and liquid markets to attract order flow to
the Exchange. The Commission also believes that the Pilot Program and
New Products Split provide reasonable benefits to specialists, given
the heightened responsibilities and costs of specialist. Because it
appears that these that these benefits do not unreasonably restrain
competition and do not harm investors, the Commission believes that the
approval of the Pilot Program and New Products Split is consistent with
the Act.
The Pilot Program and the New Products Split specify that the
application of the enhanced parity split cannot cause a customer order
on parity to received a smaller participation than any other crowd
participant, including the specialist. The Commission believes this
provision adequately protects customers orders from any negative impact
that might flow from application of the enhanced parity split. As a
result, customer orders on parity are ensured a participation that, at
a minimum, is equal to that given any other crowd participant on
parity.
The Commission notes that the Pilot Program has been operative,
albeit in differing forms, since 1994. During that period, the
Commission has required the Exchange to submit Reports discussing: (i)
The Pilot Program's impact on competition and investors; (ii)
complaints regarding the Pilot Program; and (iii) inquiries,
investigations, or disciplinary actions taken regarding the Pilot
Program. The Reports have indicated that the Pilot Program operates
well and does not adversely impact competition or investors.\18\
Furthermore, the Exchange has not received complaints regarding the
Pilot Program and has brought only one disciplinary action concerning
the Pilot Program.\19\ The Commission believes that the absence of
significant problems over the past five years demonstrates that the
Pilot Program is a reasonable benefit for the Exchange to offer to its
equity and index option specialists.
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\18\ The Exchange found that the enhanced parity split, as first
proposed in 1994, was overly burdensome when only one or two
controlled accounts were on parity with the specialist. Therefore,
the Exchange amended the Pilot Program in 1995 to make the enhanced
parity split more equitable in those situations. See Securities
Exchange Act Release No. 35429 (Mar. 1, 1995), 60 FR 12802 (Mar. 8,
1995). The Exchange also formed a subcommittee to analyze the Pilot
Program and its effect on competition, investors, and the market in
general. The subcommittee members concluded that there is no
evidence of any adverse effects on competition, investors, or the
market for equity or index options.
\19\ In 1995, the Exchange brought one disciplinary case against
an equity option specialist for making an inequitable split among
himself and the ROTs in the crowd. The specialist was censured and
suspended for one week as part of a settlement. See Exchange
Enforcement Matter No. 95-12.
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Based on the Exchange's five year experience with the Pilot
Program, and the similarity between the Pilot Program and the New
Products Split, the Commission believes that the New Products Split is
a reasonable measure to attract new products to the Exchange. Like the
Pilot Program, the New Products Split should be an incentive for
Exchange specialists to generate more business by developing and
training new products. The Commission supports the Exchange's attempts
to attract new business. The Commission also believes that because the
enhanced parity split will be available only to a specialist unit that
develops and trades a new product, the benefit is reasonably limited in
scope to those specialist units that put forth significant effort.
Therefore, the Commission believes it is appropriate to approve the New
Products Split.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\20\ that the proposed rule change (SR-Phlx-98-56) is approved.
\20\ U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\21\
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\21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-17418 Filed 7-8-99; 8:45 am]
BILLING CODE 8010-01-M
