[Federal Register Volume 60, Number 167 (Tuesday, August 29, 1995)]
[Notices]
[Pages 44923-44926]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-21359]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36137; File No. SR-Phlx-95-14]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment No. 2 to the Proposed Rule Change by the Philadelphia Stock
Exchange, Inc., Relating to Extension of Market Maker Margin Treatment
to Certain Market Maker Orders Entered from Off the Trading Floor
August 23, 1995.
I. Introduction
On March 1, 1995, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') filed a proposed rule change 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\ to extend market maker margin treatment to opening
orders entered by Phlx Registered Options Traders (``ROTs'') from off
the Exchange floor, provided that the greater of 1,000 contracts or 80%
of an ROT's total transactions on the Exchange in a calendar quarter
are executed in person,\3\ and not through the use of orders. Phlx ROTs
would also be required to execute at least 75% of their quarterly
contract volume in assigned options. The Exchange filed Amendment No. 1
to the proposal on March 29, 1995.\4\ The Exchange filed Amendment No.
2 to the proposal on July 25, 1995.\5\
\1\15 U.S.C. 78s(b)(1).
\2\17 CFR 240.19b-4.
\3\``In person'' means that options transactions are personally
executed by a Registered Options Trader on the Phlx floor.
\4\In Amendment No. 1, the Exchange proposes to require Phlx
ROTs to execute at least 75% of their quarterly trades in assigned
options for purposes of receiving market maker margin treatment for
off-floor orders. The Exchange originally proposed to require an ROT
to trade at least 50% of his quarterly contract volume in-assigned
options. In addition, Amendment No. 1 states that Phlx proposes to
delete the fine schedules under the minor rule plan originally
proposed to address violations of the heightened trading
requirements, because violations of this program are to be reviewed
directly by the Business Conduct Committee and are not to be treated
as minor rule plan violations. Finally, Phlx proposes to clarify
that the phrase ``may exempt one or more classes of options from
this calculation'' in Commentary .01 to Phlx Rule 1014, is intended
to mean that certain options may not be eligible for off-floor
market maker treatment. See Letter from Gerald O'Connell, First Vice
President, Phlx, to Michael Walinskas, Branch Chief, Office of
Market Supervision (``OMS''), Division of Market Regulation
(``Market Regulation''), Commission, dated March 29, 1995
(``Amendment No. 1'').
\5\In Amendment No. 2, the Exchange deletes the reference to
``liquidating open positions'' from Phlx Rule 1014, Commentary .01.
The Exchange notes that this amendment does not substantially change
the proposal because liquidating an open position is the same as
closing a position, which does not require the extension of margin.
The Exchange also proposes to amend Advice B-12 to clarify that the
Floor Broker is responsible for clearing the Phlx crowd before
executing a multiply-traded option on another exchange when
initiated from off-floor. Finally, the Exchange proposes to add to
Advice C-3 a reference to the new Floor Broker responsibility as
enumerated in Advice B-12. See Letter from Gerald O'Connell, First
Vice President, Phlx. to Michael Walinskas, Branch Chief, OMS,
Market Regulation, Commission, dated July 25, 1995 (``Amendment No.
2'').
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Notice of the proposal, as amended by Amendment No. 1, was
published for comment and appeared in the Federal Register on May 18,
1995.\6\ No comment letters were received on the proposed rule change.
This order approves the Exchange's proposal, as amended.
\6\See Securities Exchange Act Release No. 35710 (May 12, 1995),
60 FR 26754.
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II. Background
Generally, a trade for the account of a specialist or ROT receives
market maker, or good faith, margin,\7\ as well as favorable capital
treatment,\8\ due to the affirmative and negative market making
obligations\9\ imposed on such floor traders by Exchange and Commission
rules. Further, Rule 1014, Commentary .01 states that ROTs are
considered ``specialists'' for the purposes of the Act and the rules
thereunder, which includes capital and margin rules, respecting option
transactions initiated and effected by the ROT on the floor in the
capacity of an ROT. Accordingly, transactions initiated on-floor by
Phlx ROTs are entitled to receive favorable market maker margin
treatment. Off-floor opening\10\ market maker
[[Page 44924]]
transactions currently may not qualify for favorable margin treatment
under Exchange rules, even if such orders are entered to adjust or
hedge the risk of an ROT's positions resulting from on-floor market
making activity.
\7\Regulation T of the Federal Reserve Board, Section 220.12.
\8\SEC Rule 15c3-1(b)(1).
\9\See e.g., Phlx Rule 1014(a) and (c).
\10\Questions of margin and capital treatment do not arise in
connection with closing transactions, because such positions only
reduce or eliminate existing positions. See Amendment No. 2, supra
note 5.
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Phlx Rule 1014, Commentary .03 and Floor Procedure Advice
(``Advice'') B-3 currently require an ROT to effect at least 50% of his
quarterly contract volume in assigned options. Further, an ROT is
required to execute in person and not through the use of orders the
greater of 1,000 contracts or 50% of his quarterly contract volume,
pursuant to Advice B-3 and Rule 1014(b), Commentary .13.
III. Description of the Proposal
The Exchange is proposing to amend Rule 1014 to allow ROTs who meet
a more stringent in person, and in-assigned options requirement to
receive market maker margin and capital treatment for opening off-floor
orders. All ROTs will still be required pursuant to Advice B-3 to
trade, at a minimum, (1) in person, and not through the use of orders,
the greater of 1,000 contracts or 50% of their total transactions each
quarter, and (2) at least 50% of their quarterly contract volume in
assigned options.
Specifically, the Exchange proposes to amend Phlx Rule 1014,
Commentary .01, to extend market maker margin treatment to opening
orders entered by Phlx ROTs from off the Exchange floor, provided that
the greater of 1,000 contracts or 80% of an ROT's total transactions on
the Exchange in a calendar quarter are executed in person, and not
through the use of orders. Phlx ROTs would also be required to execute
at least 75% of their quarterly contract volume in assigned
options.\11\ In addition, the proposal requires that all off-floor
orders for which ROTs receive market maker treatment be consistent with
their duty to maintain fair and orderly markets, and, in general, be
effected for the purposes of hedging, reducing risk of, or rebalancing
open positions.
\11\Essentially, ROTs may receive favorable market maker margin
treatment for off-floor opening transactions comprising no more than
20% of their total transactions if they meet both heightened in-
person and assigned class trading requirements. See also Amendment
No. 1, supra note 4.
The Exchange believes that because an ROT cannot effectively adjust
his positions, or hedge and otherwise reduce the risk of his opening
transactions, from off the Phlx trading floor without incurring a
significant economic penalty, such ROTs must either be physically
present on the Exchange floor or face significant risks of adverse
market movements when they must necessarily be absent from the trading
floor.\12\ Because of these costs and risks, the Exchange believes that
Phlx ROTs may be prevented from effectively discharging their market
making obligations and may be exposed to unacceptable levels of risk.
\12\An ROT would have the choice of closing out all existing
options positions while off-floor or keeping such positions open
which would raise market risk concerns for the ROT. See also Phlx
Rule 1014, Commentary .08.
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Accordingly, the proposed rule change is intended to accommodate
the occasional needs of ROTs to adjust or hedge positions in their
market accounts at times when they are not physically present on the
trading floor. The Phlx believes the proposed rule change does so
without diluting the requirement that such ROTs' trading activity must
nevertheless fulfill their market making obligations, including
contributing to the maintenance of a fair and orderly market on the
Exchange.
In addition to the proposed amendment to Commentary .01 of Rule
1014, the Exchange proposes to amend five Phlx floor procedure advices
to cover such off-floor market maker orders. First, new paragraph (b)
of Advice B-3 would effectuate the proposed provisions of Commentary
.01 by referencing the heightened trading requirement in order to
receive favorable margin treatment for off-floor orders. Accordingly,
entering an off-floor order for a market maker account without
compliance with the ``1,000 contracts or 80%'' requirement can result
in a Rule 960 disciplinary proceeding, which is separate from any
violation of Advice B-3(a),\13\ in which violations currently can be
charged under the Exchange's minor rule plan.\14\
\13\Advice B-3(a) requires ROTs to effect at least 50% of their
quarterly contract volume in assigned options. Further, ROTs are
required to execute in person and not through the use of orders the
greater of 1,000 contracts or 50% of their quarterly contract
volume, pursuant to Advice B-3(a).
\14\The Phlx's minor rule violation enforcement and reporting
plan (``minor rule plan''), codified in Phlx Rule 970, contains
floor procedure advices with accompanying fine schedules. Rule 19d-
1(c)(2) authorizes national securities exchanges to adopt minor rule
violation plans for summary discipline and abbreviated reporting;
Rule 19d-1(c)(1) requires prompt filing with the Commission of any
final disciplinary actions. However, minor rule violations not
exceeding $2,500 are deemed not final, thereby permitting periodic,
as opposed to immediate reporting. Although the Exchange is
proposing to amend several advices, only Advice C-3 will contain a
minor rule plan fine. The Commission notes that the Phlx has the
discretion to take any violations, including those under the minor
rule plan, to full disciplinary proceedings and would expect the
Phlx to do so for egregious and repetitive violations of Advice C-3.
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Second Advice B-4 is proposed to be amended to create an exception
to the prohibition against entering off-floor orders into a market
maker account. Generally, Advice B-4 would restate the provisions of
Commentary .01 to Rule 1014 that an ROT who has executed the greater of
1,000 contracts or 80% of his total transactions in a calendar quarter
in person may enter opening transactions from off the floor on limited
occasions for his market maker account if such transactions are for the
purpose of hedging, reducing risk of, or rebalancing open positions.
Third, by amending the title of Advice B-8, the Phlx intends to
limit its effect to situations where an ROT uses a Floor Broker while
the ROT is on the Phlx Floor. Because ROTs cannot currently enter off-
floor opening orders into a market maker account, the language of this
advice presumes that ROTs are on the floor, and, hence, able to comply
with the requirements of initialing the order ticket. Because this
proposal would permit entering opening orders from off-floor and
because ROTs who are off-floor cannot initial and time stamp a ticket,
Advice B-8 would now expressly apply, as reflected in the new title,
only to on-floor situations. Nevertheless, the requirement that an ROT
state whether an order is opening or closing appears in Advice B-4, and
the Floor Broker must time stamp the order pursuant to Advice C-2.
Thus, the Exchange believes that off-floor orders should be
appropriately designated and handled, despite the inapplicability of
Advice B-8.
Fourth, Advice B-12 is proposed to be amended to clarify the margin
treatment of orders sent to another exchange in a multiply traded
option. Although such orders must currently be initiated from the Phlx
floor and must clear the Phlx crowd, the proposed changes would permit
off-floor orders to be sent to another exchange. Such orders must
nevertheless clear the Phlx crowd by a designated Floor Broker. The
purpose of this change is to treat orders in multiply traded options,
whether originating from on or off-floor, the same way for margin
purposes, extending limited market maker treatment.
Lastly, Advice C-3 is proposed to be amended to incorporate this
extension of specialist margin treatment into the advice enumerating
Floor Broker responsibilities. Specifically, Floor Brokers would be
required to mark floor tickets where an ROT has indicated that the
order is for his market maker account with the letter ``P''. A fine for
violations would be administered pursuant to the Exchange's minor rule
plan. The Exchange believes that this should assist its surveillance
efforts
[[Page 44925]]
respecting market maker margin for off-floor orders.
The Phlx believes that the proposed rule change is consistent with
and in furtherance of the objectives of Section 6(b)(5) and Section
11(a) of the Act in that will promote the maintenance of fair and
orderly markets on the Phlx and will contribute to the protection of
investors and the public interest. Specifically, the Phlx believes that
the proposal should increase the extent to which ROT trades contribute
to liquidity and to the maintenance of a fair and orderly market on the
Exchange by providing for a greater degree of in person trading by ROTs
and by enabling such ROTs to better manage the risk of their market
making activities. Likewise, the Phlx believes that the corresponding
amendments to Phlx advices are intended to incorporate specialist
margin treatment for off-floor orders into the provisions governing
trading requirements, ROTs entering orders, and Floor Broker
responsibilities, consistent with Section 6(b)(5).
IV. Commission Finding and Conclusions
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)\15\ in that the
proposal is designed to promote just and equitable principles of trade
and to protect investors and the public interest. In addition, the
Commission finds that the proposal is consistent with the requirement
under Section 11(b) of the Act and the rules thereunder that require
market maker transactions to be consistent with the maintenance of fair
and orderly markets.\16\
\15\15 U.S.C. 78f(b)(5).
\16\15 U.S.C. 78k and 17 CFR 240.11b-1.
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The Commission believes that the proposal is a reasonable effort by
the Phlx to accommodate the needs of ROTs to effect off-floor opening
transactions while reinforcing the requirement under Phlx Rule 1014
that ROTs' transactions constitute a course of dealing reasonably
calculated to contribute to the maintenance of a fair and orderly
market. The Commission believes that the 75% minimum assigned class
requirement, and the greater of 1,000 contracts or 80% in person
trading requirement for market maker treatment for off-floor trades,
will help ensure that ROTs' transactions continue to contribute to the
maintenance of fair and orderly markets while, at the same time,
enabling ROTs to better manage the risk of their market making
activities.
Moreover, these heightened requirements for ROTs' transactions to
receive favorable margin treatment for off-floor transactions will
improve Phlx market maker capabilities. The Commission believes these
requirements will help to ensure that ROTs will be physically present
in their assigned classes to respond to public orders and to improve
the price and size of the markets made on the Phlx floor. Thus, the
Commission believes the Phlx proposal will serve to maintain fair and
orderly markets and generally promote the protection of investors and
the public interest.\17\
\17\See Securities Exchange Act Release No. 21008 (June 1,
1984), 49 FR 23721 (June 7, 1984) (order approving proposed rule
change by the Chicago Board Options Exchange (``CBOE'') establishing
minimum in person and assigned class trading requirements for market
makers).
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The Commission believes that the Exchange's proposal to amend Phlx
floor procedure Advices B-3 and B-4 appropriately reflect the
heightened trading requirements in proposed amendment to Phlx Rule
1014. Furthermore, the Commission agrees with the Exchange that
violations of these heightened trading requirements should be subject
to Business Conduct Committee review pursuant to Phlx Rule 960.
The Commission believes that the proposed amendment to the title of
Advice B-8 is appropriate, because the Phlx intended Advice B-8 to
apply to situations when an ROT is on the floor. Additionally, the
Commission believes that the proposed amendments to Advice C-3
appropriately addresses the duties of the Floor Broker when an ROT
enters an off-floor order.
The Commission believes that the proposed amendment to Advice B-12
adequately reflects the heightened trading requirements in the proposed
amendment to Phlx Rule 1014, and the duties of Phlx Floor Brokers when
executing orders on another exchange that involve multiply-traded
options initiated by a Phlx ROT from off the Phlx floor. The Commission
notes that under Advice B-12, the Floor Broker must clear the Phlx
crowd in the same manner that a Phlx ROT must when initiating an
opening order from on the Phlx floor and sending the order for
execution on another exchange for the market maker account.\18\
\18\By imposing stringent in person, and in assigned options
trading requirements for ROTs, Advice B-3 effectively ensures that
ROTs will not be able to use the Phlx floor simply to send orders to
other markets but instead will have substantive obligations that
ensure they are acting as a bona fide market-maker. See Securities
Exchange Act Release No. 34463 (July 29, 1994), 59 FR 39798 (August
4, 1994) (SR-Phlx-92-12).
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The Commission expects the Phlx to closely monitor those ROTs
electing to receive market maker margin treatment for off-floor orders
as provided under the proposal to ensure that they are meeting the in
person, and in-assigned options classes trading requirements in
addition to their other market making obligations required under Phlx
Rule 1014, as amended. The Phlx has represented that ROTs who choose to
receive favorable margin and capital treatment but fail to satisfy the
proposal's requirements will be referred to the Exchange's Business
Conduct Committee pursuant to Phlx Rule 960 governing disciplinary
proceedings. The Commission expects the Exchange to impose strict
sanctions for violations of the rule and corresponding advices,
particularly in cases of egregious or repeated failures to comply with
the rule and advices.\19\ Such sanctions could include expulsion,
suspension, fine, censure, limitations or termination as to activities,
functions, operations, or association with a member or member
organization.\20\ The Commission notes, that in determining the
appropriate sanction, the Phlx should assess whether the off-floor
orders for which an ROT receives market maker treatment are consistent
with such ROT's duty to maintain fair and orderly markets, and, in
general, be effected for the purposes of hedging, reducing risk of, or
rebalancing open positions of the ROT.
\19\The Phlx plans to issue a circular to its membership
describing the rule change and emphasizing the importance of
monitoring off-floor trading activity. Telephone conversation
between Edith Hallahan, Attorney, Phlx, and John Ayanian, Attorney,
OMS, Market Regulation, Commission, on August 1, 1995.
\20\See Phlx Rule 960.10.
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In summary, the Commission believes that the introduction of an
increase in the required percentages of trades in person, and in
assigned classes to receive favorable margin treatment for off-floor
transactions, as described above, should help to ensure the stability
and orderliness of the Phlx's markets.
Finally, the Commission notes that the staff of the Board of
Governors of the Federal Reserve System (``Board'') has previously
issued a letter raising no objection to the Commission's approval of a
substantively similar proposal by the CBOE based on the Commission's
belief that off-floor transactions of market makers for which they can
receive market maker treatment will be designed to contribute to the
maintenance of a fair and orderly
[[Page 44926]]
market and would be consistent with the obligations of a specialist
under Section 11 of the Act.\21\
\21\See Securities Exchange Act Release No. 34104 (May 25,
1994), 59 FR 28438 (June 1, 1994), note 13, (citing letter from
Scott Holz, Senior Attorney, Board, to Howard Kramer, Associate
Director, OMS, Market Regulation, Commission, dated March 9, 1994).
See also Securities Exchange Act Release No. 35768 (May 31, 1995),
60 FR 30122 (June 7, 1995).
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The Commission finds good cause for approving Amendment No. 2 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register.
Specifically, Amendment No. 2 makes certain technical clarifications to
the proposal and raises no new regulatory issues. Accordingly, the
Commission believes it is consistent with Sections 6(b)(5) and 19(b)(2)
of the Act to approve Amendment No. 2 to the proposed rule change on an
accelerated basis.
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2 to the proposal. Persons making
written submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 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, while be available for inspection and
copying in the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. 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-95-14 and should be
submitted by September 19, 1995.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\22\ that the proposed rule change (File No. SR-Phlx-95-14), as
amended, is approved.
\22\15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\23\
\23\17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-21359 Filed 8-28-95; 8:45 am]
BILLING CODE 8010-01-M
