[Federal Register Volume 59, Number 149 (Thursday, August 4, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-18960]
[[Page Unknown]]
[Federal Register: August 4, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34463; File No. SR-Phlx-92-12]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change by the Philadelphia Stock Exchange, Inc., Relating to
Restrictions on Orders in Multiply Traded Options Entered by
Specialists and Registered Options Traders for Execution on Other
Exchanges
July 29, 1994.
On December 14, 1992, 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 restrictions on
entering orders in multiply traded options. Notice of the proposal
appeared in the Federal Register on March 12, 1993.\3\ One comment
letter was received opposing the proposed rule change,\4\ to which the
Phlx responded.\5\ This order approves the Exchange's proposal.
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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. 31961 (March 8,
1993), 58 FR 13662 (March 12, 1993).
\4\See Letter from Alger Chapman, Chairman and Chief Executive
Officer, CBOE, to Jonathan Katz, Secretary, Commission, dated April
13, 1993 (``CBOE Comment Letter'').
\5\See Letter from Gerald O'Connell, Vice President, Market
Regulation, Phlx, to Jonathan Katz, Secretary, Commission, dated
June 25, 1993 (``Phlx Response Letter'').
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Description of Proposal
The Phlx proposes to adopt Advice B-12, which would extend the
prohibitions contained in Phlx Rule 1014 and Phlx Advice B-4, regarding
off-floor opening orders for options traded on multiple exchanges.
Currently, Commentary .14 to Phlx Rule 1014 and Phlx Advice B-4
prohibit a Registered Options Trader (``ROT'') from placing an opening
order for their market functions account from off-floor. The Phlx now
seeks to restrict Phlx ROTs and specialists from sending orders which
would establish or increase a position in registered options to other
exchanges from off of the Phlx options trading floor. Before an opening
order initiated from the Phlx equity options floor may be sent to
another market for execution, it must first clear the crowd at the Phlx
when the bid or offer of the order is on or between the Phlx
disseminated market.\6\ Pursuant to the proposal, ROTs and specialists
would be required to place their off-floor opening positions in their
customer accounts, regardless of whether the execution of such orders
occurs on the Phlx or on another exchange.\7\ The fine schedule for
proposed Advice B-12 would run on a three year cycle, such that repeat
violations within a three-year period would result in escalating
fines.\8\
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\6\Clearing the crowd on the Phlx would require that the order
be loudly and audibly voiced in the crowd and, if not then executed,
the order may be sent away.
\7\Proposed Advice B-12 would only be applicable to transactions
in equity option.
\8\The fine schedule for Advice B-12 provides that a fine of
$500 will be imposed for the first violation and a fine of $1,000
will be imposed for the second violation. The sanction for the third
violation is discretionary with the Phlx Business Conduct Committee.
In addition, under a rolling three-year cycle, if three years elapse
between the first and second violation, the second violation would
be treated as a first violation. If there is a violation within the
three years after the most recent violation, the next highest fine
will be issued. Thus, a third violation less than three years after
a fine was issued for a second violation would be treated as a
``third violation,'' even though more than three years may have
elapsed after the first violation.
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Comment Letter
The CBOE believes that the Phlx proposal raises implications
regarding the multiple listing of options which should be dealt with on
a uniform basis by the options exchanges.\9\ Specifically, the CBOE
believes that the proposal would allow Phlx specialists and ROTs, who
enter transactions from the Phlx options floor, to obtain ``good
faith'' margin treatment for options transactions executed on other
exchanges even if there is little or no activity in those options on
the Phlx and the transactions have no relationship to the specialists'
and ROTs' performance at the Phlx. As a result, the CBOE believes that
multiple listing could be used as a means of giving the floor members
of options exchanges preferred access to options traded on other
exchanges without regard to whether there is any meaningful competition
in those options between the exchanges.\10\ The CBOE suggests that
specialists and ROTs should be required to effect a certain percentage
(e.g., 75%) of their contract volume in a class of options on the
exchange on which they act as a specialist or ROT before being entitled
to effect transactions on other exchanges in that options class through
their market functions accounts.\11\
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\9\The CBOE acknowledges, however, that the proposal is a
logical extension of the Phlx's existing rules because it accords
the same treatment to all transactions initiated from off the Phlx
floor without regard to whether the transactions are executed on the
Phlx or another exchange. See CBOE Comment Letter, supra note 4.
\10\Id.
\11\Id.
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Phlx Response
The Phlx refutes the arguments raised by the CBOE.\12\ The Phlx
states that by seeking to ensure that Phlx floor traders conduct their
market making functions from the Phlx equity options floor where they
can best meet their affirmative and negative market making obligations,
the proposal merely brings the Phlx's rules into line with the existing
rules of the other options exchanges, including the CBOE's. As a
result, the Phlx contends that the proposal does not raise the
implications contemplated by the CBOE of ``disparate, competitive
treatment by the different options exchanges.''\13\
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\12\See Phlx Response Letter, supra note 5.
\13\Id.
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Additionally, the Phlx argues that it has rules in place addressing
the competitive concerns raised by the CBOE. Pursuant to Phlx Advice B-
3, ROTs are required to trade in person, and not through the use of
orders, the greater of 1,000 contracts or 50% of their contract volume
on the Exchange in each quarter.\14\ Additionally, at least 50% of a
ROT's trading activity in each quarter must be in assigned options
classes. Proposed Advice B-12 does not alter the application of Advice
B-3. As a result, the Phlx argues that specialists and ROTs would not
be able to obtain good faith margin treatment for a significant number
of transactions executed on other markets relative to the number of
trades that they must execute on the Phlx equity options floor,
regardless of the level of trading activity in their assigned options
classes at the Phlx.\15\
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\14\These trades must actually be executed on the Exchange.
Trades that are announced on the Exchange floor, clear the crowd,
and are subsequently executed on another market, are not counted as
Exchange trades for purposes of this requirement. Telephone
conversation between Gerald O'Connell, Vice President, Market
Regulation, Phlx, and Sharon Lawson, Assistant Director, Office of
Market Supervision, Division of Market Regulation, Commission, on
July 18, 1994.
\15\Id.
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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 prevent fraudulent and manipulative acts and
practices, promote just and equitable principles of trade, and to
protect investors and the public interest. Specifically, the Commission
finds that the proposal is a reasonable extension of the Phlx's
existing rules by according the same treatment to all transactions
initiated from off the Phlx floor, without regard to whether the
transactions are executed on the Phlx or another exchange. The
Commission agrees with the Exchange that this restriction should serve
to ensure that Phlx floor traders are conducting their market making
activities from on the floor where they can best meet their affirmative
and negative market making obligations.
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\16\15 U.S.C. 78f(b)(5) (1988).
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The Commission appreciates the concerns raised by the CBOE;
however, the Commission believes that the Phlx has adequate rules and
procedures to ensure that Exchange ROTs and specialists can obtain
market-maker treatment for options trades executed on other exchanges
only where they perform a real market-making function for such options
on the Phlx floor. First, under Section 11(b) of the Act,\17\ Rule 11b-
1 thereunder\18\ and Phlx Rule 1014, specialists and ROTs are required
to engage in a course of dealings in a manner reasonably calculated to
contribute to the maintenance of a fair and orderly market. This
ensures that trades by such persons are for the purposes of fulfilling
market-making obligations under the Act. Secondly, Exchange Advice B-3
minimizes the opportunity for ROTs to obtain good faith margin for a
significant number of trades executed on other exchanges. By requiring
that the greater of 1,000 contracts or 50% of their contract volume be
executed on the Exchange in each quarter\19\ and that at least 50% of
their contract volume be in assigned classes in each quarter. Advice B-
3 effectively ensures that market-makers 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.\20\
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\17\15 U.S.C. 78k(b) (1988).
\18\17 CFR 240.11b-1 (1981).
\19\See supra note 14.
\20\CBOE Rule 8.7, Interpretation and Policy .03, is quite
similar to Phlx Advice B-3. This CBOE rule requires that (1) ``at
least 75 percent of a Market-Maker's total contract volume must be
in option classes to which he has been appointed pursuant to [CBOE]
Rule 8.3;'' and (2) ``a Market-Maker must execute in person, and not
through the use of orders, at least 25 percent of his total
transactions.''
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In summary, the Commission notes that only market makers who are
conducting bona fide market making activity on the Phlx floor are
entitled to good faith margin treatment for their options transactions.
As a result of the above, the Commission does not believe that the
current proposal would result in disparate, competitive treatment by
the options exchange, as envisioned by the CBOE.\21\
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\21\Indeed, the Commission believes that approval of the
proposed rule change makes the situation envisioned by the CBOE less
likely by removing the ambiguity that currently exists in the Phlx's
rules and clarifying that off-floor orders, whether executed on the
Phlx floor or at another exchange, are not entitled to good faith
margin treatment.
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\22\ that the proposed rule change (SR-PHlx-92-12) is hereby
approved.
\22\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.\23\
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\23\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-18960 Filed 8-3-94; 8:45 am]
BILLING CODE 8010-01-M
