[Federal Register Volume 59, Number 170 (Friday, September 2, 1994)]
[Notices]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-21703]
[[Page Unknown]]
[Federal Register: September 2, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34606; File No. SR-Phlx-94-12]
Self-Regulatory Organizations; Order Approving and Notice of
Filing and Order Granting Accelerated Approval of Amendment Nos. 1 and
2 to a Proposed Rule Change by the Philadelphia Stock Exchange, Inc.,
Relating to a Pilot Program for Enhanced Specialist Participation in
Parity Equity Options Trades
August 26, 1994.
On February 28, 1994, 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 enhanced specialist
participation in parity equity options trades. Notice of the proposal
appeared in the Federal Register on April 28, 1994.\3\ One comment
letter was received opposing the proposed rule change.\4\ The Exchange
filed Amendment No. 1 to the proposed rule change on April 29, 1994,\5\
and Amendment No. 2 on August 25, 1994.\6\ This order approves the
Exchange's proposal, as amended.
\1\15 U.S.C. 78s(B)(1) (1988).
\2\17 CFR 240.19b-4 (1992).
\3\See Securities Exchange Act Release No. 33935 (April 20,
1994), 59 FR 22038 (April 28, 1994).
\4\See Letter from Philip Lenowitz, to Jonathan Katz, Secretary,
Commission, dated May 31, 1994 (``Comment Letter'').
\5\In Amendment No. 1, the Phlx proposed to amend the proposed
rule language to: (1) Provide in Rule 509(c), that any meeting with
a specialist as a result of a preliminary determination by the Phlx
Quality of Markets Subcommittee that a specialist has not satisfied
the criteria specified in the rule will occur within five days after
receipt of notice of such preliminary determination by the
specialist; (2) clarify that any decision reached pursuant to Rule
509 regarding the failure of a specialist to satisfy the
requirements of the rule will be appealable pursuant to Article XI,
Section 11-1(a) of the Phlx's by-laws; and (3) clarify that the
``weakness'' referred to in Rule 509(b)(4) does not refer to any
specific activity but to the general inability of a specialist to
prevent and settle disputes in an orderly manner in the trading
crowd. See Letter from Michele Weisbaum, Associate General Counsel,
Phlx, to Brad Ritter, Attorney, Office of Market Supervision
(``OMS''), Division of Market Regulation (``Division''), Commission,
dated April 26, 1994 (``Amendment No. 1'').
\6\In Amendment No. 2, the Phlx proposed to add Rule
1014(g)(i)(3) to codify that specialists are not eligible for the
enhanced parity treatment proposed herein until they are no longer
eligible for the enhanced parity treatment afforded to new
specialist units pursuant to Commentary .17 to Rule 1014. See Letter
from William Uchimoto, First Vice President and General Counsel,
Phlx, to Brad Ritter, Attorney, OMS, Division, Commission, dated
August 25, 1994 (``Amendment No. 2'').
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Description of Proposal
Phlx Rules 119 and 120, generally, and Phlx Rule 1014(g),
specifically, direct members in the establishment of priority and
parity of orders on the options floor. These rules provide that when
bids/offers are made simultaneously, or when it is impossible to
determine clearly the order of time in which they were made, all such
bids/offers shall be on parity, and as such shall be shared equally.
Because all newly listed options classes are subject to multiple
listing and all currently listed ones are or will become so eligible,
the current parity participation rule has come under review by the
Exchange.
The Exchange proposes to adopt, on a one year pilot basis, a
proposed rule change providing that in certain circumstances and for
certain options classes, a specialist will be eligible to receive an
enhanced participation on parity equity options trades by being counted
as two crowd participants (``Enhanced Parity Split''). The Enhanced
Parity Split will only apply to transactions where the contra side
order is for more than five contracts, and where the Enhanced Parity
Split does not disadvantage a customer order that is also on parity.\7\
\7\The Exchange represents that one way to ensure that public
customers are not disadvantaged is for a specialist to forego part
or all of his second share of a trade. See Amendment No. 1, supra
note 5.
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The Enhanced Parity Split will apply to all option classes that are
listed after the rule becomes effective and for 50% of each specialist
unit's listed issues at the time the rule becomes effective. In this
regard, each specialist's registered issues will be divided into
quartiles based on the most recent quarterly customer contract volume.
The specialist will be able to choose half of his issues in each volume
quartile rounded so that the aggregate number chosen does not exceed
50% of the total number of issues in all four quartiles. The specialist
will be required to submit this list to the Allocation, Evaluation and
Securities Committee (``AES Committee'') for its review and approval.
This list, once submitted to and approved by the AES Committee, will be
in effect for the entire one-year period of the pilot program.
The Phlx also proposes to adopt Phlx Rule 509 to empower the AES
Committee to oversee each specialist's performance with respect to the
Enhanced Parity Split. A standing subcommittee of the AES Committee
entitled the ``Quality of Markets Subcommittee'' (``Subcommittee'')
will be created to review each specialist's performance on a quarterly
basis to assure that four conditions are being satisfied by a
specialist who receives the benefit of the Enhanced Parity Split in his
trading crowd. First, the specialist must demonstrate that he is the
lead market maker in the trading crowd as measured by his transacting
more contracts in an option class than any Registered Options Trader
(``ROT'') in that issue over the review period.
Secondly, the Subcommittee will review whether the specialist has
provided the Phlx with adequate market share in options which are
multiply traded. In this respect, the Subcommittee will determine
whether the Phlx has transacted at least 10% of the aggregate customer
volume in an issue that is traded by all five options exchanges, at
least 15% where four exchanges trade the issue, at least 20% where
three exchanges trade the issue, and at least 25% where only one other
exchange trades the issue. Although this is a measure of the total
customer volume executed on the Exchange rather than solely by the
specialist, in the competition for multiply traded issues, the Exchange
believes the specialist is a key party responsible for marketing the
issue to upstairs firms, updating markets, and maintaining the limit
order book. A specialist who performs these functions will, the
Exchange believes, assist the Exchange in increasing order flow.
Third, options specialist units must receive a score of at least
five on the Exchange's quarterly specialist evaluation. Rule 515
currently requires specialists to obtain this score for its activities
regarding the options classes assigned to the specialist unit. A
specialist who receives a score below five on the quarterly evaluation
is monitored by the Exchange for continued substandard performance and
may ultimately have one or more options classes removed and reallocated
to another specialist. For purposes of the Enhanced Parity Split, the
failure by a specialist to achieve a score of at least five on this
quarterly review will cause the Enhanced Parity Split to be revoked
even if the Exchange determines not to strip a specialist of assigned
options classes.
Fourth, the Subcommittee will consider whether a pattern of
weakness has been demonstrated by such things as frequent floor
official rulings with respect to any particular options class or crowd
and/or by written customer complaints being received by the Exchange or
Subcommittee regarding the specialist in any particular options
class.\8\
\8\Id.
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If the Subcommittee determines that a specialist has failed to meet
one or more of these four conditions for any issue eligible for the
Enhanced Parity Split, the Subcommittee must make a preliminary finding
that the specialist should lose the Enhanced Parity Split in that
issue. The specialist will be notified of this finding and will be
required to appear before the Subcommittee within five business days
after receipt by the specialist of the notice.\9\ At such meeting, the
specialist bears the burden of overcoming the presumption of
substandard performance.\10\
\9\Id.
\10\For example, a specialist might be able to overcome this
presumption in the case where he has transacted less contracts than
one ROT in his trading crowd during the review period. In this case,
if the specialist can demonstrate that one large block trade
occurred during the review period but for which that specialist
would have been the lead market maker, the Subcommittee may
determine that the specialist does not deserve to lose the Enhanced
Parity Split privilege.
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Any decision of the Subcommittee must be in writing and must be
delivered to the specialist on the next business day following the
Subcommittee meeting at which the decision was made. A decision to
revoke the privilege will be effective on the next business day after
receipt of the decision by the specialist. A specialist who has lost
the privilege may reapply for it at the Subcommittee's next scheduled
review. The specialist may be reinstated if the Subcommittee finds that
the condition which initially caused the revocation of the enhanced
participation privilege has been cured and that no other problems
exist. Finally, a specialist will be entitled to appeal any decisions
made by the Subcommittee pursuant to Rule 509.\11\
\11\See Amendment No. 1, supra note 5.
The Exchange believes that the proposed rule change is necessary
because the Exchange has identified the need to attract new specialist
units and to retain and encourage existing specialists units to
vigorously trade existing options classes as well as to aggressively
seek and apply for newly allocated classes. The Phlx understands that
for the most part, specialist units can seek specialist privileges or
the equivalent lead market maker status for any particular multiply
listed options class on other national securities exchanges. Therefore,
in order to compete for specialist capital and market making talent
with other national securities exchanges which list options, the Phlx
believes it is necessary to be able to afford its specialist units with
some form of enhanced parity split treatment. Specifically, in order to
address these factors, the Exchange has determined to implement this
one-year pilot program to increase the specialist's participation in
certain trades where the specialist is on parity with one or more ROTs.
The Exchange represents that while ROTs provide critical liquidity
to the market making process at the Phlx, under the Phlx's specialist
system, the role of the specialist is to provide leadership, liquidity,
and continuity, and to satisfy market making obligations in multiply
listed options classes, particularly at the incipiency of competition
for a multiply traded issue. For the options classes that will be
eligible for multiple listing, the Exchange represents that specialists
have also taken on a larger market making obligation in order to
accommodate customers in the hope of garnering critical loyalty that
will lead to sustained order flow whether the class is or is not ever
actually multiply traded.
As a point of clarification, the Exchange states that this proposed
rule change will operate in tandem with the enhanced specialist
participation provided for new specialist units pursuant to Phlx Rule
1014, Commentary .17.\12\ Upon approval of the proposed rule change, a
specialist will only be eligible to receive the Enhanced Parity Split
described herein once the specialist is no longer eligible for the
enhanced treatment available pursuant to Commentary .17 to Rule
1014.\13\
\12\See Securities Exchange Act Release No. 34109 (May 24,
1994), 59 FR 28570 (June 2, 1994) (``New Unit Enhanced Split
Order'').
\13\See Amendment No. 2, supra note 6. Pursuant to Commentary
.17 to Rule 1014, new specialist units trading new options classes
would be entitled to execute 50% of the contracts in transactions
where the new specialist unit is on parity with one ROT, and 40% of
the contracts in a transaction where the new specialist unit is on
parity with two or more ROTs. See Securities Exchange Act Release
No. 34109 (May 25, 1994), 59 FR 28570 (June 2, 1994).
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Comment Letter
The comment letter received opposing the proposed rule change
offered two arguments as to why the proposed rule change is
inappropriate.\14\ The commenter first argues that the proposed rule is
anti-competitive and will ultimately harm public customers by acting as
a disincentive for ROTs to make competitive markets. Secondly, the
commenter argues that a floor official will be unable to determine
whether a customer order is ``disadvantaged'' as prohibited by the
rule. He further argues that tracking which options are entitled to the
Enhanced Parity Split and which are not will be a difficult chore and
that the need for elaborate review machinery to assure compliance with
the proposed rule change is evidence that the rule is unmanageable.
\14\See Comment Letter, supra note 4.
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Phlx Response
Because this commenter raises the same objections that were raised
in connection with the Phlx proposal approved in the New Unit Enhanced
Split Order,\15\ the Phlx relies on its previous response letter in
order to address the objections raised in the Comment Letter.\16\ In
response to the commenter's claims that the rule will work to the
detriment of the trading public, the Phlx believes that the proposal
will in fact add liquidity to the market, thus directly benefitting
public customers. The Phlx believes the proposal will attract new
specialists to the Exchange and will encourage new and existing
specialists to make tight markets in their selected options classes in
order to attract order flow to the Exchange. The Phlx argues that
because every newly listed options class is subject to multiple
listing, disincentives are created which discourage specialists from
acting as specialists for those new classes of options. The Phlx
believes that the Enhanced Parity Split will counteract these
disincentives by offering specialists a direct benefit if they are able
to attract order flow to the Exchange. The Exchange further believes
the specialists will be able to attract this order flow, and thus
capitalize on the Enhanced Parity Split, only if they maintain tight
markets in their selected options classes. Furthermore, the proposed
rule change provides that the Enhanced Parity Split may not
disadvantage an order submitted by a public customer.\17\ As a result,
the Phlx believes that public customers will directly benefit from the
proposed rule change.
\15\See supra note 12.
\16\See File No. SR-Phlx-93-29; and Letter from William
Uchimoto, Vice President and General Counsel, Phlx, to Sharon
Lawson, Assistant Director, OMS, Division, Commission, dated
February 23, 1994.
\17\See Amendment No. 2, supra note 6.
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In response to the commenter's claims that market makers are
unfairly disadvantaged by this proposal, the Phlx makes several
arguments. First, the Phlx disagrees with the commenter's contention
that any enhanced split is anti-competitive because a ROT can always
establish priority in a trade by improving the market or by being the
first in establishing a market that would otherwise be on parity.
Secondly, the Phlx argues that specialists have responsibilities and
are subject to certain costs that market makers do not have, such as,
updating and disseminating quotes, reflecting all market interest in
the displayed quotes, and the fixed staffing cost committed to market
making in a particular issue whether it is active or not. In order to
attract specialist units to the Exchange who are willing to accept
these responsibilities, the Phlx believes it is necessary to provide
specialists with some benefits that are not available to ROTs. The Phlx
believes that any negative impact to ROTs that may be caused by this
proposal is more than offset by the benefit to the Exchange and its
customers of attracting new specialist units to the Exchange and
retaining the services of existing specialist units.
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)\18\ in that the
proposal is designed to promote just and equitable principles of trade,
to remove impediments to and perfect the mechanism of a free and open
market, and protect investors and the public interest. Specifically,
the Commission finds that the proposal may serve to remove impediments
to and perfect the mechanism of a free and open market by encouraging
specialist units to maintain tight markets in selected options classes
in order to attract order flow to the Exchange. The Commission believes
the proposed rule change is a reasonable attempt by the Phlx to enhance
the ability of specialist units to compete for order flow in the
environment of multiply-traded options classes. In addition, the
protection of investors and the public interest is maintained because
of the procedures being adopted by the Exchange which require the
specialist units to satisfy specific conditions to qualify for the
Enhanced Parity Split. Further, the proposed rule change provides that
the Enhanced Parity Split cannot disadvantage a public customer order
that is on parity with a specialist unit.\19\
\18\15 U.S.C. 78f(b)(5) (1988).
\19\See Amendment No. 2, supra note 6.
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As the Commission stated in the new Unit Enhanced Split Order, the
Commission agrees with the Exchange that in order to attract order flow
to the Exchange, the Phlx needs to be able to attract and retain well
capitalized specialist units that are willing to trade the options
classes traded on the Exchange. Additionally, the Commission disagrees
with the commenter that the proposed rule change will disadvantage
public customers. On the contrary, the proposed rule change eliminates
any direct injury to public customers by providing that customers
orders on parity may not receive a smaller participation than any other
crowd participant, including the specialist. Furthermore, because the
proposal may serve to add liquidity to the market by encouraging
specialist units to maintain tight markets in order to attract order
flow to the Exchange, the Commission believes that public customers
could benefit from the proposed rule change.\20\ Accordingly, the
Commission believes there is no evidence to support a conclusion that
the proposed rule change will disadvantage public customers.
\20\The Commission notes that contrary to the commenter's
contention, ROTs may in fact benefit from the Enhanced Parity Split
if specialists are successful in attracting order flow to the
Exchange.
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The Commission also acknowledges that specialist have
responsibilities that ROTs do not have and that these responsibilities
have certain costs associated with them, such as the staff costs
associated with continually updating and disseminating quotes. As a
result, the Commission believes it is reasonable for the Exchange to
grant certain advantages, such as the Enhanced Parity Split, to
specialists in order to attract and retain well capitalized specialists
at the Exchange. Accordingly, as long as these advantages do no
unreasonably restrain competition and do not harm investors, the
Commission believes that the granting of such benefits to specialists
is within the business judgment of the Exchange. Therefore, even though
the proposed rule change could arguably have some negative impact on
ROTs, for the reasons stated above, the Commission believes the
proposal is consistent with the Act.
Furthermore, the Commission believes that: (1) the review
procedures proposed by the Exchange, as discussed above, adequately
ensure that only specialists satisfying the conditions set forth in the
proposed rule change receive the benefit of the Enhanced Parity Split;
and (2) in cases where a specialist is found to no longer be eligible
for the Enhanced Parity Split, the appeals procedures proposed by the
Exchange adequately protect the due process rights of such specialists.
The Commission believes that these criteria balance the competing
interests of the Exchange and the specialists by ensuring regular
review of specialist performance and that specialists' due process
rights are protected in cases where the Subcommittee makes a
determination that the Enhanced Specialist Split should be denied.
Moreover, the proposal is being approved on a one-year pilot basis.
Accordingly, prior to granting an extension or permanent approval of
the pilot program, the Commission will be able to review the operation
of the rule and require the Exchange to make any changes necessary to
ensure that competition is not being unnecessarily restrained and that
investors are not being harmed.
The Commission finds good cause for approving Amendment Nos. 1 and
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, the Commission believes that Amendment No. 1 strengthens
the proposal in several ways. By requiring specialists to meet with the
Subcommittee within five days after receipt of a notice from the
Subcommittee, the specialist is provided with time in which to prepare
a response to the claims of substandard performance raised by the
Subcommittee. Similarly, by clarifying that all determinations made
pursuant to Rule 509 are appealable pursuant to the procedures in the
Exchange's by-laws, the Commission believes that the proposal does not
raise any significant due process concerns.
Furthermore, even though Amendment No. 1 does not specifically
define ``pattern of weakness'' for purposes of Rule 509(b)(4), the
Commission does not believe that this lack of specificity will create
undo confusion as the application of the rule. Any specialist that is
cited for substandard performance for this reason will still be
entitled to a meeting with the Subcommittee to discuss the reasons for
the finding and if an adverse decision is sustained after that meeting,
the specialist will be entitled to appeal that determination.
Additionally, a specialist can reapply and have the Enhanced Parity
Split reinstated once the condition which led to the suspension is
found to no longer exist. As a result, the Commission believes that the
lack of specificity does not raise any significant regulatory concerns.
Finally, Amendment No. 2 merely codifies that intent stated in the
original proposal\21\ that specialists will only become eligible for
the Enhanced Parity Split described herein once they are no longer
eligible to receive the enhanced parity treatment afforded to new
specialists pursuant to Commentary .17 to Rule 1014.
\21\See supra note 3.
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Based on the foregoing reasons, the Commission believes it is
consistent with Section 6(b)(5) of the Act to approve Amendment Nos. 1
and 2 to the Phlx's proposal on an accelerated basis.
Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 1 and 2 to the proposed rule
change. 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 in 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 Exchange. All submissions should refer to File
No. SR-Phlx-94-12 and should be submitted by September 23, 1994.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\22\ that the proposed rule change (SR-Phlx-94-12) is hereby
approved, as amended, on a pilot basis until August 26, 1995.
\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\
\23\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-21703 Filed 9-1-94; 8:45 am]
BILLING CODE 8010-01-M
