[Federal Register Volume 62, Number 185 (Wednesday, September 24, 1997)]
[Notices]
[Pages 50036-50048]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-25319]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39086; File No. SR-PCX-97-18]
Self-Regulatory Organizations; Pacific Exchange, Inc.; Order
Approving Proposed Rule Change and Notice of Filing and Order Granting
Accelerated Approval of Amendment Numbers 1, 2 and 3 to Proposed Rule
Change Relating to the PCX Application of the OptiMark System
September 17, 1997.
I. Introduction
On June 11, 1997, the Pacific Exchange, Inc. (``PCX'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to establish rules for a new
exchange facility called the PCX Application of the OptiMark System
(``PCX Application'' or ``Application''). Notice of the proposed rule
change appeared in the Federal Register on June 19, 1997.\3\ Fourteen
comment letters were received in response to the proposal.\4\ On August
1, 1997, PCX submitted an amendment (``Amendment No. 1'') to the
proposal, as well as two letters containing supplemental
information.\5\ On August 29, 1997, PCX submitted a second amendment
(``Amendment No. 2'') to the proposal.\6\ On September 16, 1997, PCX
submitted a third amendment (``Amendment No. 3'') to the proposal.\7\
This order approves PCX's proposal, as amended.
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\1\ The Exchange originally submitted this filing to the SEC on
May 20, 1997. On June 3, 1997, the Exchange submitted Amendment No.
1 to the filing. The Exchange resubmitted the entire filing on June
11, 1997. The resubmitted filing incorporates the substance of the
June 3, 1997, Amendment No. 1. All subsequent references in this
order to ``Amendment No. 1'' refer to the amendment, dated Aug. 1,
1997, submitted as an amendment to the June 11, 1997 filing. See
note 5, infra.
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 38740 (June 13,
1997), 62 FR 33448 (June 19, 1997).
\4\ Comment letters to the Commission were received from Thomas
D. Burke, Newbridge Securities, Inc., dated July 1, 1997; Steven A.
Denning, General Atlantic Partners, dated July 2, 1997; Theodore E.
James, Jr., Van Kasper & Company, dated July 3, 1997; Junius W.
Peake, University of Northern Colorado, dated July 7, 1997; Theodore
R. Aronson, Aronson & Partners, dated July 7, 1997; Praveen K.
Gottipalli, Symphony Asset Management, dated July 8, 1997; Robert A.
Hill, Melvin Specialists, Inc., dated July 9, 1997; Tim McCarthy,
Charles Schwab, dated July 10, 1997; Todd Greenberg, ProActive
Capital Management, dated July 10, 1997; Matt Fong, Treasurer, State
of California, dated July 10, 1997; Harold S. Bradley, American
Century Investment Management, Inc., dated July 15, 1997; James E.
Buck, New York Stock Exchange, Inc. (``NYSE''), dated July 15, 1997;
Tom C. Tinsley, Baan Company, N.V., dated July 17, 1997; Bill Porter
and Christos M. Cotsakos, E*Trade Group, Inc., dated July 21, 1997.
\5\ Letter from John C. Katovich, Senior Vice President, General
Counsel, and Director of Legal Affairs, PCX, to Michael Walinskas,
Senior Special Counsel, Division of Market Regulation, SEC, dated
Aug. 1, 1997. In Amendment No. 1, PCX made a technical amendment to
its short sale rule, and provided clarification regarding the
application of Rule 10a-1 under the Act to short sales in the PCX
Application. Also in Amendment No. 1, PCX responded to comments made
by the NYSE.
\6\ Letter from John C. Katovich, Senior Vice President, General
Counsel, and Director of Legal Affairs, PCX, to Michael Walinskas,
Senior Special Counsel, Division of Market Regulation, SEC, dated
Aug. 29, 1997. In addition to Amendment No. 2, the PCX also
submitted two letters containing supplemental information. See
Letter from John C. Katovich, Senior Vice President, General
Counsel, and Director of Legal Affairs, PCX, to Michael Walinskas,
Senior Special Counsel, Division of Market Regulation, SEC, dated
Aug. 29, 1997 (regarding issues related to the Intermarket Trading
System) (``PCX ITS Letter''), and Letter from John C. Katovich,
Senior Vice President, General Counsel, and Director of Legal
Affairs, PCX, to Michael Walinskas, Senior Special Counsel, Division
of Market Regulation, SEC, dated Aug. 29, 1997 (regarding
interaction of the PCX Application with the PCX floor) (``PCX Floor
Letter'').
\7\ Memorandum from John C. Katovich, Senior Vice President,
General Counsel, and Director of Legal Affairs, PCX, to Michael
Walinskas, Senior Special Counsel, Division of Market Regulation,
SEC, dated Sept. 16, 1997. In Amendment No. 3, PCX clarified the
manner in which Primary Market Protection (``PMP'') orders will be
executed once the Application is implemented. The letter also
includes several trading scenarios that illustrate the operation of
the Application vis-a-vis PCX specialists.
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II. Description of the Proposal
A. Summary of the PCX Application and Purpose
The Exchange proposes to establish rules for a new exchange
facility called the PCX Application of the OptiMark System. The PCX
Application of the ``OptiMark System'' \8\ is a computerized, screen-
based trading service intended for use by Exchange members and their
customers. The OptiMark System would provide automatic order
formulation, matching, and execution capabilities in the equity
securities listed or traded on the Exchange (``PCX Securities''). The
OptiMark System would be used in addition to PCX's traditional floor
facilities, to buy and sell PCX Securities.\9\
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\8\ The OptiMark System was developed by OptiMark Technologies,
Inc. (``OTI''), a computer technology firm located in Durango,
Colorado, based on certain patent-pending technology referred to as
``OptiMark TM.'' OTI has represented that the PCX
Application is expected to be one of several different trading
services based on that technology that will be made available from
the OptiMark System for other exchanges and markets in the future.
OTI expects its wholly-owned subsidiary, OptiMark Servicers, Inc.
(``OSI''), which currently plans to apply for registration as a
broker-dealer, to be responsible for operating portions of the PCX
Application for the Exchange and delivering the trading service to
the Exchange's members and their customers. OTI is licensing the
OptiMark System to OSI for purposes of the PCX Application.
\9\ This rule filing addresses trading in PCX Securities only.
PCX represents that if and when it proposes to extend the
Application to options or other types of securities listed or traded
on the Exchange, a rule change proposal will first be filed with the
Commission.
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Specifically, the Application would allow PCX members and their
customers to submit anonymously from their computer terminals ranges of
the trading interest to the OptiMark Systems. At specified times during
the trading day, the OptiMark System would conduct certain calculations
against such expressions of interest to identify specific orders
capable of execution. All orders formulated by the OptiMark System
would be automatically executed on the Exchange, except to the extent
that they are executed on other market centers through the Intermarket
Trading System (``ITS''). The Exchange has stated that the proposed
facility would meet institutional investors' growing demand for a new
trading medium. The Exchange also expects retail investors to benefit
from the operation of the PCX Application.
B. Description of the Proposed PCX Application Operation
The PCX Application was developed jointly by the Exchange and OTI.
Exchange members and their customers will trade on the OptiMark System
in the manner described below:
Proposed Method of Operation
Two distinct operations would be involved in running the PCX
Application: (i) The central information processing system and related
administrative and communications
[[Page 50037]]
terminal network of the OptiMark System, which includes computers that
collect and process data, log activities, and switch messages from and
to other systems and carriers, as well as the communication network
linking such computers with customer terminals; and (ii) the computer
hardware and software needed (collectively, the ``PCX Interfaces'') for
the OptiMark System to communicate with PCX's computerized order system
(including any terminals in use by PCX specialists or floor brokers).
The Exchange would continue to operate its electronic linkages with the
ITS, Consolidated Quote System (``CQS''), and the Consolidated Tape
System (``CTS''), as they currently exist.
The Exchange would have direct ownership of and control over the
PCX Interfaces. The OptiMark System would provide such electronic
communications and information services needed for the PCX Application
to operate. From time to time, various services provided by the
OptiMark System would be modified to allow for system improvement and
enhancement. The Exchange would assure that, at all relevant times, the
material terms and conditions of the PCX Application would comply fully
with the applicable rules of the Exchange.
Access to the PCX Application
The PCX Application would be available to all members of PCX and,
through them, to non-members such as institutional investors and other
non-member broker-dealers. Each interested member and non-member
customer would be eligible to enter into a subscription agreement
(``User Agreement'') with OTI and also to execute an agreement with OSI
authorizing the delivery of the trading service made available from the
OptiMark System.
The OptiMark System subscribers (``Users'') would log in from their
own computer terminals and communicate with the OptiMark System over
customary commercial information services and networks of their choice.
Those Users that serve as specialists and floor brokers on the Exchange
could also communicate with the OptiMark System from certain computer
terminals located on the floor of the Exchange. Security codes and
protocols would be required to log in to the OptiMark System. Once
logged in, Users with authorized access to the PCX Application would be
able to submit certain expressions of their trading interest in a PCX
Security to the OptiMark System. Users would be responsible for all of
such expressions and any other messages submitted to the OptiMark
System under their passwords and security codes.
Under PCX's proposal, each member of the Exchange would be granted
access to the PCX Application directly as a User. Any orders formulated
and matched by the OptiMark System based on the expressions of trading
interest received from a member User would be automatically routed,
executed and reported in that User's name. Each such member User would
be responsible for all transactions resulting from the PCX Application
for its own or customer accounts in the same way that it is currently
responsible for transactions on the floor.
Non-member Users would be required to designate in advance member
firms (``Designated Brokers'') that would authorize their access to the
PCX Application. Under a non-member's agreement with a Designed Broker
(``Give-Up Agreement''), the Designated Broker would accept
responsibility for that non-member User's transactions and provide a
written statement to the Exchange to that effect. Under the Designated
Broker's agreement with OSI (``Transmission Consent Agreement''), the
Designated Broker would authorize any and all orders formulated and
matched by the OptiMark System based on the expressions of trading
interest received from the non-member User to be automatically routed,
executed and reported in the Designated Broker's name. Both agreements
must be in force before any non-member User may be given access to the
PCX Application. At a minimum, the provisions in these agreements would
include any credit limits that may be imposed by a Designated Broker
(or its clearing broker if applicable) on a non-member User; \10\ the
Designated Broker's undertaking that it is responsible for the non-
member User's transactions; and such other terms and conditions that
may be agreed to from time to time.
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\10\ A non-member User's credit limits, as they may be
established from time to time by a Designated Broker (or its
clearing broker if applicable), will be programmed into the OptiMark
System. In addition, the Designated Broker will be notified as its
potential exposure to its customers, individually or in the
aggregate, approaches the established credit limits.
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Entry of Profiles
Under PCX's proposal, a User would submit an expression of its
trading interest in the form of a ``satisfaction profile''
(``Profile''), which would indicate the User's degree of satisfaction
or willingness (expressed as a number between zero and one) to trade at
each coordinate of a price/size grid. A User may depict a varying
degree of its trading preferences, covering a range of prices and
sizes, in a Profile.
The price/size grid over which Profiles are entered would be
unitized into individual coordinates. The price axis would be divided
into the minimum trading increments in the relevant security being
traded.\11\ The size axis would be divided into 1,000 share increments.
A User could create a three-dimensional Profile over each coordinate in
the desired region of the price/size grid by indicating a degree of
willingness (a ``satisfaction value'') to trade at that coordinate.
Such willingness to trade or satisfaction value could range from the
most satisfactory (i.e., ``1'' satisfaction value) to a cut-off point
at which a transaction at that price and size becomes undesirable
(i.e., ``0'' satisfaction value).
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\11\ PCX recently amended its rules in order to trade equity
securities in minimum increments of \1/16\ of a dollar. See
Securities Exchange Act Release No. 38780 (June 26, 1997), 62 FR
36087 (July 3, 1997).
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The delineation of the size axis into 1,000 share increments for
purposes of defining a Profile is distinguishable from the minimum
units of trading in the PCX Application, which are in round lots. An
example provided in the Exchange's proposal would be a User seeking to
submit a buy Profile for 4,100 shares that shows a 100% willingness to
trade at the price of 20, decreasing to no willingness as the price
reaches 22. Because of the 1,000 share increments on the size axis, the
User's interest in excess of 4,000 shares (i.e., the 100 shares) would
be reflected in the next available higher coordinate size--5,000. To
draw this Profile on the grid, the User would assign the satisfaction
value of 1 to all the coordinates with the associated size of 5,000
shares or less and price of 20 or below. As the associated price
increases from 20 to 22, the satisfaction value of the relevant
coordinates would decrease steadily down to 0. According to the
Exchange, the grid size of 5,000 shares does not mean that the User
actually would receive a 5,000 share trade in excess of the desired
amount, because the User could enter an instruction as part of the
Profile to limit the transaction size to 4,100 shares.
According to the proposal, each User may specify, with respect to
each Profile submitted, an associated maximum quantity of shares in any
round lot multiples starting at 1,000 shares; provided, however, those
Profiles submitted by PCX specialists and certain system-generated CQS
Profiles (as discussed below) would each have the associated round lot
size reflected in the relevant limit order book or
[[Page 50038]]
quotation, which may be less than 1,000 shares. In addition, Users may,
at their option, set boundary conditions on a Profile to restrict the
total number of shares that may be purchased or sold within any
particular price or size range. Similarly, Users may, at their option,
place restrictions on any potential purchase or sale of shares through
the ITS.
Users would submit Profiles through their own computers or
computers on the floor of the Exchange. All Profiles received by the
Application from a User would be treated confidentially and would be
viewed only by that User. Unlike orders entered on the Exchange's
traditional floor facilities, Profiles would not be widely disseminated
to elicit any trading interest when they are received. Instead, they
would be logged and maintained by the OptiMark System until they are
centrally processed. As discussed further below, Profiles would not be
executable outside of the specified times. As trading interest
contingent upon such periodic processing, Profiles received by and kept
within the OptiMark System would have no standing against orders on the
floor and no bearing on the Exchange's traditional auction-pricing
mechanism.
The Exchange has represented that, in accordance with its general
audit trail requirements, all Profiles submitted by Users would be
appropriately marked as proprietary or agency. In addition, each would
be time-stamped with a unique serial number when received by the
OptiMark System.\12\ Users would be able to revise or cancel their own
Profiles at any time prior to commencement of the next scheduled
central processing. According to the Exchange, because it would be
important for Users to be able to adjust their outstanding Profiles in
a timely manner in response to sudden market developments, adjustments
would be processed in the next central processing scheduled to take
place more than one second after receipt. Submitting a revised Profile
would result in a new time stamp, unless the only change made is a
reduction in the maximum quantity of shares previously specified.
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\12\ PCX would have access to all non-member trade information
held by a member in order to perform surveillance. Telephone
conversation between John C. Katovich, Senior Vice President,
General Counsel, and Director of Legal Affairs, PCX, and Michael
Walinskas, Senior Special Counsel, Division of Market Regulation,
SEC, Sept. 4, 1997.
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According to the Exchange, all Users would be held responsible for
the terms and conditions contained in their Profiles. Each User would
assume any and all responsibility for canceling or revising its
Profile. Users would be able to specify in advance whether to cancel
their outstanding Profiles or to keep such Profiles active in the event
of an unexpected interruption experienced in their own
telecommunications linkage to the OptiMark System. If a User decided to
keep its Profile active, it would be accountable for any and all
transactions resulting from the PCX Application based on such Profile.
Under PCX's proposal, the first match in a Cycle (as defined
below), if it involves a short sale, will only be effected if it meets
the requirements of Rule 10a-1 under the Act,\13\ i.e., if it is at a
price above the last sale price reported on a consolidated transaction
reporting system immediately prior to commencement of the Cycle, or at
the last reported price if such price is above the next preceding
different price. After the first transaction in the Cycle, short sale
orders will only be executed at a price: (i) Above the price of the
immediately preceding match within the Cycle, or (ii) equal to the
immediately preceding price if such price is above the next preceding
different price. PCX has requested an exemption from Rule 10a-1, the
Commission's short sale rule, to permit matches within a Cycle (those
subsequent to the initial match) to utilize the immediately prior match
as a reference trade for determining short sale rule compliance.\14\
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\13\ 17 CFR 240.10a-1.
\14\ Letter from John C. Katovich, Senior Vice President,
General Counsel, and Director of Legal Affairs, PCX, to Richard R.
Lindsey, Director, Division of Market Regulation, SEC, dated August
29, 1997.
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The OptiMark System would perform the necessary credit verification
procedures on each Profile submitted by a non-member User. Such
procedures would ensure that the maximum absolute dollar value of each
Profile received by the OptiMark System, when added to the non-member
Users' current credit usage, is consistent with the applicable credit
limits. All Profiles not meeting the credit validation requirement
would be deactivated.
Interaction With Existing Market Interest
According to the Exchange, the PCX Application is designed to
provide Users with certain automated access to and interaction with
quotations emanating from other participating market centers of the
ITS. At the specified times during the trading day when central
processing by the Opti-Mark System is scheduled to occur, the
prevailing bid and offer quotations in CQS from each such market that
may be reached by ITS, including the Intermarket Trading System/
Computer Assisted Execution System interface (``ITS/CAES''), would be
transformed into a pair of buy and sell Profiles (``CQS Profiles'').
Each CQS Profile would have, for the relevant limit price and size, a
satisfaction of 1 for all the corresponding coordinates in the price/
size grid. The Exchange has represented that creation of these CQS
Profiles and their interaction with the Profiles submitted by Users
would ensure that the PCX Application is consistent with the
intermarket price protection requirement under the ITS Plan.
According to the Exchange's proposal, the PCX Application is also
designed to serve as an additional trading service for the Exchange
specialists and floor brokers to use in handling existing market
interest on the floor. In their capacity as Users, the specialists and
floor brokers would be able to submit Profiles based on their customer
limit orders. The PCX specialists would be provided with a uniquely
designed electronic interface at their posts that would provide simple
retrieval instructions to facilitate designation of customer orders on
their limit order books for inclusion as Profiles in the OptiMark
System. Such an interface also would permit PCX specialists to revise
and/or cancel the relevant Profile if any of the limit orders reflected
in the Profile subsequently became executable against some other market
interest. The Profiles created from a PCX specialist's book would be
treated the same as any other Profiles submitted by Users of the
OptiMark System.\15\ Similarly, floor brokers would have the ability to
use existing terminals or designated OptiMark System terminals on the
trading floor to submit Profiles if they wish to use the PCX
Application to fill existing customer interest.
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\15\ According to the Exchange, the PCX specialists may also
submit Profiles based on their own proprietary trading strategies,
in addition to Profiles reflecting public limit orders on their
books. To the extent that a PCX specialist chooses to represent a
proprietary trading interest in its designated security by
submitting a Profile, that particular Profile will have lower time
priority than that of the Profile submitted by any other User in the
security, thereby preventing the specialist from trading ahead of
any agency orders submitted by Users. Time priorities are discussed
below.
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Central Processing
All Profiles received by the OptiMark System (including CQS
Profiles) for each relevant security would be centrally processed by
computer at one or more specified times during the trading day in order
to generate one or more orders of identified prices and sizes at which
execution may occur immediately (``orders''). Such
[[Page 50039]]
processing would involve a series of high-speed calculations
(``Cycle''). Cycles would be based on a computer algorithm that is
designed to measure and rank all relevant mutual satisfaction outcomes
by matching individual coordinates from intersecting Buy Profiles and
Sell Profiles. The matching algorithm of the OptiMark System is
intended to compute optimal trade results for Users based on their
different willingness to trade across a wide range of price and size. A
buy coordinate and a sell coordinate, each with a full satisfaction
value of 1, would be matched, based on price, standing, time of entry,
and size. If one or both coordinates have a partial satisfaction value
of less than 1 (but greater than 0), they would be matched, generally
based on the mutual satisfaction value--that is, the product of the
specific satisfaction values associated with the buy coordinate and
sell coordinate.
The Exchange has represented that Profiles would be processed
according to the following terms concerning matching eligibility
restrictions and priority principles:
1. Eligibility Restrictions. At commencement of a Cycle, each
individual coordinate with a non-zero satisfaction value from all buy
Profiles and all sell Profiles received by the OptiMark System
(including CQS Profiles) in a given PCX Security would be grouped into
the Buy Profile Data Base or the Sell Profile Data Base, respectively.
Each individual coordinate, no matter how small or large in the
corresponding size, from either Profile Data Base would be eligible to
be matched with one or more coordinates from the other Profile Data
Base and would result in one or more orders, provided that:
1.1 No buy and sell coordinates could be matched in violation
of any applicable User instructions for the respective Profiles,
including: (a) The maximum quantity associated with the Profile, (b)
any boundary conditions restricting the aggregate number of shares
that may be bought or sold at a particular price or size range, and
(c) the restrictions on any potential sale or purchase through ITS;
and
1.2 No buy and sell coodinates could be matched from contra CQS
Profiles.
1.3 No buy and sell coordinates could be matched at a price
inferior to that of another coordinate with standing (as defined
below) that is eligible for matching. A buy (sell) coordinate has
Standing if: (a) It has 1 satisfaction value and (b) all coordinates
having the same price and a smaller size, down to and including the
minimum trading increment (100 shares), are included in the
associated Profile at 1 satisfaction value; provided, however, that
no coordinate from a Profile containing any boundary conditions
restricting the aggregate number of shares that may be bought or
sold at a particular size range has Standing. Each coordinate from a
CQS Profile would have Standing. By contrast, no coordinate from a
Profile submitted by a User on an ``all-or-none'' basis would have
Standing.
2. Priority Principles. The methods for considering potential
matches between buy and sell coordinates in the Profile Data Bases
would vary, depending on whether both coordinates represent
satisfaction values of 1 or less than 1. As a result, these would be
two separate stages of a Cycle:
2.1 Aggregation Stage. The OptiMark System initially would
process eligible buy and sell coordinates in the Profile Data Bases,
each with the full satisfaction value of 1 only. At this stage of
calculation (``Aggregation Stage''), smaller-sized coordinates may
be aggregated to build sufficient size to be matched with larger-
sized coordinates to generate orders in accordance with the
following rules of priority, subject to the applicable eligibility
restrictions:
(A) Price aggressiveness. A coordinate with a more aggressive
price (i.e., a higher price for a buy coordinate and a lower price
for a sell coordinate) would have priority over coordinates with
less aggressive prices.
(B) Standing. Among the coordinates with the same price, a
coordinate with Standing would have priority over all other
coordinates without Standing.
(C) Time of entry. Among the coordinates with the same price and
Standing, the time of the entry of the associated Profile would
determine relative priority, with earlier submissions having
priority. All Profiles submitted by Users would be appropriately
time-stamped with a unique serial number when received by the
OptiMark System; provided, however, that the effective time of entry
for any Profile submitted by a PCX specialist representing
proprietary trading interest in the specialist's designated security
would fall behind that of a Profile submitted by any other User for
that security. Because each CQS Profile would be generated from the
relevant market's most current quotation prevailing at the time of
commencement of a Cycle, the effective time of entry of a CQS
Profile would be later than that of any other Profile submitted by a
User, including a PCX specialist's proprietary trading in the
specialist's designated security.\16\
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\16\ See Amendment No. 3, supra, note 7.
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(D) Size. Among the coordinates with the same price, standing
and time of entry, priority would be determined by size, with larger
sizes having higher priority.
2.2 Accumulation Stage. Upon completion of the Aggregation
Stage, the OptiMark System would consider potential matches between
eligible buy coordinates and sell coordinates in the Profile Data
Bases where one or both parties have less than 1 (but greater than
0) satisfaction values. At this stage of calculation (``Accumulation
Stage''), only those buy and sell coordinates with the same
associated price and size would be matched to generate orders in
accordance with the following rules of priority, subject to the
applicable eligibility restrictions:
(A) Mutual satisfaction. A potential match with a higher mutual
satisfaction value (the product of the two satisfaction values)
would take precedence over other potential matches with lower mutual
satisfaction values.
(B) Time of entry (based on the earlier Profile). Among the
potential matches with the same mutual satisfaction, the match with
the earlier time of entry, as determined initially by the effective
time of entry assigned to the earlier of the buy and sell Profiles
involved (the ``earlier Profile''), would have priority over other
potential matches.
(C) Size. Among the potential matches with the same mutual
satisfaction and time of entry for the earlier Profile, priority
would be given to one with a larger size.
(D) Time of entry (based on the later Profile). Among the
potential matches with the same mutual satisfaction, time of entry
(for the earlier Profile), and size, the match with the earlier time
of entry, as determined this time by the effective time of entry
assigned to the later of the buy and sell Profiles involved (the
``later Profile''), would have priority over other potential
matches.
(E) Price assignment. In regard to all remaining ties between
potential matches, which would consist solely of the coordinates for
a single pair of buy and sell Profiles from two Users that may be
matched with the same mutual satisfaction, time of entry and size,
but at different prices, priority would be given to the match at a
price more favorable to the User whose Profile has the earlier time
of entry. By way of example, among the last potential matches
remaining at the price of 10 and also at 10\1/8\, if the sell
Profile is the earlier Profile, then the match would take place at
the price of 10\1/8\. The Commission notes that two or more Profiles
that are entered into the OptiMark System representing the same
number of shares may result in executions at differing prices
depending on the other information and conditions entered into the
System.
The Exchange has represented that, for purposes of the PCX
Application, the specific times at which Profiles would be centrally
processed would vary, depending on the security involved. No Cycle,
however, would be scheduled until after the opening of the PCX market
for any such security. Similarly, no Cycle would be scheduled at or
after the closing of the PCS market for that security. The maximum
frequency with which Cycles may take place throughout the trading day
would be every 90 seconds, while the minimum would be once a day.
The Exchange has represented that the exact frequency of Cycles as
to any given PCX Security would be determined by OSI, taking into
account the general characteristics of the security (e.g., trading
volume, price, and number of shareholders), the associated Profile flow
over a period, and the current level of interest expressed by
[[Page 50040]]
Users. From time to time, OSI may alter the frequency of Cycles in
response to subsequent developments. PCX has represented that OSI will
consult with PCX prior to altering the frequency of any Cycle.\17\ Any
change in the frequency of Cycles would be effective upon three days'
advance notice to Users. Such notice would be provided electronically,
using the same telecommunications linkage and protocols available to
Users for submitting Profiles. At all relevant times, Users would be
fully informed as to when the next Cycle in a particular PCX Security
would take place.
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\17\ Telephone conversation between John C. Katovich, Senior
Vice President, General Counsel, and Director of Legal Affairs, PCX,
and Michael Walinskas, Senior Special Counsel, Division of Market
Regulation, SEC, Sept. 4, 1997.
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The Exchange would assure that the frequency of Cycles remains
commensurate with the financial community's need and demand for the
trading service. In addition, the Exchange would assure that the PCX
Interfaces and the OptiMark System have sufficient capacity in place to
handle any material increase in the volume of data prior to
implementing a change in the frequency of Cycles.
Order Execution and Reporting
The Exchange would make available the necessary PCX Interfaces to
permit orders in PCX Securities from the OptiMark System to be
executed, either on the Exchange or on other market centers
participating in ITS through the appropriate Exchange communications
linkage. The Exchange would permit one or more pairs of orders
resulting from intersection of the Profiles submitted by Users
(including PCX specialists and floor brokers) to be routed and executed
on the Exchange. Every trade resulting from the execution of a pair of
orders on the Exchange would be appropriately reported, by way of the
traditional Exchange linkage to the CTS processor for dissemination, in
the sequence in which orders are generated from the Cycle. The Exchange
would report these trades, similar to the way it currently reports
other trades in PCX Securities to the CTS. Accordingly, consistent with
the existing reporting practices, a series of orders generated from a
single Cycle for the same seller with different buyers at an identical
price would be printed on the Tape as one transaction. In general, the
report for any transaction resulting from the PCX Application would not
be distinguished on the Tape from the trade report of any other order
executed on the PCX floor.
As for one or more orders representing matched coordinates from CQS
Profiles, and other contra Profiles, the Exchange would submit an ITS
commitment reflecting each such order and seeking execution on market
centers other than PCX. Every ITS commitment would be sent under the
give-up of the relevant member User or the Designated Broker, by way of
the traditional Exchange linkage to the ITS, in the sequence in which
orders are generated from the Cycle. Each ITS commitment would be
assigned a ``T-1'' (one minute) time period as specified in the ITS
Plan. The Exchange envisions sending ITS commitments resulting from the
PCX Application in the same way other ITS commitments are currently
sent from the Exchange. According to the Exchange, ITS commitments
resulting from the PCX Application would not be distinguishable from
other ITS commitments.
The Exchange would continue to apply all existing rules governing
trading on its equity trading floor. For example, market orders routed
from members to the Exchange would continue to be executed in the same
manner. Similarly, ITS commitments received from ITS participants other
than PCX would be executed against the Exchange's prevailing quotations
as specified under the ITS Plan. As for limit orders, PCX specialists
and floor brokers would be afforded an additional (but not alternative)
opportunity to fill such interest through the PCX Application. To the
extent that the Exchange specialists and floor brokers submit Profiles
to the OptiMark System based on customer interest in their books, the
handling of any such Profiles and any resulting trade executions
through the PCX Application would be fully consistent with the
parameters under which public limit orders are currently filled.
Moreover, PCX specialists would remain fully responsible for
managing their limit order books. Accordingly, if a specialist elected
not to reflect a customer limit order in the OptiMark System, it would
remain accountable for execution at any more favorable price that could
have been obtained if such order were processed through the PCX
Application. In such a case, consistent with the Exchange's existing
floor procedures and practices, the specialist would be required to
satisfy or cause to be satisfied the customer limit order so held,
either at the limit price specified, or at any better price generated
by the Application. PCX has represented that this guarantee is limited
to customer limit orders booked prior to the commencement of a Cycle.
Therefore, orders booked after the commencement of a Cycle would not be
guaranteed an execution at prices obtained as a result of such Cycle.
In Amendment No. 3 to its filing, PCX clarified that, even if the
specialist does not submit a Profile for a limit order in its book, the
limit order will receive ``the limit price or a better price if one
occurred in that cycle, up to the amount of the order or orders
executed in OptiMark.'' \18\
---------------------------------------------------------------------------
\18\ See Amendment No. 3, supra, note 7.
---------------------------------------------------------------------------
Specifically, after a Cycle of the Application is completed, the
Application sends the orders to the PCX floor in a batch. The batch of
orders, which will be automatically executed, ``will be in a specific,
deterministic order, as defined by the Aggregation and Accumulation
Stage'' \19\ (discussed above). According to PCX, the order of
execution will be provided to the specialist, in the same manner as
executions performed in another market, such as NYSE. The specialist
will have, out of that batch of executions resulting from a Cycle, the
prices and size of each execution. If at the beginning of a Cycle a
specialist has a limit order in the book that was not reflected as a
Profile in the Application, and, as a result of orders generated
through the Application, the booked order becomes eligible for
execution, the price that will be given to the booked order will be
based upon the best price that occurs out of the batch of orders
generated by the Application, up to the size of the booked order not
entered into the Application as a Profile.
---------------------------------------------------------------------------
\19\ Id.
---------------------------------------------------------------------------
The Exchange presented the following example: There is a booked
order to buy 1,000 shares with a 10 limit price, and the specialist
does not express the order as a Profile in the Application. The
immediately succeeding Cycle of the Application generates orders
resulting in transactions at the following prices: 1,000 at 10\1/8\,
500 at 10, and 1,000 at 9\7/8\. Without the existence of the
Application, an execution in the same security on the PCX at 10 would
trigger an execution of the booked order at 10. With the implementation
of the Application, the batched transactions resulting from a Cycle
would be viewed as a unit for purposes of determining the price at
which the booked order should be filled. The specialist, therefore,
would look for the best price resulting from the Cycle in determining
the price at which to fill the booked order. In this case, the
transaction resulting at a price of 9\7/8\ for 1,000 shares would be
the determining price, and the specialist would be obligated to fill
the order at
[[Page 50041]]
9\7/8\. If, on the other hand, the Cycle resulted in a series of
transactions that included only 500 shares at the prices stated above,
and the specialist nevertheless had a booked limit order for 1,000 at
10 (which was not entered into the Application), the specialist would
be obligated to fill the first 500 shares of the booked order at 9\7/8\
and the remaining 500 shares at 10, the next best price generated by
the Cycle.
In Amendment No. 3, PCX provided an example of how limit orders
booked with PCX specialists would interact with the Application. In the
example, a specialist would have two booked limit orders at buy, the
first for 1,000 shares, and the second for 500 shares, both at a price
of 30. The example assumes that the specialist did not enter the 1,000
share order into the Application, but the specialist did enter the 500
share order into the Application as a Profile. In the example, the next
Cycle of the Application resulted in a transaction of 29\1/2\ for the
500 share order entered into the Application as a Profile. In such a
case, the specialist would be required to fill both orders at 29\1/2\.
In Amendment No. 3, PCX also further clarified the manner in which
PMP would operate in connection with the Application. Generally,
according to the PCX,
[i]f an order is received and specifically marked PMP (primary
market protection), this means that the firm sending the order has
usually requested that the order only get filled if within the range
of the designated ``primary'' market (usually the NYSE and AMEX). In
such a case, the specialist is operating under the understanding
that the order will not get filled outside the ``primary'' market
range.\20\
---------------------------------------------------------------------------
\20\ See Amendment No. 3, supra, note 7, at 2.
In order to ensure that PMP orders can be integrated into the
---------------------------------------------------------------------------
Application, PCX represented that:
during regular ``primary'' market trading hours, an order
specifically marked PMP will have to be treated just like any other
booked order when executions result from OptiMark matches, even if
the ``primary'' market range has not traded at that price.
Similarly, a PMP order reflected into OptiMark as a profile, which
is matched in OptiMark and results in an execution, will require
that the PMP limit order be filled, even if the price is out of
range from the * * * otherwise existing ``primary'' market, however
defined.\21\
---------------------------------------------------------------------------
\21\ Id. PCX will codify this clarification through a rule
amendment with the Commission. In this regard, PCX stated that the
amendment ``will be consistent with the overall premise that under
no circumstance can a specialist accept an execution arising out of
orders generated from an OptiMark cycle, without first taking care
of any eligible booked orders that were put in the book before the
cycle began.'' Id.
PCX will undertake to amend its rules so that the operation of the
Application would be considered as an exception to Rule 5.32 regarding
the execution of orders marked PMP.
The Exchange has also represented the operation of the PCX
Application would be consistent with the Exchange's intermarket price
protection obligations under the ITS Plan. The OptiMark System
incorporates existing market interest emanating from each of the ITS
participant markets to which it is not directly linked in the form of
CQS Profiles. Because of the rules of priority for considering
potential matches between buy coordinates and sell coordinates from any
Profiles (including CQS Profiles), all orders that are priced inferior
to the quotations of another market center would be generated and
executed on PCX only upon submission of appropriate ITS commitments
seeking to reach such better-priced interest. As a result, the Exchange
has represented that execution of any such orders on PCX would not
violate the trade-through rule under the ITS Plan.
The Exchange has represented that all Users would be informed of
executions that take place against the Profiles that they submitted for
their own or customer accounts promptly after the trades occur. If an
ITS commitment resulting from the PCX Application is canceled or only
partially filled, the OptiMark System would notify the relevant User
and restore to the Profile the volume of the security represented by
the unfilled order. All such reports would be sent electronically,
using the same telecommunications linkage and protocols that were used
to submit the Profiles initially. Unless specified otherwise by non-
member Users in advance, executions would not be reported to relevant
Designated Brokers until after the close of the trading day in order to
limit market impact and other such adverse effects of non-member Users'
trading.
Clearance and Settlement
The Exchange has represented that transactions in PCX Securities
resulting from the PCX Application, including any ITS commitment sent
to another market center and accepted, would clear and settle in the
same way as other transactions occurring on the Exchange floor. All
orders generated by the OptiMark System that are executed on PCX or
another market center through ITS would be reported and entered into
the comparison system on a locked-in basis. Orders generated by the
OptiMark System on behalf of a member User and the resulting
transactions would be cleared and settled using that member User's
mnemonic (or its clearing broker's mnemonic). Orders generated by the
OptiMark System on behalf of a non-member User and the resulting
transactions would be cleared and settled using the appropriate
Designated Broker's mnemonic (or its clearing broker's mnemonic).
The Exchange or any operator, administrator or licensor of the
OptiMark System would not be responsible for any User's failure to pay
for PCX Securities purchased or to deliver PCX Securities sold. Neither
OTI nor OSI would be deemed to be a party to or a participant in, as
principal or as agent, any trade or transaction entered into or
otherwise conducted by Users while using the OptiMark System for the
purposes of clearance and settlement.
Hours of Operation
The PCX Application would be initially available for execution of
orders and routing of ITS commitments during the regular PCX hours
after the opening and prior to the closing.\22\ In the event of a
suspension in trading of a security listed or traded on the Exchange,
the Exchange would suspend the related trading activities respecting
that security through the PCX Application. In addition, the Chairman
or, in the Chairman's absence, Chief Operating Officer, or other PCX
Officer(s) as the Chairman may designate, may determine that market
conditions warrant a market-wide halt pursuant to the Exchange's Policy
Statement on Market Closings. Trading on the PCX Application of the
OptiMark System would be covered by such a market-wide halt. The
Exchange may suspend the trading activities through the PCX Application
relating to one or more PCX Securities at any time upon consultation
with OTI if deemed necessary and proper to preserve system capacity and
integrity.
---------------------------------------------------------------------------
\22\ The Exchange's hours are currently 6:30 a.m. (P.T.) to 1:30
p.m. (P.T.).
---------------------------------------------------------------------------
Audit Trail and Surveillance
The Exchange would maintain, or cause to be maintained, a detailed
audit trail of each transaction resulting from the PCX Application,
including time sequenced records of Profiles submitted to the OptiMark
System, orders resulting from a Cycle, and their execution and
reporting through PCX facilities. Such data would be stored and
preserved for a period of not less than three years, the first two
years in an easily accessible place, to assure that the Exchange has
sufficient information for exercising its regulatory oversight.
[[Page 50042]]
The Exchange would apply appropriate equity trading surveillance
procedures to monitor transactions resulting from the PCX Application.
System Capacity and Integrity
The Exchange believes that the PCX Interfaces and the OptiMark
System would provide sufficient capacity to handle the volume of data
reasonably anticipated for the PCX Application. The Exchange would have
in place security procedures designed to prevent unauthorized access to
the PCX Application and to safeguard the PCX Interfaces. The Exchange
would obtain similar assurances from OTI and OSI that reasonable
security procedures are in place to safeguard the OptiMark System and
to protect against threats to the proper functioning of the OptiMark
System, including any networks used by the OptiMark System. The
Exchange would also obtain appropriate assurances that proper system
reliability and system capacity exists to ensure the integrity of the
data handled and timely response of the OptiMark computers in
connection with the PCX Application.
Fees for the PCX Application
Transactions resulting from the PCX Application would be subject to
the Exchange's customary assessment of transaction charges and the
Commission's exchange transaction fee under Section 31 of the Act. As a
sponsor of the OptiMark System within the meaning of Rule 17a-23 under
the Act, OSI, which currently plans to apply to register as a broker-
dealer, would be compensated by way of usual and customary commissions,
on a cents-per-share-filled basis, for transactions effected by a
member User for its own customer accounts through the PCX Application.
With respect to transactions effected by a non-member User, OSI would
be paid commissions on a similar basis from the relevant Designated
Broker.
III. Comments Received
The Commission received fourteen comment letters in response to its
request for comments on the PCX proposal.\23\ All of the comment
letters, except for a letter submitted by the NYSE, supported the PCX's
proposal. Letters in support of the proposal were submitted by
institutions, broker-dealers (including underwriters, specialists, and
retail and clearing brokers), the Treasurer of the State of California,
and from academia.
---------------------------------------------------------------------------
\23\ See supra, note 4.
---------------------------------------------------------------------------
Those submitting letters in favor of the implementation of the
OptiMark System provided various reasons for their support of the PCX
proposal. For example, commenters stated that the OptiMark System would
provide an alternative to the traditional method of order execution and
would be the first system available to allow institutions to use
complex trading strategies in a secure environment.
Several commenters stated that the OptiMark System would provide
both retail and institutional participants with an improved ability to
buy or sell securities in a manner that matches their objectives.
Commenters stated that both retail and institutional customers would
benefit from better prices.
One broker-dealer, for example, stated that the OptiMark System
would enable its retail customers to obtain price improvement derived
from a mixture of retail and institutional order flow between PCX floor
brokers and specialists. Another stated that the system would be
beneficial in allowing for anonymous interaction between retail orders
and institutional orders.
In addition, some commenters focused specifically on the
confidentiality of the OptiMark System. One commenter noted that,
currently, trading interest may be difficult to assess because of
concerns about information integrity and the market impact cost of
large orders. Another stated that one of the biggest problems that
institutions face today is attempting to keep their decisions to buy or
sell securities confidential. These and other commenters argued that
OptiMark would provide a solution to such problems. One commenter
stated that the system would allow a portfolio manager to add
qualitative information to each order on a non-disclosed basis.
Several commenters stated that the OptiMark System would promote
liquidity, and two commenters stated that the Application would reduce
market volatility. Several commenters stated that OptiMark would
promote market efficiency and reduce transaction costs by lowering the
market impact of trades.
Commenters also argued that the OptiMark System would further the
development of the national market system (``NMS'') envisioned in the
Securities Acts Amendments of 1975,\24\ and as reflected in Section 11A
of the Act.\25\ One such commenter stated that ``OptiMark represents
precisely the kind of `new data processing and communications
techniques' that Congress thought when it passed the 1975 Securities
Act Amendments would create the opportunity for more efficient and
effective market operations, and would foster efficiency, enhance
competition, facilitate the offsetting of customer orders, and
contribute to best execution.'' \26\ The same commenter stated that
OptiMark's operation as a facility of an exchange, ``with the
accompanying linkage to other markets through the ITS system, should
ensure that OptiMark has a positive impact on the national market
system as a whole.'' \27\
---------------------------------------------------------------------------
\24\ Pub. L. No. 94-29, 89 Stat. 131 (1975).
\25\ 15 U.S.C. 78k-1.
\26\ See Letter from Tim McCarthy, Charles Schwab, supra, note
4.
\27\ See id.
---------------------------------------------------------------------------
One commenter also stated that OptiMark would promote free market
competition and would ``erod[e] the private club benefits previously
afforded members of dominant exchanges and compel * * * limit order
disclosure to the public markets.'' \28\
---------------------------------------------------------------------------
\28\ See Letter from Harold S. Bradley, American Century
Investment Management, Inc., supra, note 4.
---------------------------------------------------------------------------
In contrast to the views of the supporting commenters, NYSE
submitted a comment letter opposing the PCX rule filing (``NYSE Comment
Letter'').\29\ The NYSE asked the Commission not to approve the filing,
but to require PCX to further explain and clarify its proposal. In its
letter, NYSE expressed several concerns about the possible
implementation of the OptiMark System. First, NYSE contended that the
system would have the effect of ``creating a hidden market'' within
PCX, which it believed would be detrimental to other trading interest
on PCX and to the NMS, and contrary to established PCX auction
rules.\30\ NYSE argued that marketable trading interest processed
through the Application would not be exposed to the PCX auction or to
the NMS until after a transaction has occurred. In NYSE's view,
OptiMark Profiles would constitute orders that should be incorporated
into PCX's floor-based trading system. More specifically, NYSE
contended that Profiles equal to or better than the price of the then-
disseminated PCX quotation should be quoted in the same manner as other
orders received by PCX. In addition, NYSE argued that a trade resulting
from use of the OptiMark System that is printed on PCX would impose new
and additional price protection responsibilities on PCX specialists.
NYSE claimed that the PCX filing was silent about the right or
obligation of PCX floor brokers to ``break up,'' and provide potential
price improvement
[[Page 50043]]
for, Profiles crossed or matched within the OptiMark System and routed
to the PCX floor for execution.
---------------------------------------------------------------------------
\29\ See Letter from James E. Buck, NYSE, supra. note 4.
\30\ Id. at 2.
---------------------------------------------------------------------------
NYSE raised concerns about the potential effect of the Application
on PCX's relationship with the ITS with respect to access and liability
for clearance and settlement. NYSE stated its belief that the
Application's access to ITS would be different from that currently used
by PCX for the sending of ITS commitments pursuant to the ITS Plan.
NYSE argued that it would be premature for the Commission to approve
PCX's filing until PCX has provided the ITS participant markets with a
clear and detailed understanding of how PCX intends for OptiMark to
access the ITS. NYSE also claimed that PCX was attempting to amend the
terms of the ITS Plan to limit PCX's liability beyond the authority set
forth in the ITS Plan.\31\
---------------------------------------------------------------------------
\31\ The NYSE cited, in particular, the language in the PCX's
filing that states:
In no event will the Exchange or any operator, administrator or
licensor of the OptiMark System be responsible for any User's
failure to pay for the PCX Securities purchased or to deliver the
PCX Securities sold. Neither OTI nor OSI will be deemed to be a
party to or a participant in, as principal or agent, any trade or
transaction entered into or otherwise conducted by Users while using
the OptiMark System for the purposes of clearance and settlement.
Letter from James E. Buck, NYSE, supra, note 4, at 5-6.
---------------------------------------------------------------------------
Finally, NYSE stated that the PCX filing did not clearly reflect
that all ITS price protection rules would be followed by the users of
the Application. NYSE noted that ITS price protection rules specify the
obligations of participant members for satisfying trade-throughs, Block
Policy trades, and locked markets involving other ITS participant
markets, and that these obligations include a requirement to issue ITS
commitments to trade. Next, it highlighted that PCX's filing stated
that users would be able to ``place restrictions on any potential
purchase or sale of shares through ITS.'' \32\ NYSE believes this
language suggests that a PCX member (or member's customer) could place
restrictions on the use of ITS that would ignore the ITS price
protection rules. Accordingly, NYSE suggested PCX's filing be amended
to note the limitation on a user's right to place limitations on the
use of ITS for price satisfaction purposes.
---------------------------------------------------------------------------
\32\ ID. at 6.
---------------------------------------------------------------------------
Further, NYSE questioned OptiMark's proposed compliance with the
Commission's short sale rule. NYSE noted a letter sent by the PCX to
the Commission's Division of Market Regulation in May 1997, requesting
relief from the short sale rule.\33\ NYSE stated that an exemption
``would not be appropriate for a system such as OptiMark which provides
price discovery.'' \34\ NYSE also referred to PCX's proposed amendment
to PCX Rule 5.14, which proposed that ``[t]he Exchange's short sale
rule (Rule 5.18) shall not be applicable to any resulting transaction
in the Exchange.'' \35\ NYSE argued that the approval of such a
proposed rule would ``establish a clear conflict that could lead to
inadvertent regulatory violations.'' \36\ NYSE recommended that PCX
amend its proposal to delete both PCX Rule 5.14 and the above-quoted
proposed language.
---------------------------------------------------------------------------
\33\ See Letter from John C. Katovich, Senior Vice President and
General Counsel, PCX, to Richard R. Lindsey, Director, Division of
Market Regulation, SEC, dated May 19, 1997 (``PCX May 19 Letter'').
\34\ See Letter from James E. Buck, NYSE, supra, note 4, at 4.
NYSE also noted it would not generally comment on this because it
understood that Commission staff would not grant the requested
exemption from Rule 10a-1 under the Act. Id.
\35\ Id.
\36\ Id.
---------------------------------------------------------------------------
On August 1, 1997, PCX submitted to the Commission a letter
responding to issues raised in the NYSE Comments Letter.\37\ In
response to NYSE's comment that the Application would create a ``hidden
market,'' PCX stated that the Application would operate in a manner
consistent with existing principles of the current auction market now
in place at PCX as well as at NYSE. PCX represented that ``[b]ids or
offers announced on the PCX floor or in the specialist's book will
continue to be collected and disseminated by the PCX in full compliance
with Rule 11AC1-1'' under the Act, and that PCX's continuous auction
facilities, separate and apart from the periodic auction conducted by
the Application, would continue to be available to members.\38\
---------------------------------------------------------------------------
\37\ See Amendment No. 1, Supra, note 5.
\38\ Id. at 2.
---------------------------------------------------------------------------
PCX argued that ``[t]he fact that Profiles will not be disseminated
as quotes does not create a hidden market'' because the Profiles are
analogous to indications of interest, and not bids and offers.\39\ PCX
further argued that the Application represents a periodic call market
facility and that quotes in such market have no meaning because trading
interest remains a generalized expression of interest until it is
processed during the call. PCX argued that no Profile is eligible for
execution until the time of the call, in contrast to a quote, which is
a firm bid or offer available for execution at any time. In this
regard, PCX believes that the display of any Profile in an open quote
stream would contradict the desire of Users submitting Profiles and
would impair the integrity of the quote system because individual Users
would represent multiple and differing price values for any given buy
or sell interest. Thus, PCX stated that it should not be required to
display in the PCX quotation User Profiles, including those coordinates
with a satisfaction value of 1.
---------------------------------------------------------------------------
\39\ Id.
---------------------------------------------------------------------------
In response to the NYSE argument that the Application would impose
new price protection responsibilities on PCX specialists, PCX stated
that although the Exchange would require its specialists, under PCX
Rule 5.32(a), to honor their obligations for executions at the same or
better prices that occur as a result of the Application, this
requirement would not constitute a new obligation. As an example, PCX
outlined how PCX specialists guarantee the price of executions that
occur on the ``other city floor'' \40\ of the PCX, noting that under
certain circumstances, a PCX specialist may be obligated to fill an
order at a price obtained from the ``other'' PCX floor. PCX noted that
the guarantee requirements imposed on PCX specialists regarding
transactions effected through the Application will likely influence
them to reflect frequently their book orders in the OptiMark system,
although they would not be obligated to do so. Further, if a specialist
did not honor its obligations to execute an order, based upon an
execution that occurs in the primary market or within the PCX market,
the specialist would be found to be in violation of existing PCX rules.
---------------------------------------------------------------------------
\40\ The PCX has equity trading floors both in San Francisco and
Los Angeles.
---------------------------------------------------------------------------
PCX also disagreed with the NYSE's comment that the PCX proposal
does not comply with PCX's crossing rules, specifically PCX Rules 5.14
(a) and (b). According to PCX, under these rules members are
responsible for assuring that all existing bids or offers, at or better
than the cross price, are filled at their limits. PCX argued that
although the OptiMark System would help a User find other trading
interest through the central processing of Profiles, this is not the
same as a cross transaction on the Exchange floor, where both sides of
the trade are brought to the specialist's post by a broker. PCX
emphasized that when coordinates from Profiles happen to match at the
time of the call, it is fortuitous and can not be considered a cross as
defined in either PCX or NYSE rules. PCX further stated that when two
Profiles with overlapping coordinates give the appearance of a cross,
the processing of these Profiles against other
[[Page 50044]]
trading interest in the PCX Application may not result in a match
between the two Profiles. Rather, the priorities established by the
Application could effectively ``break up'' any such potential match.
With respect to NYSE's comment on ITS access, the Exchange argued
that the Application would not change the method of system access in
any manner that calls for an ITS Plan amendment. Instead, the Exchange
stated that the Application would be an additional exchange facility,
through which the Exchange would be able to honor its existing ITS
commitments. The Exchange emphasized that the Application would merely
provide more convenient electronic access for the benefit of its
members and their customers, and as such, the Application would
``complement one `example' of system access described in Section 6 of
the ITS Plan through added flexibility, thereby promoting the increased
use of ITS through information and telecommunications technology
innovation, all as intended by the ITS Plan and as required by the
Commission under Section 11A of the Exchange Act.'' \41\
---------------------------------------------------------------------------
\41\ See Amendment No. 1, supra, note 5, at 4.
---------------------------------------------------------------------------
With respect to NYSE's argument that the PCX filing would
``effectively amend the terms of the ITS Plan to limit PCX's liability
beyond the terms specified in the Plan,'' PCX responded that the filing
would not have such an effect; similar limitations on liability have
not been construed or applied so as to limit an ITS Participant's
contractual obligations arising under Section 9 of the ITS Plan. PCX
further stated that NYSE itself limits its liability for any damages
sustained in connection with the use of its facilities, citing NYSE
Constitution, Article II, Section 6.
PCX strongly disagreed with NYSE's comment that PCX's proposed User
restrictions on potential purchases or sales of shares through the ITS
would have the effect of obviating the ITS price protection rules,
stating that the Exchange ``adheres strictly to the ITS price
protection rules.'' \42\ The Exchange stated that its filing
``repeatedly provides that no orders may be executed on the Exchange at
a price inferior to that of other outstanding trading interest with
standing, which includes CQS Profiles derived from the quotes of other
ITS Participants.'' \43\ The Exchange also stated that Users placing
restrictions on any potential purchase or sale of shares through ITS
would be required to forgo any potential transactions that would cause
a trade-through. The Exchange concluded that permitting a User to place
limitations on the use of ITS at the User's own risk is consistent with
the ITS plan because it does not implicate the ITS price protection
rules.
---------------------------------------------------------------------------
\42\ Id. at 5.
\42\ Id.
---------------------------------------------------------------------------
The PCX letter also mentioned the PCX's May 1997 request for
exemptive relief from the short sale rule and noted that it understood
that such relief would not be granted. Accordingly, the PCX submitted a
proposed amendment to PCX Rule 15.3(b), which (as modified by a
subsequent amendment) would add the following language to the Rule:
and provided further that no Orders designated as ``sell short'' may
be generated for execution at a price: (i) Below the price of the
immediately preceding match (or the last sale price reported on a
consolidated transaction reporting system immediately prior to
commencement of the Cycle in the case of the initial match of that
Cycle) or (ii) at such price unless such price is above the next
preceding different price.\44\
\44\ Id. at 1-2.
---------------------------------------------------------------------------
On August 20, 1997, NYSE submitted to the Commission a second
comment letter responding to issues that the PCX raised in Amendment
No. 1.\45\ In its letter, NYSE expanded upon points raised in its
initial comment letter. For example, NYSE again raised the ``hidden
market'' issue. NYSE argued that the PCX was proposing ``to sponsor two
markets (its `regular' market and the OptiMark cycles) with minimal
interaction between the two.'' \46\ NYSE also challenged OptiMark's
claim that the Cycles would constitute a periodic call market because
Cycles would be as frequent as every 90 seconds. As a result, NYSE
argued, Users could enter a priced order into a ``nearly-continuous
auction, without disclosing the order to the regular market, even if
the order matches or improves the national best bid and offer.'' \47\
NYSE argued that this activity would stand in direct conflict with
recent Commission efforts to integrate all trading interest in the
national market system, whether through electronic communication
networks or otherwise.
---------------------------------------------------------------------------
\45\ See Letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Jonathan G. Katz, Secretary, SEC, dated Aug. 20,
1997 (``NYSE Second Comment Letter).
\46\ Id. at 1.
\47\ Id.
---------------------------------------------------------------------------
In addition, NYSE reiterated that the Application would be
inconsistent with PCX's own auction rules, claiming that orders and
executions resulting from the Application would not be integrated with
other PCX trading interest and, as such, would not be like other PCX
executions. NYSE stated that PCX's rules require that all orders be
integrated into the PCX auction and interact with other trading
interest taking place on the PCX floor. NYSE argued that, contrary to
PCX's auction rules, an order entered on the PCX after the commencement
of a Cycle of the Application would ``not interact with an OptiMark
`order' that is `routed and executed on the [PCX], even if the more
recent PCX order is at a better price or has priority over the OptiMark
`order.' '' \48\
---------------------------------------------------------------------------
\48\ Id. at 2.
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In addition, NYSE argued that the PCX's proposed amendment
regarding its intended compliance with the Commission's short sale
rule, as explained in the PCX's Amendment No. 1, is inconsistent with
the wording and purposes of the rule. NYSE characterized PCX's proposal
as prohibiting short sales in the Application on minus ticks or zero
minus ticks based on the last ``match'' in the Application, and that
the Application would rely on the last transaction reported to the CTS
only for the initial Cycle. NYSE argued that Rule 10a-1, by contrast,
regulates short selling based on consolidated last sales, giving an
exchange an option of using the last sale on that exchange. NYSE
therefore argued that an exchange ``cannot regulate short sales based
on sales in only one component of an exchange's trading system.'' \49\
---------------------------------------------------------------------------
\49\ Id. at 3.
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NYSE also addressed the Application's access to, and liability for
clearance and settlement through, the ITS. With respect to access, NYSE
took issue with the PCX's statement that the Application ``will
complement one `example' of system access'' described in the ITS Plan.
NYSE argued that this statement ``raises serious questions of access to
NYSE market and to the markets of the other ITS Participants.'' \50\
NYSE stated that PCX intends to make a detailed presentation at an ITS
Committee meeting in September 1997, and argued that it would be
premature for the Commission to act on the PCX's filing before the
meeting and further consideration of the issue.
---------------------------------------------------------------------------
\50\ Id. at 4.
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With respect to the PCX's proposal regarding liability for
clearance and settlement with respect to the Application, NYSE restated
its earlier position that the PCX's proposal is inconsistent with
Section 9 of the ITS Plan, which requires each Participant to assume
responsibility for settling certain uncompared ITS trades. NYSE argues
that the PCX's proposal attempts to amend the ITS Plan to limit the
PCX's liability beyond the terms of the Plan.
[[Page 50045]]
On August 29, 1997, PCX submitted to the Commission two letters
supplementing the filing and further addressing issues raised by the
NYSE.\51\ PCX stated that it is incorrect to characterize an order
generated by an Optimark cycle as a ``cross'' given that, under PCX
Rule 5.14(a), a cross transaction is ``a transaction in which a member
effects both the purchase and sale.''\52\ PCX submitted that most
matches resulting from a Cycle would be based on trading interest
reflected in Profiles submitted by two different members, and thus
would not be crosses involving the same member. Although PCX conceded
that the same member could submit both buy and sell Profiles that could
result in a matched order, it pointed out that the member would have no
control or influence in determining the outcome of such a match. PCX
concluded that the presence of member intermediation and trading
discretion is essential to the definition of ``cross'' as it is
understood and applied in the context of continuous auction
trading.\53\
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\51\ See PCX Floor, Letter and PCX ITS Letter, supra, note 6.
\52\ PCX Floor Letter, supra, note 6, at 1.
\53\ Id.
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In response to NYSE's claim that PCX floor brokers representing
customer interest could ``miss the market'' if they chose not to use
Optimark, PCX noted that such an outcome was no different than the
situation where a floor broker either routes a customer order to
another market or is not present in the trading crowd when a cross is
announced.\54\
---------------------------------------------------------------------------
\54\ Id. at 2.
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In the PCX ITS Letter, the PCX clarified its continued
responsibility to settle trades effected through the PCX Application,
pursuant to the terms of the ITS Plan. Specifically, PCX stated that it
did not intend to modify any PCX members' obligations under the ITS
Plan nor to modify the Exchange's obligation under the Plan to ensure
settlement of trades effected via the PCX Application.\55\
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\55\ PCX ITS Letter, supra, note 6. See also, PCX Rule 5.23.
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IV. 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).\56\ The Commission
finds that the Exchange's proposal to establish rules to implement the
PCX Application of the Optimark System would promote the Commission's
mandate under Section 6(b)(5) to remove impediments to and perfect the
mechanism of a free and open market and a NMS, while protecting
investors and the public interest. In addition, the Exchange's proposal
with respect to the PCX Application is consistent with the Section
6(b)(5) requirements that rules of an exchange be designed to prevent
fraudulent and manipulative acts, to promote just and equitable
principles of trade, and are not designed to permit unfair
discrimination among customers, issuers, or broker-dealers.\57\
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\56\ 15 U.S.C. Sec. 78(f)(b)(5).
\57\ In approving the proposal, the Commission has considered
the proposal's impact on efficiency, competition, and capital
formation. 15 U.S.C. Sec. 78c(f).
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In addition, the Commission finds that the proposed rule change is
consistent with the requirements of Section 11A of the Act.\58\ The
Commission believes that the proposed Application of the OptiMark
System would further the purposes of Section 11A of the Act and the
development of a NMS by promoting economically efficient execution of
securities transactions, fair competition among markets, the best
execution of customer orders, and an opportunity for orders to be
executed without the participation of a dealer. The PCX Application
provides a new and potentially more efficient way for the Exchange to
match and execute trading interest. The Application appears principally
designed to meet the demands of sophisticated portfolio managers and
other market professionals implementing complex trading strategies.
These market participants often require instantaneous access to the
market, and desire to minimize the market impact of their transactions
through the expression of varied trading interests on a confidential
basis. At the same time, the Application is designed to allow retail
customers, through member Users, to interact with institutional trading
interests.
---------------------------------------------------------------------------
\58\ 15 U.S.C. Sec. 78k-1.
---------------------------------------------------------------------------
The PCX Application is likely to promote competition among market
centers because it has the potential to attract new market participants
and to increase order flow to the Exchange. By attracting order flow,
the Application may provide a new and enhanced source of liquidity for
investors. Further, as noted in the majority of the thirteen comment
letters that supported the proposal, both institutional and retail
investors should benefit from the Application insofar as their
expressions of trading interest are represented in the OptiMark System
and are executed on the Exchange. As a result, the Application could
enhance the ability of investors to have their orders executed on the
PCX. Moreover, the Application would increase the ability of investors'
orders to interact directly with other investors orders on the PCX.
The Commission has historically encouraged exchanges to integrate
new data communications and trade execution mechanisms into their
markets in furtherance of the development of the NMS.\59\ The
Commission, for example, approved the fully computerized National
Securities Trading System (``NSTS'') of the Cincinnati Stock Exchange,
the MAX and SuperMAX Systems of the Chicago Stock Exchange, and the
CAES operated by Nasdaq.\60\ In fact, the PCX Application of the
OptiMark System shares many of the characteristics of the Chicago Stock
Exchange's Chicago Match System, which was approved by the Commission
in 1994.\61\ Like the
[[Page 50046]]
proposed Chicago Match System, the PCX Application blends some of the
features of a call market with the continuous auction of the PCX floor.
The operation of such a hybird system will differ in important respects
from the traditional structure of a trading floor. For the reasons
discussed below, however, the Commission does not believe that these
differences would cause the PCX Application to violate the provisions
of the Act.
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\59\ In 1982, when instating the Cincinnati Stock Exchange's
NSTS as a permanent program, the Commission stated:
In mandating the development of a NMS, Congress expressly stated
that ``[n]ew data processing and communications techniques create
the opportunity for more efficient market operations.'' . . . In
carrying out Congress' mandate, the Commission has taken an
evolutionary approach by encouraging the securities industry to take
the primary initiative in fashioning trading mechanisms which are
consistent with the goals of a NMS. The Commission believes that, as
a general matter, the industry has responded well to changing
economic and technological demands by attempting to integrate state
of the art data processing and communications technology to develop
many new trading systems which have advanced the objectives of a
NMS. In this respect, the Commission believes that ITS, the NASD's
[National Association of Securities Dealers'] Computer Assisted
Execution System (``CAES'') and the NSTS represent constructive
approaches to integrating trading in physically dispersed locations.
(citations omitted)
Securities Exchange Act Release No. 19315 (Dec. 9, 1982), 47 FR
56236 (Dec. 15, 1982).
\60\ See, e.g., Securities Exchange Act Release No. 19315 (Dec.
9, 1982), 47 FR 56236 (Dec. 15, 1982) (Commission approval to
terminate the NSTS as an experimental program and extend its
duration for an indefinite period of time); Securities Exchange Act
Release No. 12451 (May 14, 1976), 41 FR 20932 (May 21, 1976)
(Commission approval of the MAX system to operate on a permanent
basis); Securities Exchange Act Release No. 32631 (July 14, 1993),
58 FR 39069 (July 21, 1993) (Commission approval to operate the
SuperMAX system on a permanent basis); Securities Exchange Act
Release No. 17601 (Mar. 4, 1981); 46 FR 16171 (Mar. 11, 1981)
(Commission Notice of the NASD filing of a proposed rule change for
the establishment of CAES); Securities Exchange Act Release No.
17744 (Apr. 21, 1981), 46 FR 23856 (Apr. 28, 1981) (Commission order
to implement an automated interface between the ITS and CAES); and
Securities Exchange Act Release No. 18713 (May 6, 1982), 47 FR 20413
(May 12, 1982) (implementing ITS/CAES interface and operations).
\61\ Securities Exchange Act Release No. 35030 (Nov. 30, 1994),
59 FR 63141 (Dec. 7, 1994). The PCX Application differs from Chicago
Match in that it is a periodic, rather than a unitary, call market.
---------------------------------------------------------------------------
First, the Commission believes that the Application, operating as a
facility of an exchange, would have the ability and capacity to carry
out the regulatory purposes of the Act.\62\ As part of its obligations
under the Act and pursuant to its own rules, the Exchange would conduct
all necessary surveillance of the operation of and trading through the
Application.\63\ The Exchange has also represented that the Application
would have a full audit trail capability, adequate computer capacity to
handle and process User Profiles and order flow, and adequate computer
security to ensure the safety and confidentiality of User
transmission.\64\
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\62\ The PCX Application is properly regulated as a facility of
an exchange, as defined in Section 3(a)(2) of the Act. The PCX
Application of OptiMark would use the PCX's premises, property, and
services for effecting and reporting transactions. For a recent
discussion of the classification of an electronic communication and
matching system as a facility of an exchange, see Securities
Exchange Act Release No. 35030, supra, note 61 (concerning the
Chicago Match System).
OSI, which plans to register as a broker-dealer and comply with
Rule 17a-23 under the Act, would be responsible for operating
portions of the PCX Application for the Exchange and would receive
commissions from Users for transactions. The Exchange has
represented that it will submit any changes to this structure to the
Commission as a rule filing.
In addition, OTI expects to offer other exchanges trading
services based on the OptiMark System technology. If another
national securities exchange chooses to use the OptiMark System, it
would be required to file a separate rule filing under Section 19(b)
of the Act.
\63\ Further, the Exchange will ensure that the Application
complies with all trading halts and trading suspensions.
\64\ As with any other exchange application, the Commission
expects to conduct a full EDP review of the Application and its
operations. See, e.g., the Commission's Automation Review Policy
guidelines. Securities Exchanges Act Release No. 27445 (Nov. 16,
1989), 54 FR 48703 (Nov. 24, 1989), and Securities Exchange Act
Release No. 29185 (May 9, 1991), 56 FR 22490 (May 15, 1991).
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Second, contrary to the NYSE's assertion, the Exchange is not
operating a hidden market in violation of the Firm Quote Rule.\65\
Specifically, the Commission does not believe that the PCX Application
violates the Firm Quote Rule. The Firm Quote Rule, among other things,
requires exchanges to collect bids, offers, quotation sizes and
aggregate quotation sizes from responsible brokers or dealers for
subject securities, and make them available to quotation vendors.
---------------------------------------------------------------------------
\65\ 17 CFR 240.11Ac1-1.
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A bid or offer is defined in the Firm Quote Rule as the ``bid price
and the offer price communicated by an exchange member or OTC market
maker to any broker or dealer, or to any customer.'' \66\ In order to
constitute a bid or offer, therefore, the underlying trading interest
must have been communicated to at least one other potential
counterparty. Bids and offers are intended to attract other parties to
deal with the person publishing the bid or offer at the quoted price.
For example, the Commission recently deemed the entry of priced orders
into an electronic communications network (``ECN'') to be bids and
offers where these orders were widely disseminated to other
parties.\67\ In contrast, the essence of the Application is its
anonymity. Only the Application is aware of the potential trading
interest until trades occur. The PCX represents that the Application
would ``not permit any interactive communication among Users whatsoever
for any solicitation of trading interest (not even on an anonymous
basis).'' \68\ The PCX further represented that the Application
``differs fundamentally from any `hit or take' or `interactive' trading
system, which allows the display of order price and size levels by a
subscriber for others to act on.'' \69\ The Commission agrees with the
PCX representation that the Application ``is not a mechanism by which
system subscribers (1) broadcast prices to other system subscribers and
(2) trade with one another at those prices,'' like an exchange or
ECN.\70\ Accordingly, the Commission believes that the Application as
proposed would not violate the Firm Quote Rule and would not fall
within the status of an ECN.
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\66\ See CFR 240.11Ac1-1(a)(4).
\67\ The term ``electronic communications network'' means, for
the purposes of 17 CFR 240.11Ac1-1(c)(5), ``any electronic system
that widely disseminates to third parties orders entered therein by
an exchange market maker or OTC market maker, and permits such
orders to be executed against in whole or in part; except that the
term electronic communications network shall not include: (i) Any
system that crosses multiple orders at one or more specified times
at a single price set by the ECN (by algorithm or by any derivative
pricing mechanism) and does not allow orders to be crossed or
executed against directly by participants outside of such times; or
(ii) Any system operated by, or on behalf of, an OTC market maker or
exchange market maker that executes customer orders primarily
against the account of such market maker as principal, other than
riskless principal.'' See 17 CFR 240.11Ac1-1(a)(8). Rule 11Ac1-
1(c)(5)(i) provides that the ``[e]ntry of any priced order for a
covered security by an exchange market maker or OTC market maker in
that security into an electronic communications network that widely
disseminates such order shall be deemed to be: (A) A bid or offer
under this section, to be communicated to the market maker's
exchange or association pursuant to paragraph (c) of this section
for at least the minimum quotation size that is required by the
rules of the market maker's exchange or association if the priced
order is for the account of a market maker, or the actual size of
the order up to the minimum quotation size required if the priced
order is for the account of a customer; and (B) A communication of a
bid or offer to a quotation vendor for display on a display device
for purposes of paragraph (c)(4) of this section.'' 17 CFR
240.11Ac1-1(c)(5)(i).
\68\ See PCX May 19 Letter, supra, note 33, at 8.
\69\ Id. at 8-9.
\70\ Id. at 9.
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Moreover, Profiles, unlike bids and offers, are conditional until
they are processed in a Cycle. In this way, Profiles are analogous to
indications of interest or CAP orders, neither of which are displayed
in exchanges or on Nasdaq. The terms ``bid'' and ``offer,'' as defined
by the Firm Quote Rule, do not include ``indications of interest.''
\71\ A Profile is only a generalized expression of interest with
conditions attached and is not eligible for execution until the
completion of the Cycle. Profiles entered into the PCX Application can
be revised and cancelled at any time prior to commencement of the next
scheduled Cycle.
---------------------------------------------------------------------------
\71\ Rule 11Ac1-1(a)(4) provides that the terms ``bid and
offer'' mean ``the bid price and the offer price communicated by an
exchange member or OTC market maker to any broker or dealer, or to
any customer, at which it is willing to buy or sell one or more
round lots of a covered security, as either principal or agent, but
shall not include indications of interest.'' (emphasis added) 17 CFR
240.11Ac1-1(a)(4).
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Further, the Commission does not believe that the PCX Application
would create a hidden market within PCX. The Commission particularly
disagrees with NYSE's suggestion that PCX's proposed non-dissemination
of Profiles to PCX's equity floor and other exchange markets is
contrary to the goals of the NMS. Rather, the Commission believes that
the unique design of the Application warrants a non-traditional
approach in determining whether to require the dissemination of trading
interest expressed through operation of the Application. The
Application reflects the efforts of PCX to establish a trading system
that blends elements of a call market with a continuous auction market,
with anonymous Profiles being continuously entered and cancelled until
the next scheduled periodic call market (performing a Cycle). The
failure to disseminate Profiles does not provide any other market
participant with an unfair market advantage as a result of seeing the
trading interest that is not shown to others. Any User only knows its
own Profile; it has no special access
[[Page 50047]]
to other Users' Profiles. Moreover, users have no control or influence
in determining the outcome of a match, other than through the
construction of their own Profiles.
In addition, the Commission believes that dissemination of Profiles
would likely be very difficult, given that Profiles represent
contingent trading interest at different prices, share amounts, and
satisfaction levels. Any accurate dissemination of Profiles, other than
Profiles containing only a satisfaction value of one, would need to be
expressed in a three-dimensional format, which could create confusion
for investors.
Third, the Commission believes that trading interest on the PCX
floor would be adequately integrated into the PCX Application.
Specifically, specialists and floor brokers would be able to reflect
customer trading interest by entering Profiles into the PCX
Application. In addition, if a specialist does not submit a limit order
to the Application, the Exchange would require that specialist to
guarantee the execution of the limit order at the price of an order
derived from a Cycle that is priced at or better than the limit order's
price, up to the amount of shares executed as a result of the
particular Cycle.\72\ Floor brokers, similarly, would remain subject to
best execution obligations. The NYSE has pointed out the possibility
that, during a small window of a few seconds, if a limit order were
sent to the Exchange immediately following the commencement of a Cycle,
this order would not have the opportunity to interact with the Profiles
entered into the PCX Application.\73\ Thus, once the Cycle is
completed, resulting orders sent to the PCX for execution at such limit
order's price or better would bypass the limit order, even though such
limit order had priority under the PCX's current rules. The Commission
acknowledges that there is a possibility of this scenario occurring.
Because of the virtually instantaneous nature of the Cycles, however,
such a scenario is likely to occur very infrequently.\74\
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\72\ For example, if a specialist received a customer limit
order to buy 1,000 shares at 20 prior to the commencement of a
Cycle, and the best priced order generated by the Cycle was assigned
a price of 19\1/2\, involving 900 shares, with the next best priced
order at 19\3/4\, involving 1,000 shares, the specialist would be
obligated to fill 900 shares of the customer limit order at 19\1/2\,
and fill the balance at 19\3/4\.
\73\ NYSE Second Comment Letter, supra, note 45, at 2.
\74\ Contrary to NYSE's understanding, PCX specialists would not
be required to guarantee customer limit orders booked after the
commencement of a Cycle at prices obtained as a result of such
Cycle.
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Fourth, the Commission notes the Exchange's representations that
the operation of the PCX Application would be consistent with the
Exchange's and its members' obligations under the ITS Plan.
Specifically, the Exchange represents that the PCX Application would be
operated in a manner consistent with the Exchange's intermarket price
protection obligations under the ITS Plan. The PCX Application would
incorporate existing market interest from each of the ITS participant
markets in the form of CQS Profiles. All orders priced inferior to the
quotations of another ITS participant market would be executed on the
Exchange only upon submission of appropriate ITS commitments seeking to
reach such better-priced interest. For orders representing matched
coordinates from CQS Profiles and other Profiles, the Exchange would
submit an ITS commitment reflecting each such order for execution on
other market centers to which the OptiMark System is not directly
linked. Every ITS commitment would be sent under the give-up of the
member User or the Designated Broker, by way of the traditional
Exchange linkage to the ITS, in the sequence in which orders are
generated from the Cycle.
PCX has represented that it proposes to send ITS commitments
resulting from the PCX Application in the same way as other ITS
commitments are currently sent by the Exchange. The Commission notes
that PCX has represented that the Application will be implemented in a
manner fully consistent with the ITS Plan, and PCX is engaged in
discussions with other ITS participants regarding the requirements of
the ITS Plan.
The Commission believes that PCX has adequately represented that
its proposed disclaimer of liability (proposed PCX Rule 15.8) covering
the operation of the PCX Application does not operate to change or
modify in any way PCX's obligations for clearance and settlement of
trades matched through the Application and submitted for execution on
another market center pursuant to the ITS Plan.
Fifth, the Commission also believes that the PCX will meet its
obligation with respect to the reporting of transactions resulting from
the Application. The Exchange has represented that transactions
resulting from orders routed to the PCX floor from the Application
would be reported to the CTS in the sequence in which such orders are
generated from a Cycle. The Exchange has represented that it would
report these trades in a manner similar to the way it currently reports
other trades in PCX Securities to the CTS. Transaction reports
resulting from a Cycle of the Application, moreover, would not be
distinguishable on the CTS from the trade report of any other order
executed on the PCX floor. Although such transaction reports may occur
in rapid sequence, with numerous reports being generated in a short
period of time, the individual transaction reports would still be
reported and displayed in order of the execution of the transactions.
Sixth, although non-members would have access to the Application,
such access would only be through an Exchange member broker-dealer.
Before submitting Profiles to the PCX Application, non-members would be
required to designate a member firm that would authorize their access
to the PCX Application and accept responsibility for these non-member
transactions. The Exchange states that it expects the Designated
Brokers, or the clearing brokers of the Designated Brokers, to impose
credit limits on non-member Users of the PCX Application.\75\ Other
exchanges have allowed non-members to access their facilities through
member broker-dealers under similar conditions. For example, the
Chicago Stock Exchange's Chicago Match System provided for direct non-
member access through personal computers and modems, using a member
broker-dealer give-up. The non-member access permitted by the
Commission with respect to the Chicago Match System is substantially
similar to the non-member User access proposed by PCX.\76\
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\75\ Further, Exchange members would be required to maintain
information and records concerning non-members access for which they
are responsible. The Exchange has represented to the Commission that
it would require its members to make such non-member User
information available to the Exchange upon request, so that the PCX
can fulfill its duties regarding surveillance.
\76\ See Securities Exchange Act Release No. 35030, concerning
the Chicago Match System, supra, note 61. As with the PCX
Application, the CHX required non-member users of the Chicago Match
System to enter into several agreements to ensure that a CHX member
had responsibility and control over the non-member's activities.
These responsibilities, included, among other things, controlling
and clearing the orders entered by non-members, assuming legal
responsibility of the non-member orders entered, and ensuring
appropriate credit limits. See id. The Commission's approval order
for the Chicago Match System also noted that the then anticipated
non-member use of the Chicago Match System was analogous to non-
member access to the NYSE's Designated Order Turnaround System (now
referred to as ``SuperDOT''). The SuperDOT System is an electronic
order-routing system that enables NYSE members and their customers
to transmit market and limit orders in all NYSE-listed securities
directly to the specialist post where the securities are traded, or
to the member firm's booth. Non-member customers, however, must
obtain the electronic means to access SuperDOT through a broker-
dealer member. Like the Chicago Match System, the NYSE's SuperDOT
system requires NYSE members to monitor customers' electronic orders
and to provide the NYSE with an acknowledgement indicating their
responsibility for orders. See id.
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[[Page 50048]]
Seventh, PCX is adopting reasonable requirements for the clearance
and settlement of transactions resulting from the Application. In
particular, the Commission believes it is appropriate for PCX to
require that: (i) All orders generated by the Application that are
executed on PCX or another market center through ITS be reported and
entered into the comparison system on a locked-in basis; (ii) orders
generated by the Application on behalf of a member User and the
resulting transactions be cleared and settled using that member User's
mnemonic (or its clearing broker's mnemonic, as applicable); and (iii)
orders generated by the Application on behalf of a non-member User and
the resulting transaction be cleared and settled using the appropriate
Designated Broker's mnemonic.
Finally, the Commission believes that PCX has established that
short sales effected through the Application, pursuant to the requested
exemption and in accordance with the restrictions contained in proposed
Rule 15.3(b), would not be susceptible to the practices that Rule 10a-1
is designed to prevent. PCX has amended its proposal to provide for
substantial compliance with Rule 10a-1.\77\ PCX represents that the
first match of a Cycle, if it involves a short sale, would be in
compliance with Rule 10a-1. Subsequent matches would use the price of
the immediately preceding match in the Cycle, rather than the last
trade in the consolidated transaction reporting system as a reference.
The Division of Market Regulation, by delegated authority, intends to
grant PCX an exemption from Rule 10a-1 to permit matches within a Cycle
(those subsequent to the initial match) to use the immediately prior
match as a reference for determining compliance with Rule 10a-1. The
Commission, therefore, believes that PCX has adequately addressed
concerns arising under the short sale rule.
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\77\ The NYSE asserted that new Rule 15.4 proposed by PCX
improperly stated that ``the Exchange's short sale rule (Rule 5.18)
shall not be applicable to any resulting transaction in the
Exchange.'' See Letter from James E. Buck, NYSE, supra, note 4, at
4. The Commission notes that the PCX has removed this statement from
proposed new Rule 15.4.
---------------------------------------------------------------------------
The Commission finds that good cause exists to grant approval to
Amendment Nos. 1, 2, and 3 to the proposed rule change on an
accelerated basis. Collectively, these amendments reflect PCX's
proposed handling of short sales affected through the Application and
clarify PCX specialist obligations relating to price protection for
orders generated by the Application. The short sale amendment narrows
the scope of the proposed short sale exemption attendant to OptiMark
transactions. Moreover, as stated above, the Commission has determined
that PCX's proposed short sale restrictions substantially mirror the
requirements of Rule 10a-1 and are designed in a manner that will not
permit the types of short sale practices Rule 10a-1 was designed to
prohibit. Accordingly, the Division intends to issue PCX an exemption
from Rule 10a-1. In addition, the Commission believes that the
amendments pertaining to specialist price protection obligations
resulting from orders generated by the Application merely clarify and
provide explanatory examples of how the PCX rules relating to the
Application will ensure price protection of limit orders. The
Commission therefore finds good cause to accelerate approval of
Amendment Nos. 1, 2, and 3.
V. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1, 2, and 3. 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. Sec. 552, will be available for inspection and
copying in the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. 20549. 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 October 15, 1997.
VI. Conclusion
For the reasons discussed above, the Commission finds that the
proposal is consistent with the Act.\78\
---------------------------------------------------------------------------
\78\ 15 U.S.C. Secs. 78f and 78s(b)(2).
---------------------------------------------------------------------------
It therefore is ordered, pursuant to Section 19(b)(2) of the
Act,\79\ that the proposed rule change (SR-PCX-97-18) is hereby
approved, as amended.
\79\ 15 U.S.C. Sec. 73s(b)(2).
---------------------------------------------------------------------------
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\80\
---------------------------------------------------------------------------
\80\ CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-25319 Filed 9-23-97; 8:45 am]
BILLING CODE 8010-01-M
