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Self-Regulatory Organizations; Notice of Filing of a Proposed Rule Change and Amendment No. 1 by the Pacific Exchange, Inc. Relating to Options Trading Rules

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Start Preamble March 29, 2000.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) [1] and Rule 19b-4 thereunder,[2] notice is hereby given that on October 1, 1999, the Pacific Exchange, Inc. (“PCX” or “Exchange”) the proposed rule change as described in Items I, II and III below, which Items have been prepared by the Exchange. On March 28, 2000, the Exchange filed Amendment No. 1 to the proposed rule change.[3] The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons.

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I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

The PCX proposes to modify certain rules on options floor trading by clarifying existing provisions, eliminating superfluous provisions, and codifying current policies and procedures. The text of the proposed rule change is available at the Office of the Secretary, the PCX, and at the Commission.

II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

1. Purpose

The Exchange is proposing to make the following changes to the text of the PCX rules on options trading.

A. Definition of Term “Options Issue”

The PCX proposes to adopt new Rule 6.1(b)(12) to define the term “option issue” as “the option contract overlying a particular underlying security.” The Exchange notes that the commonly-used term “issue” appears in several locations in the PCX rules. [4] The Exchange believes that the term “issue” means the same as “option” or “option contract” when used, for example, as in PCX Rule 6.65(a), which states: “Trading on the Exchange in any option contract shall be halted or suspended whenever * * *.” However, the Exchange believes that the use of the terms “option” and “option contract” would often result in ambiguities that the use of “issue” would not create. While the term “class of options” is used in many PCX Rules to refer generally to options overlying a particular underlying security, [5] the Exchange believes that the use of the term “class” can be ambiguous because it may refer either to a “put class” or a “call class.” [6] Accordingly, the Exchange is proposing to formally adopt the definition of the term “option issue.”

B. General Rules Applicable to Options Trading

PCX Rule 6.1 sets forth a list of general PCX trading rules that are applicable, by cross-reference, to Exchange transactions in option contracts. Most of these rules relate primarily to the trading of equity securities on the Exchange. The Exchange is proposing to remove PCX Rules 5.2(a), 5.6(a)-(c), 5.8(d), 5.8(h), 5.12(a) and 5.13(a)-(b) from that list. Each of the cross-references to be removed is discussed below:

  • PCX Rule 5.2(a)—“Types of Orders.” [7] The Exchange believes that the first part of this rule—the part stating that all orders on the Exchange must be “day,” “immediate or cancel” or “good ‘till canceled”—applies to options trading, and accordingly, the Exchange is adopting PCX Rule 6.62, Commentary .01, to incorporate this part of the rule into the rules on options trading. However, the remainder of PCX Rule 5.2(a) either does not apply to options trading [8] or is superfluous.[9]
  • PCX Rule 5.6(a)—“Bids—Offers—Quotations.” [10] The Exchange believes that PCX Rule 6.74 [11] adequately covers the meaning of bids and offers as applied to options trading. The Exchange notes that the part of PCX Rule 5.6 covering the display of bids and offers on other market centers is superfluous in light of PCX Rule 6.73, which provides the requirements for bids and offers to have standing on the Options Floor.[12] Moreover, bids and offers are not displayed on the Options Floor for Intermarket Trading System (“ITS”) purposes.
  • PCX Rule 5.6(b)—“Regular Way.” [13] The Exchange believes that the current cross-reference to this equity trading rule is also superfluous because, unlike settlement of equity securities, settlement of option contracts is not based on a distinction between “regular way” and “non-regular way.”
  • PCX Rule 5.6(c)—“All or None.” [14] The Exchange believes that the cross-reference to this equity trading rule is erroneous and inconsistent with current practices. For example, assume that a floor broker who is holding an order to sell twenty option contracts enters a trading crowd and calls for a market. Next, assume that there are two responses: (1) a floor broker holding an “all or none” order for twenty contracts for a customer bids $3, and (2) a market maker bids $3. Under current practices and consistent with PCX Rule 6.75(a), if the broker were first to vocalize a bid, the broker would have first priority to Start Printed Page 17692execute the order.[15] However, if PCX Rule 5.6(c) were applied, the market maker's bid would have priority, even if it were made second in sequence. The Exchange believes that PCX Rule 6.75 should prevail over PCX Rule 5.6(c), in accordance with current practices.
  • PCX Rule 5.8(d)—“Simultaneous Bids and Offers.” [16] The Exchange notes that simultaneous bids and offers are not recognized in the general rules on priority of bids and offers for options contracts. The Exchange believes that PCX Rule 6.75 and 6.76 are exhaustive and that the cross-reference to Rule 5.8(d) is erroneous.
  • PCX Rule 5.8(h)—“Marking Stop loss Orders.” [17] This rule covers the manual handling of stop loss orders. The Exchange believes that the procedure covered by this rule is unnecessary and that the responsibility of floor brokers to use due diligence in their handling of orders, as codified in the rules on option trading, is sufficient.[18]
  • PCX Rule 5.12(a)—“Seller Responsible for Recording.” [19] The Exchange believes that the specific procedures currently set forth for reporting options transactions—Codified in PCX Rule 6.69 and OFPA G-12—adequately address this procedure and that the cross-reference to PCX Rule 5.12 is unhealthy and unnecessary.
  • PCX Rule 5.13(a)-(b)—“Comparisons.[20] The Exchange believes that PCX Options Rule 6.16 adequately covers the Exchange procedures for comparison of trade information and that the cross-reference to PCX Rules 5.13(a)-(b) is superfluous.

C. Trading Floor Badges

The Exchange proposes to eliminate superfluous and unnecessary provisions currently set forth in OFPA F-1 and F-6 for trading floor badges on the Options floor.[21] The Exchange is also proposing to merge the remaining parts of those OFPAs into PCX Rule 6.2(d).

D. Visitors to the Options Floor

The Exchange is proposing to re-number OFPA F-2 as PCX Rule 6.2(e)(“Visitors on the Options Floor”). The Exchange is also proposing to eliminate subsection 6 of OFPA F-2, which limits the number of visitors and lengths of time during which visitors are permitted on the Options floor.[22] The Exchange is also proposing to make technical changes to OFPA F-2 and to eliminate superfluous provisions, including a summary of the provisions of current PCX Rule 6.2(a).[23] Finally, the Exchange proposes to add a new provision to PCX Rule 6.2(e), stating that a group of visitors comprising more than fifteen persons may not enter the Trading Floor without prior approval of the Chair or Vice Chair of the Options Floor Trading Committee.

E. Complaints from Floor Members

The PCX proposes to adopt PCX Rule 6.2(f) (replacing OFPA E-5 [24] and OFPA E-6 [25] ), which advises options floor members as to where they may direct complaints concerning situations arising on or relating to the Options Trading Floor. Specifically, the proposed rule states that Floor Members may direct complaints concerning situations arising on or relating to the Options Trading Floor to the Options Surveillance Department or to the Enforcement Department so that appropriate follow-up action may be taken.

F. Series of Options Open for Trading

The Exchange is proposing to update PCX Rule 6.4(a) so that it will conform with current practices by changing from three to four the number of different expiration months that will normally be opened at the commencement of trading a particular option issue.[26] The Exchange also proposes to remove erroneous provisions on the specific expiration month that may be added at the commencement of trading of a particular issue and at the time a previous month's series expires. The rule currently states that three months will normally be opened, with the first expiration month being within approximately three months thereafter, the second month being approximately three months after the first and the third being approximately three months after the second. In addition, the rule states that additional series of the same class may be opened for trading on the Exchange at or about the time a prior series expires, and the expiration month Start Printed Page 17693of each such series shall normally be approximately nine months following the expiration of such series. However, the current industry practice is normally to add four expiration months, the first two being the two nearest months, and the third and fourth being the next two months of the quarterly cycle previously designated by the Exchange for that specific issue [27] When a previous expiration month's series expire, a new expiration month is added to assure that there are always four expiration months.

G. Verification of Compared Trades

The PCX proposes to reduce the amount of time during which members or their representatives are required to remain available on the trading floor after the Trade Processing Department closes. The reduction will be based on the number of transactions processed per trading day. Specifically, the Exchange proposes to require that members of their representatives be available after Trade Processing closes for 30 to 60 minutes, depending on the number of transactions involved. Currently, members or their representatives are required by PCX Rule 6.17, Commentary .01 to remain available after the close as follows: when fewer than 8,000 transactions on the Exchange have occurred, 45 minutes; but when more than 8,000 trades have occurred, one hour and 15 minutes. Under the proposal, these times will be modified as follows: 0-8,000 transactions, 30 minutes; 8,000-12,000 transactions, 45 minutes; and over 12,000 transactions, 60 minutes. The Exchange believes that the new requirements are more reasonable and better reflect the Exchange's needs.

H. Resolution of Uncompared Trades

The PCX proposes to modify PCX Rule 6.21 by changing the basis for establishing a loss as the result of an uncompared trade so that it will be the opening price on the business day following the trade date. Currently, the basis is the lesser of either the opening price on the business day following the trade date or the price at which the uncompared trade was closed. After careful consideration and review of this proposal by Exchange members and member firms, the Exchange proposes this change in an effort to simplify and make uniform the administration of pricing uncompared trades. [28] The Exchange is also proposing to require that notice of uncompared trades must be provided no later than the scheduled commencement of trading (unless a floor official directs otherwise). The Exchange believes that the current time requirement—15 minutes from the scheduled commencement of trading—is overly flexible.

I. Reports of Open Exercise Positions

The Exchange is proposing to clarify and simplify PCX Rule 62.7, which currently requires member organizations to file certain reports on open positions with the Exchange. The Exchange is proposing to restate the text of Commentary .01 in the text of PCX Rule 6.27 and to eliminate Commentaries .02 and .03.[29] As amended, PCX Rule 6.27 will provide that the Exchange may require each member organization to file with the Exchange a report, as of the 15th of each month, of all open positions resulting from the exercise of options contracts in accounts carried by a member organization. It will then incorporate current Commentary .01 into the rule by adding that such reports, when required, must be filed no later than the second business day following the day as of which the report is made.

J. Fast Markets

The PCX proposes changes to PCX Rule 6.28 by merging the Text of OFPA G-9 into PCX Rule 6.28. Currently, OFPA G-9 lists procedures that will become effective in a fast market situation. The Exchange proposes this change to simplify and consolidate rules relating to fast market and unusual market conditions. In addition, the rule will add a cross-reference to the current requirement of market makers to trade a minimum of one contract based on quoted markets, pursuant to PCX Rule 6.37(f), during fast markets. The rule change will specify that regular trading procedures will be resumed when two floor officials determine that the conditions supporting the fast market no longer exist. Finally, it will remove, as unnecessary, the current provision allowing floor officials to assign brokerage responsibilities for particular series to specific floor brokers in the trading crowd during fast markets.

2. Statutory Basis

The Exchange believes that the proposal, as amended, is consistent with Section 6(b)(5) of the Act [30] because it is designed to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, and in general, to protect investors and the public interest.

B. Self-Regulatory Organization's Statement on Burden on Competition

The Exchange believes that the proposed rule change will impose no burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received from Members, Participants or Others

Written comments were not solicited or received with respect to the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action

Within 35 days of the date of publication of this notice in the Federal Register within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will:

A. by order approve the proposed rule change, or

B. institute proceedings to determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as amended, is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609. 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 Start Printed Page 17694public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying at the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the Exchange. All submissions should refer to File No. SR-PCX-99-36 and should be submitted by April 25, 2000.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[31]

Start Signature

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble


3.  In Amendment No. 1, the Exchange withdrew the proposed changes to PCX Rule 6.6 because the changes were previously made and approved in Securities Exchange Act Release No. 40875 (December 31, 1998), 64 FR 1842 (January 12, 1999). See letter from Michael D. Pierson, Director—Regulatory Policy, PCX, to Heather Traeger, attorney, Division of Market Regulation, SEC, on March 27, 2000 (“Amendment No. 1”).

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4.  See, e.g., PCX Rule 6.8. Com. .08(a) (“If a firm desires to facilitate customer orders in the XYZ option issue. * *  *”); PCX Rule 6.28(a)(9) (“the permissible size of orders that may be automatically executed” may be increased “in a particular issue, or for all option issues”); PCX Rule 6.82(e) (“[t]he allocation of option issues PCX Rule 6.82(e) (“[t]he allocation of option issues] to LMMs shall be effected by the Options Allocation Committee”).

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5.  See, e.g., PCX Rule 6.4(a) (“After a particular class of option * * * has been opened for trading. * * * ”); PCX Rule 6.37(c) (“Whenever a Market Maker enters the trading crowd for a class of options in which he does not hold a Primary Appointment. * * * ”; PCX Rule 6.64, Com .02 (“For those option classes and within such time periods as the Options Floor Trading Committee may designate. * * * ”).

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6.  PCX Rule 6.1(a)(10) states that “[t]he term ‘class of options’ means all option contracts of the same type of option covering the same underlying stock” (emphasis added), while the term “type of option” is defined in PCX Rule 6.1(a)(7) to mean “the classification of an option contract as either a put or call (emphasis added).” Therefore, the term “class” may refer to either a put call or a call class option contracts.

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7.  PCX Rule 5.2(a) states: “All orders on the Exchange must either be ‘day,’ ‘immediate or cancel,’ ‘good 'til canceled (‘GTC’), or ‘good 'til canceled’ that are eligible for execution in the post—1:00 p.m. auction market trading and closing price protection sessions’ (‘GTX’). Each class of orders must be recorded on the proper ticket provided therefor.”

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8.  “GTX” orders are not recognized on the Options Floor. See PCX Rule 5.25(f) (“GTX Orders Under P/COAST”).

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9.  The order ticket requirement of PCX Rule 5.2(a) is superfluous because current PCX Rules 6.67-6.69 expressly cover the use of order tickets for option orders.

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10.  PCX Rule 5.6(a) states: “Bids and offers shall be for one trading unit or multiples thereof to constitute an Exchange quotation. Bids and offers in other market centers which may be displayed on the Floor for the purpose of ITS or other purposes shall have no standing in the trading crowd on the Floor.”

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11.  PCX Rule 6.74 states; “Unless otherwise specified, all bids or offers made on the floor shall be deemed to be for one option contract unless a specific number is expressed in the bid or offer. A bid or offer for more than one option contract shall be deemed to be for that amount or any lesser number of option contracts, unless specified otherwise.”

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12.  PCX Rule 6.73 states: “Bids and offers to be effective must be made at the post by public outcry, except that bids and offers made by the Order Book Official shall be effective if displayed in a visible manner in accordance with PCX Rule 6.55. All bids and offers shall be general ones and shall not be specified for acceptance by particular members.”

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13.  PCX Rule 5.6(b) states: “Bids and offers made without stated conditions shall be considered to be ‘regular way.’ ‘Regular way’ bids or offers have priority over conditional bids or offers.”

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14.  PCX Rule 5.6(c) states: “A bid or offer may be made ‘all or none’; however, regular bids or offers at equal or better prices shall have priority. No ‘all or none’transaction in round lots may be effected unless all regular bids or offers at equal or better prices are executed thereby or simultaneously or unless the holders of such regular bids or offers consent thereto. All bids and offers, unless specifically made ‘all or none,’ shall be subject to split-up without objection except that in no case may a division of stock be made of less than round lots except by mutual consent.”

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15.  PCX Rule 6.75(a) provides in part that “If two or more bids represent the highest price * * * priority shall be afforded to such bids in the sequence in which they are made.”

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16.  PCX Rule 5.8(d) states: “When bids or offers are made simultaneously, or when it is impossible to determine clearly the order of time in which they were made, all such bids or offers shall be on parity, except as noted in Rule 5.8(e).”

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17.  PCX Rule 5.8(h) states: “All stop loss orders must clearly indicate in writing that they are such and, in addition, the amount and the price of the stock appearing at the top of the buy and sell ticket must be circled.”

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18.  See PCX Rule 6.46 (“Responsibilities of Floor Brokers”).

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19.  PCX Rule 5.12(a) states: “The seller shall be responsible for transactions being properly recorded by the floor reporters.”

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20.  PCX Rule 5.13(a) states: “Every transaction on the Exchange must be compared as provided herein unless the same shall have been officially removed from the record in accordance with Exchange rules.” PCX Rule 5.13(b), Comparison Ticket, states “The comparison ticket shall contain and constitute a record of the name, quantity and price of the securities traded and the names of the buying and selling members from which daily transaction sheets will be prepared for member firms.”

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21.  The provisions being eliminated include the following: “Rule 6.45 requires that each Floor Broker shall have in effect a Letter of Authorization that has been issued for such Floor Broker by a clearing member, and Section 77 of Rule VI requires that each Market Maker shall have in effect a Letter of Guarantee which has been issued for such market maker by a clearing firm.” (OFPA F-6)

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22.  Subsection 6 of OFPA F-2 currently provides: “The inviting member of member organization floor manager may not sign in more than four guests at any given time. Visitors may remain on the Options Trading Floor a maximum of two hours during the trading session and one-half hour after it. Visitors, except those referred to in paragraph #4 above, may not be allowed on the Options Trading Floor more than five times in a calendar month, regardless of the duration of each visit.”

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23.  This part of OFPA F-2 states: “Rule 6.2(a) limits admission to the Floor to members, employees of the Exchange, clerks or messengers employed by members, and such other persons as may be provided for in the Rules. Pursuant to this Rule, the Exchange encourages the presence of appropriate visitors on the Options Trading Floor, but it is deemed necessary to strictly enforce certain procedures governing the admission to the Floor of such visitors.”

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24.  OFPA E-5 states:

“A Member of the Options Floor with a complaint concerning a situation arising on or relating to the Floor, should: (1) Notify the Surveillance Department of the circumstances involved, and (2) subsequent to such notification, submit the complaint in writing to the Surveillance Director. If the concerned Member believes it necessary for the Surveillance Department to personally review or rectify the situation, a member of the Department will immediately come to the Floor. A study will be conducted on all matters referred to the Surveillance Department pursuant to this Floor Procedure Advice. Upon completion of such study, the Member(s) filing the complaint will be informed of the conclusion (i.e., filed closed or referred to the Compliance Department for further review or action). A written report of each study will be submitted to the Options Floor Trading Committee. General Information regarding such study may be given to concerned Members; however, the specific details shall remain confidential.”

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25.  OFPA E-6 states: “Upon receipt of a written complaint from a member of the Options Floor, the Compliance Department shall commence an investigation into the allegations contained in such complaint. The Compliance Department may, among other things, interview the Complainant, and any witnesses and parties to the action which gave rise to the complaint. The Compliance Department may request a written response from the parties involved and any witnesses. Upon the Compliance Department obtaining the facts pertinent to the issue, a written recommendation will be drafted and presented to the Options Floor Trading Committee. After the Options Floor Trading Committee has received the written recommendation of the Compliance Department, the item should be placed on the Committee's agenda for discussion, and final action, insofar as the Options Floor Trading Committee is concerned. The Compliance Department may, in addition, commence Disciplinary Proceedings based upon any violation of the Pacific Exchange Constitution, Rules, Commentaries or procedures uncovered during the investigation of the complaint.”

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26.  Cf. CBOE Rule 5.5, Interp. & Policy .03.

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28.  Cf. CBOE Rule 6.61. Interp. & Policy. 01.

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29.  Commentary .02 provides: “An open exercise position with respect to which the Options Clearing Corporation has assigned an exercise notice to the member organization and the member organization has not delivered the shares of the underlying stock in accordance with the Rules of the Options Clearing Corporation and these Rules.” Commentary .03 currently provides: “All such reports shall be delivered to the Department of Member Organizations of the Exchange.” The Exchange does not believe that a specified department needs to be identified in this rule and, in any event, member firms are currently on notice that such reports must be filed with the Department of Options Surveillance.

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[FR Doc. 00-8222 Filed 4-3-00; 8:45 am]