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Self-Regulatory Organizations; Notice of Filing and Immediate Effectiveness of Proposed Rule Change by the Pacific Exchange, Inc., Relating to Schedule of Fees and Charges for Options Market Share Shortfall Fee, Surcharge Fee, and Options Issue Transfer Fee

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Start Preamble January 29, 2002.

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 December 26, 2001, the Pacific Exchange, Inc. (“PCX” or “Exchange”) filed with the Securities and Exchange Commission (“Commission” or “SEC”) the proposed rule change as described in Items I, II and III below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

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

The PCX proposes to modify its Schedule of Fees and Charges to reflect a new options market share shortfall fee, surcharge fee, and options issue transfer fee.

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 PCX 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 PCX 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

Option Market Share Shortfall Fee

The Exchange is proposing to adopt a new Lead Market Maker (“LMM”) shortfall fee, of $.35 per contract, to be paid by the LMM allocated any “Top 120 Option” if at least 10 percent of the total national monthly contract volume (“total volume”) for such Top 120 Option is not achieved on the PCX in that month.[3] A “Top 120 Option” is defined by the proposal as one of the 120 most actively traded equity options in terms of the total number of contracts traded nationally for a specified month based on volume reflected by the Options Clearing Corporation (“OCC”)[4] .

The PCX states that at the end of each trading month, the total number of contracts executed on the PCX (the “PCX volume”) in a particular Top 120 Option will be subtracted from the amount that represents 10 percent of the total national volume for that option (“10% total volume”) to determine the number of contracts that represent the “shortfall” for that Top 120 Option for purposes of calculating this fee.

Specifically, the PCX will apply the following calculation: 10% total volume minus PCX volume equals the shortfall volume. If the shortfall volume is a number of contracts greater than zero, the shortfall volume will be multiplied by $.35 per contract to determine the LMM shortfall fee for that month for that Top 120 Option.[5]

In sum, if the PCX fails to garner 10 percent of the total volume for a particular month for a Top 120 Option, the LMM for that Top 120 Option would be required to pay the Exchange the LMM shortfall fee for each contract that falls below 10 percent up to the amount that would represent 10 percent of the total volume for that option.[6]

The total volume for purposes of the 10 percent threshold is based on the current month's volume.[7] However, the determination of whether an equity option is considered a Top 120 Option for purposes of the fee is based on a different time period. The Top 120 Options for January will be based on November's volume. Thereafter, the Exchange will continue the two-month differentiation, so that February's Top 120 Options will be based on December's volume, and March's Top 120 Options will be based on January's volume, and so forth.

The purpose of the proposed rule change is to amend PCX's schedule of dues, fees and charges to impose a fee for any deficiency between what the PCX actually traded and 10 percent of the total volume for each respective month. PCX intends the proposed fee to provide the PCX with the approximate revenue it would have received had a Top 120 Option traded at least 10 percent of the total volume in a given month on the PCX. The PCX represents that the options LMM shortfall fee Start Printed Page 5632generally parallels the amount that the Exchange would have received if an equity option contract were traded on the PCX with an LMM.[8]

Pursuant to PCX rules, options are allocated to LMMs based on certain factors. LMMs submit written applications that include the LMMs experience and capitalization, a demonstration of the LMM's ability to trade the particular option, and any other reasons why the LMM believes it should be assigned or allocated the security.[9] Once an option is allocated to an LMM, certain performance reviews may be conducted.[10] A Top 120 Option is unique and may require specific qualifications as determined by the Options Allocation Committee (“OAC”) and strategic efforts.

Moreover, the PCX believes that the options traded by the LMM and the transactions related thereto, may be especially valuable to that LMM and to the Exchange due to their potential profitability. Therefore, the Exchange believes that the LMM should compete for order flow in the national market, because that LMM is the key party responsible for marketing and receiving order flow in that particular option. The PCX believes that an LMM's willingness to apply to be or continue to be an LMM in a Top 120 Option, in light of the shortfall fees, is an important tangible demonstration of commitment to making the efforts required to achieve at least a 10 percent national volume level at the PCX.

The Exchange believes that it is necessary to continue to attract order flow to the Exchange in order to remain competitive. The proposed fee should encourage LMMs to vigorously compete for order flow, which not only enhances the LMM's role, but also provides additional revenue to the Exchange. Moreover, the Exchange expects that LMMs' efforts to maintain at least 10 percent of the total volume should contribute to deeper, more liquid markets and tighter spreads. Thus, competition should be enhanced, and important auction market principles preserved.

The above-described proposed fee will be effective the January 2002 trade month.

Surcharge Fee

The Exchange proposes to adopt a surcharge fee of 2.5% on the total amount billed on regular PCX member monthly invoices. The rate will be applied to total invoice amounts excluding registered representative fees, marketing fees and member dues and fines. This fee includes fees, charges, and pass through fees, and applies only to Options billings, not Equities and Clearing billings. The PCX states that the purpose of the fee is to generate revenue for the Exchange.

The above-described proposed fee will be effective the January 2002 trade month.

Options Issue Transfer Fee

The Exchange proposes to establish a new fee for transfers of options issues. The fee imposes a charge of $1000 per option issue transferred upon the transferor. PCX Rule 6.82(e) provides for allocation of option issues to LMMs by the Options Allocation Committee (“OAC”). The OAC selects the candidate who appears best able to perform the functions of an LMM in the designated option issue. Factors to be considered for selection include, but are not limited to, experience with trading the option issue; adequacy of capital; willingness to promote the Exchange as a marketplace; operational capacity; support personnel; history of adherence to Exchange rules and securities laws; and trading crowd evaluations.[11] Issues may only be transferred by a firm or between nominees with the express approval of the OAC.[12] To transfer issues, the transferor must file an application with the Exchange. That application is posted to the floor for comment. After the comment period, the OAC evaluates and approves or denies the transfer. The Exchange researches the relevant statistics for the OAC evaluation. Each issue transferred expends Exchange resources.

Transfers of issues were first permitted in June 2000. Since that time, the Exchange has processed 37 transfers involving over 452 issues. The PCX states that the purpose of the fee is to cover administrative fees relating to transfers.

The above described proposed transfer fee will be effective January 1, 2002.

2. Statutory Basis

The Exchange believes that the proposal is consistent with section 6(b) of the Act,[13] in general, and section 6(b)(4),[14] in particular, in that it provides for the equitable allocation of reasonable dues, fees and other charges among its members.

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

The Exchange does not believe that the proposed rule change will impose any 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

The foregoing rule change has become effective pursuant to section 19(b)(3)(A) of the Act [15] and subparagraph (f)(2) of Rule 19b-4 [16] thereunder, because it establishes or changes a due, fee, or other charge imposed by the Exchange. At any time within 60 days of the filing of a rule change pursuant to section 19(b)(3)(A) of the Act, the Commission may summarily abrogate the rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 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 Start Printed Page 5633proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the PCX. All submissions should refer to file number SR-PCX 2001-51 and should be submitted by February 27, 2002.

Start Signature

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[17]

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble


3.  The shortfall fee is similar to the Philadelphia Stock Exchange's shortfall fee. See Securities Exchange Act Release No. 43201 (August 23, 2000), 65 FR 52465 (August 29, 2000).

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4.  The PCX intends to divide by two the total volume amount reported by OCC, which reflects both sides of an executed transaction, thus avoiding one trade being counted twice for purposes of determining overall volume.

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5.  If the result of the first equation (10% total volume minus PCX volume) was negative, meaning the PCX volume exceeded 10% total volume for a Top 120 Option, then there would be no shortfall to which the LMM shortfall fee would apply. Under the proposal, any excess volume (over the 10% total volume target) could not be carried over to another month, nor could any excess volume in one option be assigned to another option. Telephone conversation between Cindy Sink, Senior Attorney, Regulatory Policy, PCX, and Ira Brandriss, Special Counsel, and John Riedel, Attorney-Advisor, Division of Market Regulation (“Division”), Commission, January 15, 2002 (“Telephone conversation with the PCX”).

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6.  Telephone conversation with the PCX.

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7.  For example, for the month of December, the LMM shortfall fee would apply to 10 percent of total December volume minus the PCX December volume.

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8.  The $.35 is intended by the PCX to represent the following amounts, which, the PCX believes, may be generated by a trade on the PCX with an LMM: a $0.21 LMM transaction fee, an estimated $.06 from Options Price Reporting Authority (recognizing that tape revenue can fluctuate significantly due to changes in trade and pool size), and a $.05 options comparison fee, all of which could have been collected by the Exchange per contract traded by the crowd. Transactions not involving an LMM would generate less revenue. The above listing of fees commonly charged in an LMM transaction does not represent the fees generated by every such transaction, but has been utilized by the PCX on a general basis, with room for fluctuation, to calculate what it believes to be an appropriate shortfall fee. Telephone conversation with the PCX.

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9.  See PCX Rule 6.82(e)(1).

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10.  See PCX Rule 6.82(f).

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11.  See PCX Rule 6.82(e)(1).

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11.  See PCX Rule 6.82(e)(2).

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[FR Doc. 02-2792 Filed 2-5-02; 8:45 am]