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Self-Regulatory Organizations; Order Approving Proposed Rule Change and Amendment No. 1 by the Pacific Exchange, Inc. Eliminating the Requirement That Market Makers With No Public Accounts and Who Do Not Solicit Public Accounts, Maintain Certain Information Barriers

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Start Preamble February 17, 2004.

I. Introduction

On September 16, 2003 the Pacific Exchange, Inc. (“PCX” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”),[1] and Rule 19b-4 thereunder,[2] a proposed rule change to eliminate the Information Barrier requirement set forth in PCXE Rule 7.26 for certain Market Makers. On December 16, 2003, PCX amended the proposed rule change.[3] The proposed rule change, as amended, was published for comment in the Federal Register on January 12, 2004.[4] No comment letters were received on the proposal. This order approves the proposed rule change.

II. Description of the Proposal

The Information Barrier requirements set forth in PCXE Rule 7.26 are designed to provide safeguards to prevent the use or communication of material non-public information by market making firms (and affiliated broker-dealers) to inappropriately benefit business activities in which they may engage, such as investment banking or options market making. Such information could relate to, for example, the Market Maker's customer and directed order flow or other information obtained by the Market Maker in the course of its business. PCX believes that such barriers help to ensure that market making firms do not illegally take advantage of or communicate such information to benefit their business activities, to the detriment of investors, customers, issuers and the integrity of the market.

For business reasons, certain registered Market Makers, or broker-dealers with which such Market Makers are affiliated, engage solely in proprietary trading. Accordingly, such firms do not maintain public customer accounts or solicit or accept orders or funds (and hence, would not accept directed order flow) from or on behalf of public customers, including broker-dealers and other securities firms. Under such circumstances, because the market making firm does not engage in any other business activities that may benefit from information obtained by the Market Maker in the course of the firm's market making activities, the Exchange believes that the concerns noted above which form the basis for the Information Barrier requirements set forth in PCXE Rule 7.26 do not apply.[5] Nevertheless, PCXE Rule 7.26 would require such a firm to develop and implement Information Barriers.

Under such circumstances, the Exchange believes that an Information Barrier requirement is not necessary and would impose an undue burden on the market making firm. Accordingly, the PCX proposes to eliminate this requirement in the limited circumstances where a market making firm and its affiliated broker-dealer neither maintain public customer accounts, nor solicit or accept public customer orders, including from broker-dealers and other securities firms (and does not accept directed order flow or utilize any order type which presupposes the participation of public customers), and engage solely in proprietary trading. The Exchange believes that this limited modification is consistent with the purposes of the rule. However, if the market making firm or its affiliated broker-dealer subsequently decides to maintain public customer accounts or solicit public customer accounts (and directed order flow or order types which presuppose the participation of public customers), then the requirements of PCXE Rule 7.26 Start Printed Page 8511would apply. Furthermore, this limited modification would not alter or adjust any other obligation imposed on Market Makers, including those set forth in PCXE Rules 7.21 (Obligations of Market Maker Authorized Traders)[6] and 7.23 (General Obligations of Market Makers).

III. Discussion

The Commission finds that the proposed rule change, as amended, is consistent with the Act and the rules and regulations promulgated thereunder applicable to a national securities exchange [7] and, in particular, with the requirements of Section 6(b)(5) of the Act.[8] Specifically, the Commission finds that approval of the proposed rule change, as amended, is consistent with the Act in that it is designed to promote just and equitable principles of trade; to remove impediments to and perfect the mechanism of a free and open market and a national market system; and in general, to protect investors and the public interest.

The proposed rule change would amend PCXE Rule 7.26 to carve an exception where, even though a firm is registered as a Market Maker, or is an affiliated broker-dealer, it has no customer accounts, and engages solely in proprietary trading. The Commission believes that it is not necessary for a Market Maker, or its affiliated broker-dealer, that fits this limited exception, to be required to maintain an information barrier between the market making and other business activities. The Commission believes it is reasonable to remove a requirement that could become unduly burdensome, since the Market Maker, or its affiliated broker-dealers, is not engaged in activities that would inappropriately benefit other business activities within the firm. Furthermore, the Commission believes that the modification of PXCE Rule 7.26 may remove impediments that could hinder competition between a Market Maker fitting the limited exception, or its affiliated broker-dealer, and those Market Makers engaged in broader businesses. However, the Commission notes that, if in the future these Market Makers, or their affiliated broker-dealers, engage in other business activities, such as investment banking or options market making, or maintain customer accounts, solicit or accept public customer orders, the Commission expects that the Exchange will require compliance with the Information Barrier requirements of PCXE Rule 7.26.

IV. Conclusion

For the foregoing reasons, the Commission finds that the proposed rule change, as amended, is consistent with the Act and the rules and regulations thereunder applicable to a national securities exchange, and, in particular, with Section 6(b)(5).[9]

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,[10] that the proposed rule change (SR-PCX-2003-49), as amended, is approved.

Start Signature

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[11]

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble

Footnotes

3.  See December 15, 2003 letter from Steven B. Matlin, Senior Counsel, Regulatory Policy, PCX, to Nancy J. Sanow, Assistant Director, Division of Market Regulation, Commission, and attachment (“Amendment No. 1”). Amendment No. 1 replaced and superseded the PCX's original filing in its entirety.

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4.  Securities Exchange Act Release No. 49018 (January 5, 2004), 69 FR 01771.

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5.  The proposed rule change is designed to accommodate the needs of these Market Makers. The current rule did not foresee the business conditions that currently exist which necessitate this change.

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6.  See PCXE Rule 1.1(v) (definition of “Market Maker Authorized Trader”).

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7.  In approving this proposal, the Commission has considered the proposed rule's impact on efficiency, competition and capital formation. 15 U.S.C. 78c(f).

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[FR Doc. 04-3886 Filed 2-23-04; 8:45 am]

BILLING CODE 8010-01-P