[Federal Register: October 16, 2003 (Volume 68, Number 200)]
[Notices]
[Page 59663-59666]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16oc03-137]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48598; File No. SR-PCX-2003-46]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Pacific Exchange, Inc. Relating to Transmission of
Identity Orders
October 7, 2003.
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 September 5, 2003, the Pacific Exchange, Inc. (``PCX'') filed with
the Securities and Exchange Commission the proposed rule change as
described in Items I, II, and III below, which the PCX has prepared. On
September 30, 2003 the PCX submitted 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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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Peter Bloom, Managing Director of Regulatory
Policy, PCX, to Nancy Sanow, Assistant Director, Division of Market
Regulation, Commission dated September 29, 2003 (``Amendment No.
1''). In Amendment No. 1, the PCX replaced its proposed rule change
in its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The PCX, through its wholly owned subsidiary PCX Equities, Inc.
(``PCXE''), proposes to amend its rules governing the Archipelago
Exchange (``ArcaEx''), the equities trading facility of PCXE.
Specifically, the PCX proposes to offer an identity order feature to
its Equities Trading Permit (``ETP'') Holders.\4\ In accordance with
the proposal, an ETP Holder may affirmatively choose, on an order-by-
order basis, to display orders with its unique ETP identifier
(hereinafter referred to as the ``ETPID''). To facilitate the change,
the PCX proposes to amend PCXE Rules 7.7(b) (``Transmission of Bids or
Offers'') and 7.36(b) (``Order Ranking and Display'') to clarify and
reconcile when ETP Holders may display their identities. The PCX also
wishes to make additional changes to PCXE Rule 7.7(a). The text of the
proposed rule change is below. Proposed new language is italicized;
deletions are in brackets.
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\4\ See PCXE Rule 1.1(n) for the definition of ``ETP Holder.''
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* * * * *
Rule 7.7(a). [The names of ETP Holders bidding for or offering
securities through the use of the facilities of the Corporation shall
not be transmitted from the facilities of the Corporation to a non-
holder of an ETP.] No ETP Holder having the right to trade through the
facilities of the Corporation and who has been a party to or has
knowledge of an execution shall be under obligation to divulge the name
of the buying or selling firm in any transaction.
(b) Except as otherwise permitted by these Rules, no ETP Holder
shall transmit through the facilities of the Corporation any
information regarding a bid, offer, [or] other indication of an order,
or the ETP Holder's identity to a non-holder of an ETP or to another
ETP Holder until permission to disclose and transmit such bid, offer,
[or] other indication of an order, or the ETP Holder's identity has
been [disclosed and permission to transmit such information has been]
obtained from the originating ETP Holder or the originating ETP Holder
affirmatively elects to disclose its identity.
* * * * *
Order Ranking and Display
Rule 7.36--No change.
(a)(1)-(a)(2)--No change.
(b) Display. Except as otherwise permitted by Rule 7.7, [A] all
orders at all price levels in the Display Order Process of the Arca
Book shall be displayed to all Users and other market participants on
an anonymous basis.
(c)--No change.
* * * * *
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
[[Page 59664]]
comments it had 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
A. Introduction
The PCX proposes to offer ETP Holders the ability to display their
identities with orders entered into the ArcaEx. The identity order
feature would offer an ETP Holder the choice to display its unique
ETPID with a specified order. Alternatively, an ETP Holder may choose
to remain anonymous.
Any identity orders entered into ArcaEx would be included in the
Arca Book data feed that ArcaEx makes available free of charge to Users
\5\ and other subscribers. Identity orders would also be included in
the ArcaEx limit order book that is displayed for free on the ArcaEx
Web site.
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\5\ See PCXE Rule 1.1( yy) for the definition of ``User.''
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ArcaEx would process orders designated as identity orders no
differently from other orders sent to ArcaEx. PCXE Rules 7.36 (Order
Ranking and Display) and 7.37 (Order Execution) set forth the order
interaction process for orders entered on the ArcaEx. Orders designated
as identity orders would be ranked, displayed, and executed under the
same criteria (under PCXE Rules 7.36 and 7.37) as anonymous orders in
the ArcaEx. ArcaEx has no capacity limitations on the number of
identity orders that could be displayed for an individual security.
The purpose of the identity order feature is to provide more
visibility to those ETP Holders who may choose to identify their ETPIDs
with their trading interest in a particular security. The PCX believes
that the identity order feature would benefit investors by increasing
market transparency in an automatic execution venue such as ArcaEx. By
providing a mechanism by which ETP Holders could display their
identities, ArcaEx hopes to attract more orders and contribute more
liquidity to the market while adding to the transparency of trading
interest.
B. Order Interaction
As with all orders entered on ArcaEx, identity orders would be
centrally processed for execution by computer, subject to the price,
time, and priority rules that govern the automated matching and
execution of orders. No ETP Holder has any special control over the
timing of an execution or any special order handling advantages on
ArcaEx. All Users would see and be privy to the same orders ranked in
the ArcaEx Book. No User would have special access to trading interest
that is not also available to others on ArcaEx, and all Users would
have the equivalent opportunity to receive fills.
An ETP Holder displaying an identity order would be subject to the
same rules applicable to the ETP Holder's orders entered on ArcaEx on
an anonymous basis.\6\ Use of the identity order by ETP Holders would
not require registration as a Market Maker \7\ on ArcaEx under PCXE
rules. Market Maker status is available only to those ETP Holders who
seek registration as Market Makers.\8\ Only those ETP Holders that seek
registration as a Market Makers are required to maintain two-sided
markets in return for the benefits of Market Maker status, e.g., the
ArcaEx rebates to Market Makers for the execution of ``Q Orders'' \9\
and the ability to obtain exempt credit under Regulation T. ETP Holders
that elect to use the identity order would have no commitment to ArcaEx
to maintain two-sided identity orders on a continuous basis.
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\6\ For example, ETP Holders would remain prohibited from
trading ahead of customer limit orders pursuant to PCXE Rule
6.16(a), which provides that ``[n]o ETP Holder may accept and hold
an unexecuted limit order from its customer (whether its own
customer or a customer of another ETP Holder) and continue to trade
on the Corporation the subject security for its own account at
prices that would satisfy the customer's limit order, without
executing that limit order; provided, however, that an ETP Holder
may negotiate specific terms and conditions applicable to the
acceptance of limit orders. * * *''
\7\ See PCXE Rule 1.1(u) states that ``[t]he term ``Market
Maker'' shall refer to an ETP Holder that acts as a Market Maker
pursuant to Rule 7.''
\8\ PCXE Rule 7.20(a) states that ``[n]o ETP Holder shall act as
a Market Maker in any security unless such ETP Holder is registered
as a Market Maker in such security by the Corporation pursuant to
this Rule. * * *'' PCXE Rule 7.23 and Rule 7.34(b) set forth the
obligations of market makers and apply only to those ETP Holders who
are registered as Market Makers. For example, a Market Maker must
maintain a two-sided order or ``Q Order'' in every stock in which
the Market Maker is registered.
\9\ See PCXE Rule 7.31(k) for the definition of ``Q Order.''
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C. Market Makers
With respect to Market Makers, the PCX's proposal would not alter
the responsibilities of Market Makers, nor does it change the manner in
which Market Maker orders would be processed and executed within
ArcaEx. Market Makers are obligated to enter and maintain continuous,
two-sided limit orders in the securities in which they are registered.
There would be no limit, however, on the number of orders a Market
Maker may enter into ArcaEx, whether anonymous or identity orders. A
Market Maker would be able to maintain multiple proprietary orders,
including multiple Q Orders in the securities in which were registered.
Under the proposal, Market Makers would be permitted to use the
identity order feature for any and all of the orders that they are
eligible to use. As with any identity order, a Market Maker's ETPID
would be displayed in relation to a specified order. A Market Maker may
choose to make the Q Order or any other order an identity order.\10\
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\10\ As stated above, ArcaEx has no capacity limitations on the
number of identity orders that can be displayed for an individual
security.
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Whether utilizing anonymous orders or identity orders, Market
Makers would remain subject to the rules governing their conduct and
the handling of orders. Specifically, PCXE Rule 7.26(a) states that a
Market Maker must maintain an information barrier between the market
making activities and other business activities, including conducting a
public securities business and acting as a General Authorized Trader
(``GAT'') \11\ on ArcaEx. This separation between the Market Making
activities of an ETP Holder and the handling of public orders is an
important mechanism to separate the Market Maker from knowledge of
pending transactions, order flow information, and other sensitive
information at other parts of the firm.\12\ As long as the Market Maker
has an effective system of internal controls that operate to prevent
the Market Making desk from obtaining knowledge of customers' limit
orders that are received for execution by other business units of the
broker-dealer, the Market Maker does not have responsibilities to
protect customer limit orders received by other parts of the firm.\13\
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\11\ Rule 1.1(o) defines a General Authorized Trader ``GAT'' to
mean ``an authorized trader who performs only non-market making
activities on behalf of an ETP Holder.''
\12\ See PCXE Rule 7.26(b).
\13\ For example, where an ETP Holder has an agency desk and a
Market Maker desk, both desks will be permitted to use identity
orders. Should an agency desk utilize identity orders to represent
customer orders, Market Makers from the same firm would not have
responsibilities to protect the customer orders, assuming an
appropriate information barrier is in place. Once the agency desk
displays an identity order in the ArcaEx limit order book, the price
time rules in the automated execution system of the ArcaEx ensure
that the customer order will be executed in a fair and consistent
manner. A Market Maker from that same firm is subject to the same
rules, and importantly, has no special advantage over the execution
of other orders in the book, including the customer order
represented by the agency desk. The price time priority granted to
orders in the ArcaEx book dictate that orders with the best price
are executed first, and, where there is more than one order at the
best price, the order first in time receives an execution. With
these rules, a Market Maker's order at a price equal to the price of
other orders in the ArcaEx book, would receive an execution over
these orders only if the Market Maker's order was entered first. A
Market Maker's order entered after other orders in the book can
receive an execution over other orders in the book only if the
Market Maker order is at a better price (by a minimum of one penny)
than the orders displayed. These rules for the ranking, display and
interaction of orders apply equally to all orders entered by all
Users of the ArcaEx.
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[[Page 59665]]
D. Section 11(a) Under the Act
The PCX believes that the use of identity orders on ArcaEx would
not confer ETP Holders any time and place advantages over other orders
on ArcaEx. As such, the introduction of identity orders would not
change the analysis of Section 11(a) of the Act \14\ to the PCX
provided to the Commission prior to the approval of ArcaEx.\15\
Accordingly, the introduction of the identity order would not change
the PCX's conclusion that the order execution algorithm of ArcaEx
complies with the requirements of, and satisfies the policy concerns
underlying, Section 11(a) of the Act \16\ without requiring public
customer priority.
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\14\ 15 U.S.C. 78k.
\15\ See Letter, dated April 19, 2001 from Cherie MacCauley,
Counsel to PCX, Wilmer Cutler & Pickering to John Polise, Division
of Market Regulation.
\16\ 15 U.S.C. 78k(a).
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Section 11(a) of the Act \17\ prohibits a member of a national
securities exchange from effecting transactions on the exchange for its
own account, the account of an associated person, or an account in
which it or an associated person exercises investment discretion
(collectively, ``covered accounts''), unless an exception applies. In
enacting this provision, Congress was concerned about members
benefiting in their principal transactions from special ``time and
place'' advantages associated with floor trading--such as the ability
to ``execute decisions faster than public investors.'' \18\ The
Commission, however, has adopted a number of exceptions to the general
statutory prohibition for situations in which the principal
transactions contribute to the fairness and orderliness of exchange
markets or do not reflect any time and place trading advantages. The
PCX believes that the use of identity orders on ArcaEx would not alter
Rule 11a2-2(T),\19\ commonly referred to as the ``effect versus
execute'' rule,\20\ which provides an exemption that applies to the
PCX. The effect versus execute rule imposes four requirements
``designed to put members and non-members on the same footing, to the
extent practicable, in light of the purposes of Section 11(a).'' \21\
Given ArcaEx's automated matching and execution services, no ETP Holder
enjoys any special control over the timing of execution or special
order handling advantages, as all orders would be centrally processed
for execution by computer, rather than being handled by a member
through bids or offers made on the trading floor. Because ArcaEx's
open, electronic structure is designed to prevent any ETP Holders from
gaining any time and place advantages, the PCX believes that ArcaEx
satisfies the four requirements of the ``effect versus execute'' rule
as well as the general policy objectives of Section 11(a) of the
Act.\22\
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\17\ 15 U.S.C. 78k(a).
\18\ See Securities Exchange Act Release No. 14563 (March 14,
1978), 43 FR 11542 (March 17, 1978); Securities Exchange Act Release
No. 14713 (April 28, 1978), 43 FR 18557 (May 1, 1978); Securities
Exchange Act Release No. 15533 (January 29, 1979), 44 FR 6093 (Jan.
31, 1979). The 1978 and 1979 Releases cite the House Report at 54-
57.
\19\ 17 CFR 240.11a2-2(T).
\20\ Rule 11a2-2(T) permits an exchange member, subject to
certain conditions, to effect transactions for covered accounts by
arranging for an unaffiliated member to execute the transactions
directly on the exchange floor. To comply with the rule's
conditions, a member (1) must transmit the order from off the
exchange floor; (2) may not participate in the execution of the
transaction once it has been transmitted to the member performing
the execution; (3) may not be affiliated with the executing member;
and (4) with respect to an account over which the member or an
associated person has investment discretion, neither the member nor
the associated person may retain any compensation in connection with
effecting the transaction without express written consent from the
person authorized to transact business for the account in accordance
with the rule.
\21\ See 1978 Release II at 18560.
\22\ 15 U.S.C. 78k(a).
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E. Surveillance
According to the PCX, PCXE has developed procedures to maintain a
high level of surveillance of ETP Holders and their use of specific
order types, including those orders designated as identity orders, for
executions that take place on ArcaEx. Among its procedures, the PCX has
developed mechanisms to help detect manipulation of prices on ArcaEx
whether or not through use of identity orders.
Use of identity orders would help an ETP Holder to advertise the
trading interest and activity the firm has in a particular stock.
Should an ETP Holder attract order flow and wish to match buy and sell
orders for execution away from the centralized limit order book of
ArcaEx, an ETP Holder would have to report that trade to a marketplace
that allows broker-dealers to ``print'' trades to the tape.
Specifically, broker-dealers in the Nasdaq dealer market are permitted
to define parameters of a trade (i.e., price) without bringing the
trade to an exchange system for validation. By design, the Nasdaq
dealer market enables broker-dealers to control trade execution outside
of a centralized price validation system. The regulation of these
trades is the responsibility of the marketplace that supports and
encourages the execution of these trades away from an exchange
infrastructure. Any executions by a broker-dealer brought to a
marketplace that permits ``printing'' are trades appropriately within
the jurisdiction of the alternate marketplace.\23\ Should Nasdaq (or
other marketplace) determine that it requires information or assistance
from the PCX for the surveillance of these trades, the PCX would
provide such information and assistance.
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\23\ The ability of broker-dealers to advertise trading interest
is not limited to the use of exchange trading systems. Broker-
dealers can display indications of interest through services such as
Autex (offered by Thompson Financial). Autex permits broker-dealers
to display the price and size of indications of interest and
communicate with other subscribers interested in facilitating
trades. While not a trading system, Autex allows broker-dealers to
advertise their trading activity and attract trading interest.
Broker-dealers finding counterparties through this service must
bring such trades to Nasdaq's dealer market which permits the
printing of trades. Whether the prices of these transactions are
executed within the standards of best execution or other standards
of appropriate order handling is the business of the regulator for
the marketplace supporting the ``printing'' infrastructure.
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To facilitate the identity order feature, the Exchange proposes to
make changes to PCXE Rules 7.7(b) and 7.36(b). Currently, PCXE Rule
7.7(b) prohibits an ETP Holder from transmitting information
``regarding a bid, offer or other indication of an order'' to a non-ETP
Holder until the bid, offer or other indication information has been
disclosed and permission to transmit the information has been obtained
from the originating ETP Holder. Conversely, PCXE Rule 7.36(b) provides
for anonymity in displaying orders in the Display Order Process \24\ of
the ArcaEx Book.\25\
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\24\ See PCXE Rule 7.36(a)-(c) for a discussion of the Display
Order Process.
\25\ See PCXE Rule 1.1(a) for a definition of Arca Book.
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The Exchange wishes to revise PCXE Rule 7.36(b) to state that
except as provided by PCXE Rule 7.7(b), all orders at all price levels
will continue to be displayed on an anonymous basis. Therefore, a User
could choose to either display its ETPID or remain anonymous.
[[Page 59666]]
Additionally, the Exchange proposes to revise PCXE Rule 7.7(a) \26\
to reflect the proposed changes to PCXE Rules 7.7(b) and 7.36(b).
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\26\ PCXE Rule 7.7(a) provides that ``[t]he names of ETP Holders
bidding for or offering securities through the use of the facilities
of the Corporation shall not be transmitted from the facilities of
the Corporation to a non-holder of an ETP. No ETP Holder having the
right to trade through the facilities of the Corporation and who has
been a party to or has knowledge of an execution shall be under
obligation to divulge the name of the buying or selling firm in any
transaction.''
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2. Statutory Basis
The Exchange believes that the proposal is consistent with Section
6(b) of the Act,\27\ in general, and Section 6(b)(5) of the Act,\28\ in
particular, in that it will promote just and equitable principles of
trade; facilitate transactions in securities, remove impediments to and
perfect the mechanisms of a free and open market and a national market
system; and protect investors and the public interest.
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\27\ 15 U.S.C. 78f(b).
\28\ 15 U.S.C. 78f(b)(5).
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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 on the proposed rule change were neither solicited
nor received.
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 or 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 Exchange consents, the Commission will:
A. by order approve such 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 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 proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference 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-2003-46 and
should be submitted by November 6, 2003.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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\29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-26102 Filed 10-15-03; 8:45 am]
BILLING CODE 8010-01-P