[Federal Register: March 13, 2003 (Volume 68, Number 49)]
[Notices]
[Page 12134-12138]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13mr03-141]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47467; File No. SR-PCX-2002-75]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Pacific Exchange, Inc., as Amended, and Notice of Filing
and Order Granting Accelerated Approval to Amendment No. 2 Relating to
New Order Types and To Amend PCXE Rule 7.37
March 7, 2003.
I. Introduction
On December 9, 2002, pursuant to section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 thereunder,\2\ the
Pacific Exchange, Inc. (``PCX'' or ``Exchange''),
[[Page 12135]]
through its subsidiary, PCX Equities, Inc. (``PCXE''), filed with the
Securities and Exchange Commission (``Commission'') a proposed rule
change to establish new order types on the Archipelago Exchange
(``ArcaEx''), the equity facility of the PCXE, and to amend the ArcaEx
Working Order Process to enable the execution of such order types. The
PCX filed Amendment No. 1 to the proposal on January 15, 2003.\3\ The
PCX filed Amendment No. 2 on March 7, 2003.\4\ The proposed rule
change, as amended by Amendment No. 1, was published for comment and
appeared in the Federal Register on January 29, 2003.\5\ The Commission
received no comment letters in response to the proposed rule change.
This order approves the PCX's proposed rule change, as amended, and
notices and grants accelerated approval to Amendment No. 2 to the
proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ In Amendment No. 1, the Exchange submitted a new Form 19b-4,
which replaced the original filing in its entirety.
\4\ See Letter from Peter Bloom, Acting Managing Director,
Regulatory Policy, PCX, to Marc McKayle, Special Counsel, Division
of Market Regulation, Commission, dated March 7, 2003 (``Amendment
No. 2''). In Amendment No. 2, the Exchange made various clarifying
and technical amendments to the proposed rule text to: (1) Reference
the ``Joint Self-Regulatory Organization Plan Governing the
Collection, Consolidation and Dissemination of Quotation and
Transaction Information for Nasdaq-Listed Securities Traded on
Exchanges (``Nasdaq Unlisted Trading Privileges Plan'') in proposed
PCXE Rule 1.1(aa), (2) clarify that the term ``OTC/UTP Listing
Market'' shall have a meaning consistent with the Nasdaq Unlisted
Trading Privileges Plan, (3) clarify the definition of ``Sweep
Reserve Order'' by replacing the word ``price'' with the word
``size,'' (4) clarify the definition of ``Random Reserve Order'' by
indicating that the random reserve value is expressed in round-lot
increments and by correcting a grammatical error, (5) amend the
definition of ``Pegged Order'' to reflect that the display price
will track the relevant Consolidated Quote information for such
orders on a real-time basis and that the displayed price of a Pegged
Order designated as a Discretionary Order will track the National
Best Bid or Offer (``NBBO''), and that the discretionary price of
such order would re-price in correlation to any changes to the
displayed price, and (6) clarify that Immediate or Cancel (``IOC''),
NOW, Post No Preference (``PNP''), Passive Discretionary, Discretion
Limit, IOC Cross and PNP Cross orders in Nasdaq securities would
received executions no worse than the ArcaEx Best Bid or Offer
(``BBO'').
\5\ Securities Exchange Act Release No. 47223 (January 21,
2003), 68 FR 4527 (January 29, 2003) (SR-PCX-2002-75).
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II. Description of the Proposal
The proposal would amend PCXE rules to: (1) Adopt several new order
types to accommodate the trading of securities listed on the Nasdaq
Stock Market, Inc. (``Nasdaq''), on an unlisted trading privileges
(``UTP'') basis; (2) amend PCXE Rule 7.37 to provide for a limited
exemption from the ArcaEx guarantee of executions at the NBBO or better
for certain order types trading Nasdaq securities; (3) reflect the
operational requirements of two proposed order types in the Working
Order Process; and (4) make various minor technical rule changes to
conform to the Nasdaq UTP Plan, which extends UTP to Nasdaq SmallCap
securities.
A. Proposed New Order Types
As part of its ongoing preparation for the trading of Nasdaq
securities on the ArcaEx pursuant to UTP,\6\ PCX proposes to make
several new order types available to Electronic Trading Permit
(``ETP'') Holders \7\ and Sponsored Participants \8\ (collectively
``Users''), which are currently in use on the Archipelago electronic
communication network (``ECN'').\9\ The proposed new order types are
discussed below.
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\6\ The Nasdaq UTP Plan was initially approved in 1990. See
Securities Exchange Act Release No. 28146 (June 26, 1990), 55 FR
27919 (July 6, 1990) (S7-24-89). It has subsequently been amended on
several occasions to, among other things, admit new Participants.
See also Securities Exchange Act Release No. 46381 (August 19,
2002), 67 FR 54687 (August 23, 2002) (S7-24-89) (Order approving
most recent amendments to Nasdaq UTP Plan, the 13th Amendment).
\7\ See PCXE Rule 1.1(n).
\8\ A ``Sponsored Participant'' means ``a person which has
entered into a sponsorship arrangement with a Sponsoring ETP Holder
pursuant to [PCXE] Rule 7.29.'' See PCXE Rule 1.1(tt).
\9\ The broker-dealer commonly referred to as the Archipelago
ECN is Archipelago Securities, a wholly owned subsidiary of
Archipelago Holdings LLC and a member of the NASD. The ECN function
will cease to operate as such once all the Nasdaq securities have
been transferred to ArcaEx.
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1. Inside Limit Order
An Inside Limit Order is a limit order that is to be executed in
whole or in part on ArcaEx. If the order were not executed in its
entirety, the remaining portion of the order would be routed pursuant
to PCXE Rule 7.37(d) to the market participant \10\ with the best
displayed price. Any unfilled portion of the order would not be routed
to the next best price level until all quotes at the current best bid
or offer are exhausted. If the Inside Limit Order were no longer
marketable, it would be ranked in the Arca Book pursuant to PCXE Rule
7.36.
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\10\ See PCXE Rule 1.1(w) (definition of ``market
participant'').
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2. Discretionary Orders
Currently, a User can submit a Discretionary Order, which is an
order to buy or sell a stated amount of a security at a specified,
undisplayed price (the ``discretionary price''), as well as at a
specified, displayed price. The undisplayed prices of a Discretionary
Order are represented in the Working Order Process \11\ and can be
matched with orders on the other side of the market under prescribed
conditions. The Exchange proposes to adopt two new variations of the
Discretionary Order called a ``Passive Discretionary Order'' and a
``Discretion Limit Order.'' A summary of these proposed order types is
discussed below.
a. Passive Discretionary. The Exchange proposes to add PCXE Rule
7.31(h)(2)(A) to define a Passive Discretionary Order. A Discretionary
Order may be designated as a Passive Discretionary Order and such order
would be routed pursuant to PCXE Rule 7.37(d) only if the displayed
price is marketable against an away market participant. If the
discretionary price of a Passive Discretionary Order were marketable,
such order would only interact with trading interest in the ArcaEx Book
pursuant to PCXE Rule 7.37(b)(2) and would not be routed away. Under
the proposal, the Passive Discretionary order type will be available
for exchange-listed and Nasdaq securities. For Passive Discretionary
Orders in exchange-listed securities, if the discretionary price is
marketable, such order will only interact with trading interest in the
ArcaEx Book pursuant to PCXE Rule 7.37(b)(2) and will not be routed
away. A Passive Discretionary Order for ITS Trade-Through Exempt
Securities (as defined in PCXE Rule 7.37) will be permitted to trade at
a price no more than three cents ($0.03) away from the NBBO displayed
in the Consolidated Quote. For Passive Discretionary Orders in Nasdaq
securities, if the discretionary price can be matched against orders in
the ArcaEx Book, then such order will interact with trading interest in
the ArcaEx Book pursuant to 7.37(b)(2). The NBBO or better execution
guarantee set forth in PCXE Rule 7.37 will not apply to Passive
Discretionary Orders in Nasdaq securities. Instead, Passive
Discretionary Orders in Nasdaq securities would trade at no worse than
the ArcaEx BBO. \12\
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\11\ The Working Order Process is the third step in the ArcaEx
execution algorithm. Working Orders are defined to include any order
with a conditional or undisplayed price and/or size, including All-
or-None, Discretionary, and Reserve Orders. See PCXE Rule 7.37(b)(2)
(description of ``Working Order Process'').
\12\ See Amendment No. 2, supra note 4.
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In the event that a Passive Discretionary Order routed from ArcaEx
to another market participant is not executed in its entirety at the
other market participant's quote, ArcaEx would attempt to execute the
residual trading interest in the ArcaEx Book pursuant to PCXE Rule
7.37. Finally,
[[Page 12136]]
Passive Discretionary Orders that are not marketable would be ranked in
the ArcaEx Book pursuant to PCXE Rule 7.36.
b. Discretion Limit. The Exchange also proposes to add PCXE Rule
7.31(h)(2)(B) to define a Discretion Limit Order. A Discretionary Order
may be designated as a Discretion Limit Order for Nasdaq securities
only. If the discretionary price of a Discretion Limit Order could be
matched against trading interest in the ArcaEx Book, then such order
would be executed at the discretionary price or better against the
displayed share size of available trading interest in the ArcaEx Book,
regardless of size. If the discretionary price of a Discretion Limit
Order could be matched against an away market participant, then such
order would be routed pursuant to PCXE Rule 7.37(d) but only if the
displayed share size of the Discretion Limit Order is equal to or less
than the displayed share size of the away market participant. The NBBO
or better execution guarantee set forth in PCXE Rule 7.37 would not
apply to Discretion Limit Orders. Instead, Discretion Limit Orders,
which will only be available for the trading of Nasdaq Securities, will
not trade at a price inferior to the ArcaEx BBO. \13\
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\13\ See Amendment No. 2, supra note 4.
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3. Reserve Orders
Under current PCXE Rule 7.31(h)(3), a Reserve Order is a limit
order with a portion of the size displayed and with a reserve portion
of the size (``reserve size'') that is not displayed on the ArcaEx
Book. With this filing, the Exchange proposes to adopt two new
variations of the Reserve Order, a ``Sweep Reserve Order'' and a
``Random Reserve Order.'' These proposed order types would be ranked
and maintained in the Display Order Process \14\ and/or Working Order
Process of the ArcaEx Book according to price-time priority and would
be processed for internal matches in the same manner as standard
Reserve Orders pursuant to PCXE Rule 7.37(b)(2). The proposed rule
change regarding Sweep Reserve Orders should clarify how ArcaEx treats
such orders when routing to other market participants is required. In
the case of a Random Reserve Order, the proposed rule change would
allow a User to define the original display quantity and a random
reserve value in a share amount that would be used to determine the
displayed quantity within a defined range each time it is replenished.
These proposed order types are discussed separately below.
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\14\ The Display Order Process is the second step in the ArcaEx
execution algorithm. In this process, the ArcaEx system matches an
incoming marketable order against orders in the Display Order
Process at the display price of the resident order for the total
size available at the that price or for the size of the incoming
order. See PCXE Rule 7.37(b)(1) description of ``Display Order
Process'').
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a. Sweep Reserve Order. Under proposed PCXE Rule 7.31(h)(3)(A), a
Reserve Order may be designated as a Sweep Reserve Order. Based upon a
User's instruction, if the displayed price of a Sweep Reserve Order is
marketable against an away market participant(s), then such order will
be routed (i) serially as component orders, such that each component
corresponds to the displayed size, or (ii) only once in its entirety,
including both the displayed and reserve portions. The Exchange
believes that this rule change codifies current order routing
methodology, and believes that the proposed Sweep Reserve Order type is
clearly implied in current PCXE Rule 7.37(d)(2)(A)(ii).
b. Random Reserve Order. The Exchange proposes to add PCXE Rule
7.31(h)(3)(B) to define a Random Reserve Order. Under the rule
proposal, a User could determine a display and reserve quantity for a
Reserve Order. In addition, a User could also define a random reserve
delta (expressed in a share amount) to determine the number of shares
to display when the quote is refreshed from reserve.\15\ Users are
required to display at least 100 shares for all Reserve Orders
including Random Reserve Orders. If the User does not specify the
random reserve delta or the random reserve delta is set to zero, the
ArcaEx system would assign the displayed size of the Reserve Order to
vary to within 20% of the original specified displayed size. Should a
User enter a Random Reserve Order with a display amount of 500 shares
or less and a random reserve delta that is unspecified or set to zero,
the order would be handled as a regular Reserve Order. The ArcaEx
system would refresh the display quantity to the original displayed
size, and would not vary the display quantity.
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\15\ See Amendment No. 2, supra note 4.
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4. Pegged Orders
The Exchange proposes to modify the ArcaEx trading system to accept
Pegged Orders. A Pegged Order is a limit order to buy or sell a stated
amount of a security at a display price set to track the current bid or
ask of the NBBO in an amount specified by the User.\16\ The tracking of
the relevant Consolidated Quote information for Pegged Orders would
occur dynamically on a real-time basis. The associated price of each
Pegged Order that is updated would be assigned a new entry time with
priority in accordance with PCXE Rule 7.36(a). A Pegged Order may be
designated as a Reserve Order or Discretionary Order and would be
subject to the applicable order execution rules. The displayed price of
a Pegged Order designated as a Discretionary Order would track the
NBBO, and discretionary price of such order would re-price in
correlation to any changes to the displayed price.\17\ Finally, Pegged
Orders are only eligible during the Core Session.
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\16\ See proposed PCXE Rule 7.31(cc) (definition of ``Pegged
Order'').
\17\ See Amendment No. 2, supra note 4.
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B. Changes to PCXE Rule 7.37
The Exchange's current rules governing the order execution
processes for orders in the ArcaEx Book are set forth in PCXE Rule
7.37. Presently, PCXE Rule 7.37 provides, in part, that for an
execution to occur in any Order Process, the price must be equal to or
better than the NBBO. The requirements of this rule do not apply to
orders designated as IOC, NOW and PNP in certain exchange-traded funds
(``ETFs'') that are subject to the Commission's order granting a de
minimis exemption from the trade-through restrictions of the
Intermarket Trading System (``ITS'') Plan; provided, however, that any
resulting executions will be at a price no more than three cents
($0.03) away from the NBBO displayed in the Consolidated Quote.\18\ The
Exchange proposes that the requirements of PCXE Rule 7.37 would not
apply to existing order types (IOC, NOW and PNP orders) and proposed
new order types (Passive Discretionary, Discretion Limit, IOC Cross and
PNP Cross)\19\ in Nasdaq securities, provided however that such orders
in Nasdaq securities would not result in an execution at a price less
than the ArcaEx BBO.\20\
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\18\ See Securities Exchange Act Release No. 46428 (August 28,
2002), 67 FR 56607 (September 4, 2002) (Order Pursuant to Section
11A of the Act and Rule 11Aa3-2(f) thereunder Granting a De Minimis
Exemption for Transactions in Certain ETFs from the ITS Trade-
Through Provisions. See also Securities Exchange Act Release No.
46684 (October 17, 2002), 67 FR 65618 (October 25, 2002) (SR-PCX-
2002-69).
\19\ See Securities Exchange Act Release No. 47178 (January 13,
2003), 68 FR 3076 (January 22, 2003) (Order approving File No. SR-
PCX-2002-74). The Commission recently approved a separate proposed
rule change establishing IOC Cross and PNP Cross Orders.
\20\ See Amendment No. 2, supra note 4.
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C. Working Order Process
The Exchange proposes the following conforming changes to certain
provisions of the Working Order Process set forth in PCXE Rule
7.37(b)(2):
Under the proposal PCXE Rule 7.37(b)(2) will be amended to clarify
the
[[Page 12137]]
conditions in which a Passive Discretionary Order and Discretion Limit
Order would be routed to an away market participant's quote. Passive
Discretionary Orders would be routed away only if the displayed price
is marketable against an away market participant. Discretion Limit
Orders would be routed away only if the displayed share size of such
order is equal to or less than the displayed share size of the away
market participant.
Several pricing scenarios have been added to the Working Order
Process regarding incoming marketable orders that could be matched
against a Passive Discretionary Order. First, for Nasdaq securities, if
the ArcaEx BBO is outside the NBBO and a Passive Discretionary Order(s)
within the Working Order Process has a discretionary price worse than
the NBBO, then the incoming order would execute against such Passive
Discretionary Order(s) at the price of the incoming order or the
displayed price of the Discretionary Order(s), whichever is better.
Second, for Nasdaq securities, if the ArcaEx BBO is outside the NBBO
and a Passive Discretionary Order(s) within the Working Order Process
has a discretionary price equal to or better than the NBBO, then the
incoming order would execute against such Passive Discretionary
Order(s) pursuant to current PCXE Rule 7.37(b)(2)(A)(ii). Finally, for
ITS Trade-Through Exempt Securities (as defined in PCXE Rule 7.37), if
the ArcaEx BBO is outside the NBBO and a Passive Discretionary Order(s)
within the Working Order Process has a discretionary price worse than
the NBBO by three cents ($0.03) or less, the incoming order would
execute against such Passive Discretionary Order(s) at the price of the
incoming order or the displayed price of the Discretionary Orders(s),
whichever is better.
D. Technical Changes
The Exchange has proposed to adopt several minor technical changes
throughout PCXE Rules 1.1 and 7.18 to conform to the Nasdaq UTP Plan,
which extends UTP to Nasdaq SmallCap securities. Accordingly, the
Exchange is proposing to delete references to the term ``Nasdaq/NM
Security'' and replacing it with ``Nasdaq Security.'' In addition,
several definitions contained in PCXE Rule 1.1 are being amended to
reflect the change in name of the Nasdaq UTP Plan. Finally, current
PCXE Rule 1.1(jj), which defines the term ``OTC/UTP Primary Market,''
is being amended to reflect that the Listing Market, rather than the
Primary Market, would have the authority to call a Regulatory Halt
pursuant to PCXE Rule 7.18(c). A definition of ``OTC/UTP Listing
Market'' is being adopted from the Nasdaq UTP Plan.\21\
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\21\ See supra note 6.
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III. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2, including whether Amendment No. 2
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 Amendment No. 2 of File No. SR-PCX-2002-75
and should be submitted by April 3, 2003.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
After careful review, the Commission finds, for the reasons
discussed below, that the proposal is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to the
PCX.\22\ The Commission finds that the proposed rule change is
consistent requirements of section 6(b)(5) of the Act \23\ and the
objectives of section 11A(a)(2) of the Act.\24\ Section 6(b)(5)
requires, among other things, that the rules of a national securities
exchange be designed to facilitate transactions in securities and to
remove impediments to and perfect the mechanism of a free and open
market and a national market system. Section 11A(a)(2) of the Act
authorizes the Commission to establish a national market system for
securities, which should include the establishment of new data
processing and communications techniques.\25\
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\22\ In approving this rule, the Commission notes that it has
considered the proposal's impact on efficiency, competition, and
capital formation. See 15 U.S.C. 78c(f).
\23\ 15 U.S.C. 78f(b)(5).
\24\ 15 U.S.C. 78k-1(a)(2).
\25\ 15 U.S.C. 78k-1(a)(2).
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In proposing to establish new order types on ArcaEx, PCX seeks to
provide market participants with more choices that will permit a more
accurate representation of their trading interest on its electronic
auction trading facility. In the Commission's view, the proposed order
types could provide a new and advanced way for sophisticated trading
interests and strategies to be represented and executed on ArcaEx.
Further, the Commission believes that by amending the rules to include
pricing and execution scenarios for the new order types in the Working
Order Process the proposed rule change should assist Users in
effectuating such trading interests and strategies. The Commission
believes that the implementation of the new order types may enhance the
ability of investors to represent their trading interest more
completely than is currently possible on ArcaEx. In addition, the new
order types may facilitate enhanced order interaction and foster price
competition. The depth and liquidity of the market on ArcaEx could
increase as a result of the enhanced interest and competition on
ArcaEx. The Commission believes that, such order types could assist
ArcaEx in attracting new market participants and to increase order flow
to the PCXE, which in turn could promote greater competition among
market centers.
Pursuant to PCXE Rule 7.37 quotes and orders on the ArcaEx, except
those in ITS Trade-Through Exempt Securities, must be executed at a
price equal to or better than the NBBO, unless ArcaEx has routed the
order to an away market at the NBBO. Under the proposal, executions in
IOC, NOW, PNP, Passive Discretionary, Discretion Limit, IOC Cross, and
PNP Cross orders for Nasdaq securities would also be included in the
ArcaEx exception to the PCXE Rule 7.37 price protection provision.
Specifically, executions in such orders in Nasdaq securities could be
effected at a price no worse than the ArcaEx BBO. The Commission notes
that currently there is no trade-through prohibition for Nasdaq
securities because the Nasdaq UTP Plan does not provide for intermarket
linkages between its participants like the listed securities
market.\26\ The Commission believes that without the presence of an
intermarket linkage for Nasdaq UTP Plan participants it would be
impracticable for PCXE to attempt to provide intermarket price
protection for the above-mentioned orders in Nasdaq securities.
Nonetheless, the Commission emphasizes that this approval order does
not diminish investor protections, and that such orders in Nasdaq
[[Page 12138]]
securities on ArcaEx are still subject to a broker's duty of best
execution for its customer.
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\26\ See supra note 6.
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The Commission finds good cause for approving Amendment No. 2 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register. In
Amendment No. 2, the Exchange made various clarifying and technical
amendments to the proposed rule text to: (1) Reference the ``Joint
Self-Regulatory Organization Plan Governing the Collection,
Consolidation and Dissemination of Quotation and Transaction
Information for Nasdaq-Listed Securities Traded on Exchanges'' in
proposed PCXE Rule 1.1(aa), (2) clarify that the term ``OTC/UTP Listing
Market'' shall have a meaning consistent with the Nasdaq Unlisted
Trading Privileges Plan, (3) clarify the definition of ``Sweep Reserve
Order'' by replacing the word ``price'' with the word ``size,'' (4)
clarify the definition of ``Random Reserve Order'' by indicating that
the random reserve value is expressed in share amounts and by
correcting a grammatical error, (5) amend the definition of ``Pegged
Order'' to reflect that the display price will track the relevant
Consolidated Quote information for such orders on a real-time basis and
that the displayed price of a Pegged Order designated as a
Discretionary Order will track the NBBO, and that the discretionary
price of such order would re-price in correlation to any change in the
displayed price, and (6) clarify that IOC, NOW, PNP, Passive
Discretionary, Discretion Limit, IOC Cross and PNP Cross orders in
Nasdaq securities will received executions at a price no worse than the
ArcaEx BBO. Because Amendment No. 2 is of a technical, clarifying, non-
substantive nature, and does not raise any novel regulatory issues or
issues that were not considered by the Commission prior to its
submission, the Commission finds good cause for accelerating approval
of the proposed rule change, as amended by Amendment No. 2.
V. Conclusion
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\27\ that the proposed rule change, (File No. SR-PCX-2002-75) as
amended, be, and it hereby is approved.
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\27\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\28\
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\28\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-6072 Filed 3-12-03; 8:45 am]
BILLING CODE 8010-01-P