Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Philadelphia Stock Exchange, Inc. Regarding Trading the Quote Spread on PACE

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34259; File No. SR-Phlx-92-09]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the Philadelphia Stock Exchange, Inc. Regarding Trading the

Quote Spread on PACE

June 27, 1994.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on April

10, 1992, the Philadelphia Stock Exchange, Inc. (``Phlx'' or

``Exchange'') filed with the Securities and Exchange Commission

(``Commission'') the proposed rule change as described in Items I, II

and III below, which Items have been prepared by the self-regulatory

organization. On April 14, 1994, the Phlx submitted Amendment No. 1 to

the proposal.\1\ On June 6, 1994, the Phlx submitted Amendment No. 2 to

the proposal.\2\ The Commission is publishing this notice to solicit

comments on the proposed rule change from interested persons.

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\1\See letter from Gerald D. O'Connell, Vice President, Market

Surveillance, Phlx, to Sharon Lawson, Assistant Director, Division

of Market Regulation, Commission, dated April 14, 1994. The Phlx

amended the language of the rule to clarify what level of activity

will constitute a violation of the rule. Specifically, the Exchange

proposes that three occurrences within one month will constitute

such a violation.

\2\In Amendment No. 2 the Exchange (a) clarified that the three

occurrences referred to in the proposed commentary are meant to be

in the same stock, and (b) changed the word ``may'' to ``will''

constitute a violation. See letter from Gerald D. O'Connell, Vice

President, Phlx, to Sharon Lawson, Assistant Director, Commission,

dated June 1, 1994.

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

of the Proposed Rule Change

The Phlx, pursuant to Rule 19b-4 of the Act, proposes to adopt

Commentary .18 to Phlx Rule 229\3\ to prohibit the use of the

Philadelphia Stock Exchange Automated Communication and Execution

System (``PACE'') volume execution guarantees with offsetting orders in

low-volatility, high volume stocks in order to ``trade the quote

spread.'' Specifically, Commentary .18 would read as follows:

\3\PACE is the Phlx's small order entry and execution system and

Rule 229 details the execution guarantees due a PACE order. See

Philadelphia Stock Exchange Rules, Rule 229.

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Any established pattern of trading via PACE generating short-

term trading profits by unjustly exploiting PACE volume execution

guarantees is prohibited. Specifically, it is deemed an unjust use

of PACE to place an order to buy at the primary market's bid price

and simultaneously or shortly thereafter place an order to sell for

a related account at the primary market's offer price, or vice-

versa, with the intent to capitalize on the expectation that

transactions on the primary market at the respective limit prices

will elect the limit orders on the Phlx requiring their execution

and thus generate a short-term trading profit without the need for a

change in the quoted price of the issue on the primary market. Three

such occurrences in the same security within a one-month period will

constitute an established pattern in violation of this provision.

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 self-regulatory organization

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 self-regulatory organization

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

PACE is the Exchange's automated order routing, delivery and

execution system for equity's securities. Pursuant to Phlx Rule 229,

customer orders entered through PACE are entitled to certain execution

guarantees.\4\ The Phlx proposes to adopt Commentary .18 to Phlx Rule

229 to address the practice of customers using PACE volume execution

guarantees with offsetting limit orders in low-volatility, high-volume

stocks in order to ``trade the quote spread.''

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\4\See Phlx Rule 229, Commentary .10.

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Specifically, this practice is encountered when orders are placed

through PACE to buy on the bid and sell on the offer, with the

expectation that each of the orders will be executed when the required

volume trades on the primary market. As a result, a profit may be

realized on the quote spread without any quote change in the stock.

There are currently many Exchange-traded stocks with low-

volatility, high-volume trading characteristics. The bid-ask spread for

these stocks is often narrow and static. Because of PACE volume

guarantees, limit orders to buy less than 600 shares of those stocks at

a price equal to the primary market's bid as well as to sell at a price

equal to the primary market's offer can often receive automatic

executions on the Exchange.\5\

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\5\See Phlx Rule 229, Commentary .10.

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Specifically, these smaller-sized orders are executed when 1,000

shares or more of that security trade on the primary market at the

order's limit price. In this regard, proposed Commentary .18 is

designed to address the practice of customers ``trading the quote

spread'' by depending on the aforementioned PACE volume execution

guarantees to generate short term trading profits by using offsetting

limit orders in low-volatility, high-volume stocks.

For example, an order may be placed through PACE to buy on the bid

while another order in that stock for the same or related account is

sent through PACE to sell the same number of shares on the offer. The

expectation is that each of the orders will be executed at their

respective limit prices when the required volume trades on the primary

market. When both orders are filled due to volume guarantees, a profit

is locked-in, equal to the amount of shares multiplied by the spread

between the bid and offer less commissions. This profit can occur

within minutes after the orders are placed and without any quote change

in the stock. Utilizing PACE to trade the quote spread in this manner

disadvantages other market participants, including other PACE orders on

the Phlx book, and serves to create an erroneous impression as to the

level of bona fide investment activity in the subject stocks.

The Exchange notes that this practice is exploitative of the PACE

volume execution guarantees and is unfair to both the specialist and to

the other PACE orders on the specialist book.

2. Statutory Basis

The proposed rule change is consistent with Section 6 of the Act,

in general, and Section 6(b)(5) in particular, in that it is designed

to prevent manipulative acts and practices and to prevent

discrimination between customers, issuers, and brokers.

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

The Phlx does not believe that the proposed rule change will impose

any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received from Members, Participants or Others

The Phlx has neither solicited nor received written comments on the

proposed rule change.

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

Commission Action

Within 35 days of the 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 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. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.

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 at the

Commission's Public Reference Section, 450 Fifth Street, NW.,

Washington, DC 20549. Copies of such filing will also be available for

inspection and copying at the principal office of the Phlx. All

submissions should refer to File No. SR-Phlx-92-09 and should be

submitted by July 22, 1994.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.

Jonathan G. Katz,

Secretary.

[FR Doc. 94-16039 Filed 6-30-94; 8:45 am]

BILLING CODE 8010-01-M