Self-Regulatory Organizations; Notice of Filing and Partial Accelerated Approval of a Proposed Rule Change by the American Stock Exchange, Inc. Relating to the Definition of Public Customer Orders and Requirements That Specialists Fill Incoming Orders or Update Existing Markets

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34431; File No. SR-Amex-93-23]

Self-Regulatory Organizations; Notice of Filing and Partial

Accelerated Approval of a Proposed Rule Change by the American Stock

Exchange, Inc. Relating to the Definition of Public Customer Orders and

Requirements That Specialists Fill Incoming Orders or Update Existing

Markets

July 22, 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 July 25,

1993, the American Stock Exchange (``Amex'' or ``Exchange'') filed with

the Securities and Exchange Commission (``Commission'') the proposed

rule change as described in Items I and II below, which Items have been

prepared by the self-regulatory organization. The Commission is

publishing this notice to solicit comments from interested persons and

is simultaneously granting partial accelerated approval to the portion

of the rule change relating to requirements that Specialists fill

incoming orders or update existing markets.

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

of the Proposed Rule Change

The Amex proposes to amend Amex Rule 958A to (i) clarify the

definition of ``public customer order'' and (ii) incorporate a

requirement that Amex specialists respond to orders, at the currently

disseminated bid or offer, either by satisfying the order or updating

the existing market in the subject series.

The text of the proposal is available at the Office of the

Secretary, Amex, and at the Commission.

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 Items 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

The Exchange states that the purpose of the proposed rule change is

to (i) clarify the definition of what is a ``public customer order'' in

options for purposes of Exchange Rule 958A (the ``Rule''), (ii) give

the Exchange the ability to determine the option series which are

subject to the rule, (iii) provide for appropriate order marking

procedures for such orders and (iv) incorporate a ``trade or fade''

requirement for Specialists applicable to multiply-traded options.

First, the proposed rule change clarifies the definition of what is

a ``public customer order.'' The Exchange states that options

specialists are required by Amex Rule 958A to guarantee execution of

customer orders for at lest 10 contracts at a single price. The Rule

mandates that such specialists are required to buy (sell) at least 10

contracts at the bid (offer) price disseminated on the display screen a

the time the order reaches the specialist's post. This is frequently

referred to as the ``firm quote'' or ``ten up'' rule. Holding

specialists to a firm quote requirement ensures that they will

continually update options market quotations on a timely basis and

execute customer orders at such quoted markets.

The Exchange states that while specialists are willing to ensure

``ten up'' single price executions at displayed market quotes for

``true'' off-floor public customers, they are understandably reluctant

to do so for off-floor professionals. The Exchange believes that the

term ``non-broker dealer customer orders'' as presently used in

paragraph (b) of the Rule has proven to be vague and imprecise,

creating uncertainty as to whether a particular order is entitled to

the guarantee.

Accordingly, the Exchange proposes to amend paragraph (b) of the

Rule to use the term ``public customer order'' and to define such term.

Under the amendment, a ``public customer order'' would be entitled to

receive the ten-up guarantee. The proposal defines a ``public customer

order'' as an order which is not for a ``professional trading

account.'' The proposal further defines a ``professional trading

account'' as: (1) An account of a registered broker-dealer; or (2) an

account of a person engaged in business or employed as a professional

trader in securities; or (3) an account of a person whose orders are

computer generated and automatically transmitted to the Exchange via

Auto-Ex, the Exchange's automatic execution system; or (4) an account

of a person who has been determined by the Exchange to have engaged in

a pattern of trading that has previously been determined to have the

effect of abusing the purposes of the Auto-Ex system. Lastly, any

account in which any person referred to in clauses (1) through (4) of

the preceding sentence is a participant, has an interest or exercises

investment control shall be deemed to be an account of such person. The

Exchange believes that this proposed definition will serve to identify

those persons originally intended to receive the benefits of the ten-up

rule.

With respect to orders entered by registered representatives for

their own accounts, paragraph (c) of the proposed rule considers such

orders to be ``public customer order'' (thereby entitled to ``ten-up''

treatment), provided the representative's account does not fall within

the purview of the definition of ``professional trading account.''

Further, the proposed rule seeks to prohibit persons engaged in a

``pattern of trading'' from using the Exchange's Auto-Ex system to

profit from the inability of the Specialists to post quoted markets in

response to market movement. In determining what constitutes a

``pattern'' or abuse of the system, the Exchange would consider, among

other things, the frequency of transactions in an account; whether the

account has direct access to the Exchange's electronic order entry,

delivery and execution systems; and whether participants in the account

have access to non-public market information. Additionally, since the

Auto-Ex system was designed for small orders (currently equity option

orders of ten contracts or less), persons entering a number of small

orders for the same series within a relatively short period of time

could be deemed to be abusing the system.

The Exchange believes that these changes will address Specialists'

needs to have sufficient time within which to adjust quotes to reflect

changes in the markets underlying their options. The Exchange further

believes that this proposal will also provide all market makers

(Specialists and non-Specialists alike) who participate in the Auto-Ex

system with legitimate relief in situations where other professionals

from ``off floor'' seek to profit by placing their orders through Auto-

Ex before Specialists can update their quotes.

Second, the proposed rule change provides that Exchange Rule

958A(a) will apply to options series that are determined from time to

time at the discretion of the Exchange. Currently, Amex rule 958A(a)

provides that the ten-up guarantee applies to options series in the two

nearest-term expiration months. The Exchange represents that while

member firms have asked that such guarantees be expanded beyond near-

term expiration series, as a practical matter, on a voluntary basis,

Exchange Specialists in many cases do guarantee ten-up markets in the

two further-term months. Accordingly, the Exchange believes that in

order for it to have the needed flexibility to determine from time to

time which option series are to be subject to the Rule, the proposed

amendments to paragraph (a) are needed.

Third, the proposed rule change adds a new Commentary .01 to Rule

958A that provides that all orders subject to the Rule be marked in

accordance with procedures established by the Exchange. The Exchange

believes that this new Community will assist the Exchange in conducting

surveillance for violations of the Rule.

Fourth, the proposed rule change adds a new Commentary .03 to Amex

Rule 958A that provides:

With respect to broker-dealer order to buy (sell) at the

displayed offer (bid), or portions of customer orders that are not

entitled to an execution pursuant to the provisions of paragraph (a)

[the ten-up rule], the specialist is required to either (1) sell

(buy) the number of contracts specified in the order, or (2) change

the displayed offer (bid) to reflect that such displayed offer (bid)

is no longer available.\1\ In such an instance, where a displayed

offer (bid) is revised, it shall be considered conduct inconsistent

with just and equitable principles of trade for the specialist to

immediately re-display the previously disseminated offer (bid),

unless such action is warranted by a change in market conditions.

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\1\The Commission understands the provision to allow an

exchange, upon receipt of a market or marketable limit order, to

execute less than the total number of contracts contained in the

order, but the exchange then becomes obligated to update its

quotation if it is not willing to transact with any more of the

order at the same price. For example, if as a result of displaying a

more competitive offer, an exchange is sent an order to buy 50

contracts that was originally received by another exchange, it may

buy fewer than 50 contracts at its quoted price, but must then

revise its quotation to reflect that the price is no longer

available.

The Exchange states that Rule 19c-5 under the Act effectively

permitted multiple listing of all options selected for trading on or

after January 22, 1990. With respect to options on exchange-listed

stocks that began trading on one of the five option exchanges prior to

January 22, 1990 (``grandfathered options''), the Commission and the

options exchanges have been working to ``achieve the orderly

expansion'' of multiple trading to those options.\2\ The Exchange

states that an integral part of the expansion of multiple trading to

the grandfathered options is the adoption of joint-exchange procedures

to identify and minimize potential customer ``trade-throughs'' in

multiple traded options. A trade-through is an order executed on an

exchange at a price which appears to be inferior to a price displayed

at another exchange. Thus, a trade-through occurs when an order appears

to have ``traded through'' the better displayed price.

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\2\The Amex states that proposed Commentary .03 is in response

to a letter from Chairman Breeden to James R. Jones, Chairman, Amex,

dated June 30, 1992.

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In order to minimize the possibility of trade-throughs, the Amex

states that it is currently modifying the procedures and automated

systems to detect the existence of apparently better markets in

multiply-traded options. Further, to immediately address member firm

concerns about trade-throughs, the Exchange represents that its

specialists have agreed to guarantee best execution of customer orders

by either (i) matching the best bid (offer) quoted on another exchange,

or (ii) going to such other exchange, executing the trade (as

principal) at the better price and then filling the customer order at

that better price.

The Exchange states that to assure that a competing exchange's

disseminated price is in fact the best price at which a trade can be

effected, the options exchanges have discussed the need to develop a

``trade or fade'' rule. Such a rule requires that any exchange

displaying the best quoted market, upon receipt of an order, either

``trade'' at the displayed price of ``fade'' (withdraw) that price. For

example, if an Amex specialist in an option multiply listed at another

exchange is offering to sell at 2\3/4\ when a 2\1/4\ offer is being

displayed by such other exchange, the Amex specialist can either change

his offer to meet the better (2\1/4\) price or attempt to buy the

options at the other exchange for 2\1/4\ (before selling it to the

customer at that price). If however, the Amex specialist in attempting

to buy the option(s) at the other exchange finds that the competing

market maker/specialists is unwilling to trade at (honor) his displayed

price, then such market maker/specialist must fade (withdraw) the price

to reflect an offer of 2\3/8\ or higher. Thus, the Exchange believes

that incorporating a trade or fade requirement into Amex Rule 958A will

further ensure that options customers will receive the best executions

for the orders.

The Exchange believes that the proposed rule change is consistent

with Section 6(b) of the Act, in general, and Section 6(b)(5) in

particular, in that it is designed to remove impediments to and perfect

the mechanism of a free and open market and a national market system.

(B) Self-Regulatory Organization's Statement on Burden on Competition

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

a burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act. With respect to the portion of

the proposed rule change clarifying the definition of ``public customer

order,'' only ``professional trading accounts'' would be affected by

the amendments and the Amex believes that any incidental burden on such

accounts is justified by the more than countervailing benefits to

public customers and others that would result from the adoption of

these amendments.

(C) Self-Regulatory Organization's Statement on Comments on the

Proposed Rule Change Received From Members, Participants, or Others

Written comments on the proposed rulechange were neither solicited

nor received.

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

Commission Action

The Amex has requested that the current proposal be given

accelerated effectiveness. For the reasons set forth below, the

Commission has determined to give the portions of the proposed rule

change dealing solely with the addition of Commentary .03 to Amex Rule

958A, which will require specialists to trade at a disseminated quote

or update their markets, accelerated effectiveness prusuant to Section

19(b)(2) of the Act.

The Commission finds that the portions of the proposed rule change

relating to the requirement that specialists trade at a disseminated

quote or update their markets is consistent with the requirements of

the Act and the rules and regulations thereunder applicable to a

national securities exchange and, in particular, the requirements of

Section 6(c)(5).\3\ Specifically, the Commission finds that requiring

Amex specialists to execute orders or update their markets facilitates

transactions in securities, protects investors and the public interest,

and promotes fair competition among options markets by reducing the

likelihood that an outdated quote from one options market will hinder

the execution of an order on another options market by making such

execution appear to be at an inferior price (i.e., a ``trade-

through'').

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\3\15 U.S.C. 78f(b)(5) (1988).

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Currently, in light of the expansion in the multiple trading of

options, the options exchanges have either implemented or are working

to implement systems upgrades which will prevent orders that are

identified as potential ``trade-throughs'' from being automatically

executed and will re-route these orders to the appropriate market maker

or specialist for non-automated execution. Further, to attract order

flow, many market makers and specialists from the different options

exchanges have represented to their customers that they will execute

the orders they receive at the best price available at any of the five

options exchanges. The current proposal, therefore, will, consistent

with Section 6(b)(5) of the Act, facilitate options transactions by

encouraging Amex specialists to keep their markets up-to-date. This, in

turn, should reduce the likelihood that outdated quotes will cause

orders on other exchanges, that could be automatically executed, to be

rerouted for non-automated handling. It also should reduce the

likelihood that outdated quotes will cause orders executed on other

exchanges at current market prices to appear to be executed at inferior

prices. The commission further notes that, concurrently with approval

of this proposal, it is approving similar proposals by the Pacific

Stock Exchange, Inc. (``PSE''), the Philadelphia Stock Exchange, Inc.

(``PHLX''), the New York Stock Exchange (``NYSE'') and the Chicago

Board Options Exchange, Inc. (``CBOE'').\4\

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\4\See Securities Exchange Act Release No. 34435, 34434, 34433,

and 34432, (July 22, 1994), respectively.

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The Commission finds good cause for approving the above-noted

portions of the proposed rule change prior to the thirtieth day after

the date of publication of notice of filing thereof in the Federal

Register. The Amex proposal to require specialists to trade at a

disseminated quote or update their markets is substantially similar to

proposals by PSE, PHLX, NYSE and the CBOE. The PSE, PHLX and the CBOE

proposals were subject to a full notice and comment period and no

comments were received.\5\ Accordingly, since the Commission finds that

no new issues are raised by the current proposal, the Commission

believes it is consistent with Sections 19(b)(2) and 6(b)(5) of the

Act\6\ to approve the Amex's proposal to permit the Amex to implement

its trade or fade requirements at the same time as these requirements

are implemented by the other options exchanges.

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\5\See Securities Exchange Act Release Nos. 31962 (March 8,

1993), 58 FR 13661 (March 12, 1993), 34158 (June 3, 1994), 59 FR

30074 (June 10, 1994), and 32406 (June 3, 1993), 58 FR 32404 (June

9, 1993), respectively.

\6\15 U.S.C. 78s(b)(2) and 78f(b)(5) (1988).

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With respect to the other portions of the proposed rule change, the

Commission, 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 find such longer period

to be appropriate and publishes its reasons for so finding or (ii) as

to which the self-regulatory organization consents, 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. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 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 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

above-mentioned self-regulatory organization. All submissions should

refer to the file number in the caption above and should be submitted

by August 22, 1994.

It is therefore ordered, pursuant to Section 19(b)(2) of the

Act,\7\ that the portion of the proposed rule change (SR-Amex-93-23)

relating to the addition of Commentary .03 to Amex Rule 958A is

approved.

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\7\15 U.S.C. 78s(b) (1988).

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\8\

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\8\17 CFR 200.30-3(a)(12) (1993).

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Margart H. McFarland,

Deputy Secretary.

[FR Doc. 94-18583 Filed 7-29-94; 8:45 am]

BILLING CODE 8010-01-M