Self-Regulatory Organizations; Pacific Stock Exchange, Inc.; Order Approving Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval to Amendments No. 1 and No. 2 to Proposed Rule Change Relating to Method for Execution of Cross Transactions

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33391; File No. SR-PSE-91-11]

Self-Regulatory Organizations; Pacific Stock Exchange, Inc.;

Order Approving Proposed Rule Change and Notice of Filing and Order

Granting Accelerated Approval to Amendments No. 1 and No. 2 to Proposed

Rule Change Relating to Method for Execution of Cross Transactions

December 28, 1993.

I. Introduction

On August 26, 1991, the Pacific Stock Exchange, Inc. (``PSE'' or

``Exchange'') submitted to the Securities and Exchange Commission

(``SEC'' or ``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 relating to the method for the

execution of cross transactions on the PSE. On June 7, 1993, the PSE

submitted Amendment No. 1 to the proposed rule change in order to

clarify certain terms used in the original filing.\3\ On August 18,

1993, the PSE submitted Amendment No. 2 to the proposed rule change in

order to clarify its interpretation of certain provisions regarding

specialist participation in cross transactions.\4\

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\1\15 U.S.C. 78s(b)(1) (1988).

\2\17 CFR 240.19b-4 (1991).

\3\See letter from Kenneth, J. Marcus, Director, Equity

Surveillance/Compliance, PSE, to Diana Luka-Hopson, Branch Chief,

Division of Market Regulation, SEC, dated June 3, 1993 (``Amendment

No. 1'').

\4\See letter from Kenneth J. Marcus, Director, Equity

Surveillance/Compliance, PSE, to Beth Stekler, Attorney, Division of

Market Regulation, SEC, dated August 9, 1993 (``Amendment No. 2'').

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The proposed rule change was published for comment in Securities

Exchange Act Release No. 29712 (September 20, 1991), 56 FR 49217

(September 27, 1991). No comments were received on the proposal. This

order approves the proposed rule change, including both amendments on

an accelerated basis.

II. Description of the Proposal

Exchange Rule 5.14(b) outlines the traditional method for the

execution of cross transactions on the PSE.\5\ Under that rule, a

member effecting a cross transaction must first assure that all

existing bids or offers by the specialists, in the books or at the

posts, at or better than the cross price, are filled at their

limits.\6\ Thereafter the member must publicly announce both sides of

the cross; the member's offer must be higher than his or her bid by the

minimum trading differential permitted for that security.\7\ Rule

5.14(b) then allows the member to execute the cross transaction at his

or her bid or offer. Under this method, however, another member can

``break up'' the cross by trading with either the bid or the offer side

of the transaction when it is presented to the crowd.

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\5\In a cross transaction, a member who holds an order to buy

and an order to sell an equivalent amount of the same security

wishes to execute the orders against each other. See PSE Rule

5.14(a). Because he or she already holds both sides of the trade,

the member does not want the orders to interact with other market

interest.

\6\As a general matter, the bid/offer entered at the best price

(i.e., the highest bid or the lowest offer) is entitled to priority

over bids/offers at inferior prices; similarly, the first bid/offer

clearly established at a given price is entitled to priority over

other bids/offers at that same price. See PSE Rule 5.8(c).

\7\PSE Rule 5.3(b) sets forth the minimum trading differential

for securities listed on the PSE.

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The Exchange proposes to formalize several policies that its Equity

Floor Trading Committee previously developed to encourage the execution

of cross transactions on the PSE. Specifically, the proposed commentary

to Rule 5.14(b) will codify the PSE's policy that all efforts should be

made to facilitate the execution of crosses; and will clarify which

orders a member must satisfy before he or she can execute such a

transaction.\8\ The proposed commentary also will interpret Rule

5.14(b), together with the PSE's priority rule,\9\ to prohibit the

specialist from participating in a cross to establish or increase his

or her position,\10\ unless the member effecting the transactions gives

the specialist permission to do so.

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\8\Among other things, see supra note 6 and accompanying text, a

member effecting a cross first must satisfy the interest the

specialist ``publicly displayed and verbally stated'' at the time of

the cross.

\9\See PSE Rule 5.8(e). Under this rule, an order originated on

the floor to establish or increase a proprietary position must yield

to any order originated off the floor.

\10\According to the PSE, this policy initially was established

on May 2, 1984. In conjunction with this filing, the Exchange has

clarified that the specialist will be able to participate in a cross

transaction in order to decrease his or her position. See Amendment

No. 1, supra, note 3. Under those circumstances, the specialist's

participation will be subject to the additional restrictions

discussed below. See infra, notes 11-13 and accompanying text.

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In addition, the Exchange proposes to place additional restrictions

on when a specialist can break up a cross transaction.\11\Thus under

the proposed commentary to Rule 5.14(b), the specialist will be

prohibited from participating, for the benefit of his or her own

account, on (1) either side of a customer-to-customer cross,\12\or (2)

the customer side of a cross with the principal account of a member,

where the cross is at a price inside the disseminated PSE market. The

PSE, however, will interpret this provision to allow a specialist who

is willing to better the price to participate in a cross

transaction.\13\Finally, for purposes of Rule 5.14(b), the Exchange

will define a ``customer order'' as an order that a broker represents

in an agency capacity, including a professional order that is not for

an account associated with the executing broker.

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\11\As discussed below, see infra, notes 16-17, the proposed

restrictions are based on recent amendments to Philadelphia Stock

Exchange (``Phlx'') Rule 126.

\12\This restriction will apply whether the customer orders are

represented by the same broker or ``by separate agents,'' as defined

in Amendment No. 1, supra, note 3.

\13\See Amendment No. 2, supra, note 4.

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The PSE believes that the proposed rule change maintains the

auction at market principles of price improvement and priority to

existing orders, while at the same facilitating the execution of

crosses on the PSE. In addition, the PSE believes that the proposed

rule change is consistent with policies recently adopted by other

exchanges.\14\ The PSE states that the proposed rule change is

consistent with Section 6(b)(5) of the Act in that these changes will

promote just and equitable principles of trade and will protect

investors and the public interest by continuing the effort to remove

impediments to a free and open market.

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\14\See infra, note 16.

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III. Discussion

The Commission finds that the proposed rule change is consistent

with the requirements of the Act and the rules and regulations

thereunder applicable to a national securities exchange, and, in

particular, with the requirements of sections 6(b) and 11(a).\15\In

particular, the Commission believes that the proposed rule change is

consistent with the Section 6(b)(5) requirement that the rules of an

exchange be designed to promote just and equitable principles of trade,

to prevent fraudulent and manipulative acts and, in general, to protect

investors and the public interest; and with the section 6(b)(8)

requirement that the rules of an exchange not impose any unnecessary

burden on competition. The Commission also believes that the proposed

rule change does not operate in a manner inconsistent with the

traditional auction market principle of customer priority, as embodied

in section 11(a) of the Act.

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

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After careful review, the Commission has concluded that the

proposed rule change should further competition among the exchanges, as

well as between exchanges and other markets, and should increase the

opportunities for the efficient execution of cross transactions. In the

past, the Commission has recognized the competition that exists between

various markets for order flow, and especially for block business.

Several exchanges recently have sought Commission approval to amend

their rules, on the grounds that exchange rules may hinder members'

ability to execute a cross transaction without interference and thus

may place an exchange at a competitive disadvantage. Despite serious

reservations, the Commission has approved those proposals which are

consistent with traditional auction market principles.\16\

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\16\See, e.g., Securities Exchange Act Release Nos. 27205

(August 31, 1989), 54 FR 37180 (September 7, 1989) (File No. SR-

Phlx-89-17) (approving Phlx proposal to prohibit members from

interfering, with either side of an agency cross or the customer

side of a facilitation cross, by buying or selling for their own

account at the cross price; except that a specialist can participate

to the extent of a publicly disseminated bid or offer at that

price); and 31343 (October 21, 1992), 57 FR 48645 (October 27, 1992)

(File No. SR-NYSE-90-39) (approving New York Stock Exchange

(``NYSE'') ``clean cross'' proposal to allow members to execute

agency crosses of 25,000 shares or more, at a price at or within the

prevailing quotation, without interference, irrespective of any pre-

existing bids or offers at the cross price; however, the cross could

be broken up at a better price).

Several other proposals to facilitate the execution of crosses

on a given exchange are pending with the Commission, including File

Nos. SR-Amex-92-41 (American Stock Exchange ``clean cross''

proposal) and SR-MSE-93-05 (Chicago Stock Exchange proposal to

encourage specialists to refrain from interfering in cross

transactions).

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In response to today's competitive market environment, the PSE has

proposed to codify its policy that members should make their best

efforts not to interfere in another member's cross transaction and, in

particular, that the specialist should not participate unless he or she

is liquidating a position. The PSE also has proposed to add a new

requirement, based on a comparable rule on the Phlx, that the

specialist's proprietary bid or offer yield to the customer side of a

cross transaction at the cross price.\17\ Looking at the proposal as

whole, the Commission believes that it will clarify the roles of

various market participants and assure that, under routine

circumstances, crosses are executed in a fair and orderly manner. In

sum, the Commission finds that this proposed rule change should improve

the PSE's ability to compete for block business and should enhance the

depth and liquidity of the Exchange market.\18\

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\17\As noted above, this part of the PSE proposal is based on

recent amendments to Phlx Rule 126. See supra, note 16. Briefly, the

Phlx requires that a member's proprietary bid or offer yield to the

customer side of a cross transaction at the cross price. In

approving the Phlx proposal, the Commission took note of the fact

that most principal trading activity on the floor of that regional

stock exchange, other than facilitation crosses, is undertaken by

the specialist.

\18\The Commission appreciates all the exchanges' competitive

concerns with respect to the facilitation of cross transactions and,

at the same time, continues to emphasize the importance of adherence

with traditional auction market principles.

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In terms of auction market principles, the Commission believes that

the proposed rule change strikes an appropriate balance between the

competing needs of various customer orders represented for execution on

the PSE and the proprietary trading operations of Exchange members and

member organizations, including specialists. The Commission notes that

Rule 5.14(b) will continue to require that a member effecting a cross

transaction first assure that all existing bids or offers on the

specialist's book or represented in the trading crowd, at or better

than the cross price, are filled at their limits.\19\ On that basis,

the Commission has concluded that the PSE proposal adheres to the

auction market principles of time and price priority and that this

method for the execution of crosses (and, in particular, the priority

granted to the customer side of the transaction) will not disadvantage

existing orders.\20\ In fact, limit orders on the PSE which coincide

with the cross price could benefit from being assured of receiving an

execution at that price.

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\19\See supra, note 6.

\20\In this regard, the PSE proposal contrasts favorably with

other rule changes approved by the Commission, such as the NYSE's

clean cross proposal, see supra note 16.

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Furthermore, the Commission finds that the PSE proposal does not

restrict the opportunity for customer orders to receive price

improvement. To this end, the Commission interprets the proposed

commentary to Rule 5.14(b), and the Exchange agrees with that

interpretation,\21\ to allow the specialist to participate in a cross

transaction to provide one side with a better price, notwithstanding

the other provisions of this rule.\22\ In addition, under the PSE's

method, it is possible for interest in the trading crowd, including an

order for the principal account of a member, to break up the cross and

to improve the price.

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\21\See Amendment No. 2, supra, note 4.

\22\Id.

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Finally, the Commission believes that the PSE proposal would not

grant priority, parity or precedence to the order of a member in a

manner inconsistent with section 11(a)(1)(G) of the Act or SEC Rule

11a1-1(T)(a)(3) thereunder.\23\ For purposes of its proposed rule

change, the PSE has defined the term ``customer order'' as an order

that a broker represents in an agency capacity, including a

professional order that is not for an account associated with the

executing broker. Because this definition of ``customer order''

excludes (and, thus, does not grant priority to) an order for an

account over which the broker or an associated person of the broker

exercises investment discretion, the Commission is satisfied that the

proposed rule change complies with section 11(a).

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\23\17 CFR 240.11a1-1(T)(a)(3).

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The Commission finds good cause for approving Amendments No. 1 and

No. 2 prior to the thirtieth day after the date of publication of

notice of filing thereof. Amendments No. 1 and No. 2 merely clarify

certain language used in the original filing and make no substantive

changes to the proposed rule. Finally, the Commission did not receive

any comments on the original proposal, which was noticed for the full

statutory period.

Interested persons are invited to submit written data, views and

arguments concerning Amendments No. 1 and No. 2 to the proposed rule

change. 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 rules change that are filed with the Commission, and all

written communications relating to Amendments No. 1 and No. 2 between

the Commission and any persons, 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 Section, 450 Fifth Street, NW., Washington, DC 20549. Copies

of such filing will also be available at the principal office of the

PSE. All submissions should refer to File No. SR-PSE-91-11 and should

be submitted by January 25, 1994.

IV. Conclusion

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

Act,\24\ that the proposed rule change (SR-PSE-91-11), including

Amendments No. 1 and No. 2 on an accelerated basis, is approved.

\24\15 U.S.C. 78s(b)(2) (1988).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\25\

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\25\17 CFR 200.30-3(a)(12) (1991).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-46 Filed 1-3-94; 8:45 am]

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