Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Pacific Stock Exchange Incorporated Relating to Proprietary Brokerage Order Routing Terminals

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38270; File No. SR-PSE-97-02]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the Pacific Stock Exchange Incorporated Relating to

Proprietary Brokerage Order Routing Terminals

February 11, 1997.

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 January 17, 1996, the Pacific Stock Exchange Incorporated (``PSE''

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

(``Commission'' or ``SEC'') the proposed rule change as described in

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

regulatory organization. The Commission is publishing this notice to

solicit comments on the proposed rule change from interested persons.

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

\2\ 17 CFR 240.19b-4.

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

of the Proposed Rule Change

The PSE is proposing to adopt a formal policy governing the use by

PSE Members and Member Organizations (``Members'') of any proprietary

brokerage order routing terminals (``Terminals'') on the Options Floor

of the Exchange. The text of the proposed policy is available at the

Office of the Secretary, the Exchange, 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 Exchange 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 Exchange 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 is proposing to adopt a policy governing proprietary

brokerage order routing terminals that Members may use on the Options

Floor of the Exchange. The Policy includes specific provisions on

Exchange approval of Terminals; Restrictions on Members' use of

Terminals; Exchange Inspection and Audit; Exchange Liability;

Termination of Exchange Approval; and pilot status of the program.

Exchange Approval

The proposed Policy specifies that Members must obtain prior

Exchange approval to use any proprietary brokerage order routing

terminals on the Options Floor. It states that the Exchange may grant

such approval for use on an issue-by-issue basis. To request such

approval, Members must submit a letter of application to the Exchange

specifying the make, model number, functions and intended use of the

equipment, and must also provide additional information upon the

request of the Exchange. The policy further provides that the format of

any orders to be transmitted over the Terminals must also be pre-

approved by the Exchange.

The Exchange believes that it should have the flexibility to permit

the use of Terminals on an issue-by-issue basis so that it will have an

opportunity to observe the use of Terminals in particular trading

crowds and to consider the benefits and any unforeseen problems that

may result before floor-wide implementation occurs.

Paragraph 2 of the Policy states that, in considering the approval

of an application, as well as whether a previously issued approval

should be withdrawn, the Exchange will take into

[[Page 7287]]

account such factors as the physical size of the Terminal; space

available at the post where the Terminal is to be used;

telecommunication, electrical and radio frequency requirements;

Terminal characteristics and capacity; and any factors that the

Exchange considers relevant in the interest of maintaining fair and

orderly markets, the orderly and efficient conduct of Exchange

business, the maintenance and enhancement of competition, the ability

of the Exchange to conduct surveillance of the use of the Terminal and

the business transmitted through it, the adequacy of applicable audit

trails, and the ability of the Terminal to interface with other

Exchange facilities.

Paragraph 3 of the Policy provides that Members must report to the

Exchange every proposed material change in functionality of a Terminal

and every proposed change in the use of a Terminal. It further provides

that Members must not implement any such proposed changes unless and

until they have been approved by the Exchange, and that Members must

also promptly file with the Exchange supplements to their applications

whenever the information currently on file becomes inaccurate or

incomplete for any reason.

Restrictions on Use of Terminals

Paragraph 4 sets forth four restrictions applicable to Members' use

of Terminals on the Options Floor. The first restriction is that

Members may receive brokerage orders in the trading crowd via

Terminals, but must represent such orders in the trading crowd by open

outcry in a manner that is consistent with Exchange rules.

The second restriction states that when a Member executes an order

that was received over a Terminal, the Member must fill out and time

stamp a trading ticket within one minute of the execution. Exchange

rules on record keeping and trade reporting are unchanged.

The third restriction states that Terminals may be used to receive

brokerage orders only, and that Terminals may not be used to perform a

market making function. It states that any system used by a Member to

operate a Terminal must be separate and distinct from any system that

may be used by a Member of any person associated with a Member in

connection with market making functions. It further states that, for

the purpose of this paragraph, orders initiated from off the floor of

the Exchange that are not counted as ``Market Maker transactions''

within the meaning of PSE Rule 6.32 and that do not create a pattern of

offering in the aggregate either to make two-sided markets or

simultaneously to represent opposite sides of the market in any class

of options shall not be deemed to be used to perform a market making

function.

The Exchange believes that if Terminals were permitted to be used

to perform market making functions from off the floor of the Exchange,

it may become undesirable for Exchange market makers to continue to

assume the costs and obligations associated with being a registered

market maker, which in turn could harm the liquidity and quality of the

Exchange's market. The Exchange is particularly concerned that off-

floor market making effectively would establish a market making

structure devoid of affirmative market making obligations that could

result in less deep and liquid markets during periods of market stress,

when off-floor Terminal market makers would not be required to continue

making markets. Moreover, the Exchange believes that surveillance of

market making through the Terminals currently would be particularly

difficult.

The Exchange intends to interpret the term ``market making'' in

accordance with its traditional definition as defined under the Act,

i.e., holding one's self out as being willing to buy and sell a

particular security on a regular or continuous basis.\3\ The definition

of market making would not capture parties who enter orders on one side

of the market; nor would it capture parties who enter two-sided limit

orders on occasion. A party would not be deemed to be engaging in

market making unless it regularly or continuously holds itself out as

willing to buy and sell securities.

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\3\ See. 15 U.S.C. 78c(a)(38).

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The fourth restriction in Paragraph 4 states that no Member or any

person associated with a Member may use for the benefit of such member

or any person associated with such Member any information contained in

any brokerage order in the Terminal system until that information has

been disclosed to the trading crowd. Accordingly, prior to placing an

order or making or changing a bid or offer on the Exchange or in any

other securities or futures market, a Member must disclose such

information to the trading crowd. The Exchange believes that this

restriction will help to ensure that Members using Terminals trade on

the same terms and conditions as other market participants and do not

receive any trading advantages to interact with orders transmitted

through the Terminals.

Inspection and Audit

Paragraph 5 of the proposed policy states that the operation and

use of all aspects of the Terminal and all orders entered through the

Terminal are subject to inspection and audit by the Exchange at any

time upon reasonable notice. It further provides that Members must

furnish to the Exchange such information concerning the Terminal as the

Exchange may from time to time request upon reasonable notice,

including without limitation an audit trail identifying transmission,

receipt, entry, execution and reporting of all orders. For the purpose

of this paragraph, a notice of at least twenty-four hours shall be

deemed to be reasonable (however, shorter periods may be provided in

appropriate circumstances).

Exchange Liability

Paragraph 6 states that neither the Exchange nor its directors,

officers, employees or agents shall be liable to a Member, a Member's

employees, a Member's customers or any other person for any loss,

damage, cost, expense or liability arising from the installation,

operation, relocation, use of, or inability to use a Terminal on the

floor of the Exchange (including any failure, malfunction, delay,

suspension, interruption or termination in connection therewith).

Termination of Approval

Paragraph 7 of the Policy provides that the Exchange may at any

time determine to terminate all approvals for the installation and use

by Members of Terminals on the floor of the Exchange or at particular

trading posts, in which event such approvals will be deemed terminated

on the 30th calendar day following the day on which the Exchange gives

notice to such Member(s) of such termination of approval. It further

provides that Members who incur costs in developing or implementing

proprietary systems do so at their own risk, due to the fact that the

Exchange intends to roll out its own brokerage order routing system for

Floor Brokers. It further provides that a Member's approval to use a

Terminal may also be summarily terminated by the Exchange, once notice

has been provided to the affected Member, if any statement by such

Member in its application or any supplement thereto is inaccurate or

incomplete, or if such Member has failed to comply with any provision

of this Policy, or if the operation of the Terminal is causing

operational difficulties on the floor of the Exchange, and the Member

has

[[Page 7288]]

failed to cure the same within seven calendar days following the giving

of notice (or such shorter period of time as the Exchange may deem

appropriate if it determines the circumstances have created a situation

requiring a shortened cure period). It states that Members must

immediately stop using their Terminals and must remove such Terminals

from the floor of the Exchange upon the termination of approval

pursuant to this paragraph, and that nothing in this paragraph shall be

construed as a waiver of or limitation upon whatever right Members may

otherwise have to seek appropriate relief pursuant to PSE Rule 11 in

the event the Exchange terminates approval of a Member's Terminal

pursuant to this paragraph.\4\

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\4\ PSE Rule 11.7 provides due process protections for persons

who have been aggrieved by Exchange action. It gives such persons an

opportunity to be heard and to have the complained of action

reviewed by the Exchange.

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Pilot Program

Finally, Paragraph 8 of the proposed policy states that the Pilot

Program expires six months after its implementation, but may be renewed

upon an Exchange filing with the Securities and Exchange Commission

pursuant to the Securities Exchange Act of 1934.

The Exchange notes that, except in certain minor respects, the

proposed Policy is consistent with an approved rule change of the

Chicago Board Options Exchange (``CBOE'') relating to the use of

proprietary brokerage order routing terminals on the CBOE floor.\5\

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\5\ See Exchange Act Release No. 38054 (December 16, 1996), 61

FR 67365 (December 20, 1996).

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Basis

The Exchange believes that proposal is consistent with Section 6(b)

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

in that it is designed to facilitate transactions in securities; to

foster cooperation and coordination with persons engaged in regulating,

clearing, settling, and processing with respect to transactions in

securities; to promote just and equitable principles of trade; and to

protect investors and the public interest.

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 self-regulatory organization 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. 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, 450 Fifth Street, N.W., Washington,

D.C. 20549. Copies of such filing will also be available for inspection

and copying at the principle office of the PSE. All submissions should

refer to File No. SR-PSE-97-02 and should be submitted by March 11,

1997.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\6\

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\6\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97-3915 Filed 2-14-97; 8:45 am]

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