[Federal Register Volume 65, Number 250 (Thursday, December 28, 2000)]
[Notices]
[Pages 82435-82437]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-33124]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-43747; File No. SR-Phlx-00-62]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change by the Philadelphia Stock Exchange, Inc. Relating
to Mandatory Auto-Quote Settings to Update Quotations Based on a
Certain Minimum Movement in the Underlying Security
December 19, 2000.
I. Introduction
On August 1, 2000, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 \2\ thereunder, a
proposal to grant the Chairman of the Exchange's Board of Governors (or
his designee) the authority to mandate that the Exchange's Auto-Quote
System (``Auto-Quote'') be set to update options quotations based on a
certain minimum movement in the underlying security. On September 14,
2000, the Commission published the proposed rule change in the Federal
Register.\3\ The Commission received no comments on the proposal. This
order approves the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 43254 (September 6,
2000), 65 FR 55663.
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II. Description of the Proposal
Phlx has proposed to amend Commentary .01 to Exchange Rule 1080,
``Philadelphia Stock Exchange Automated Options Market (AUTOM) and
Automatic Execution System (AUTO-X),'' to allow the Chairman of the
Exchange's Board of Governors (or his designee) (``Chairman'') to
increase the increment by which the price of the underlying security
would have to change before Auto-Quote \4\ would generate new quotes
for the overlying options.
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\4\ Auto-Quote is the Exchange's electronic options pricing
system that enables specialists to automatically monitor and
instantly update quotations, based on incremental changes in the
price of the security underlying the option.
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Outbound options quotations are forwarded electronically by the
Exchange to the Options Price Reporting Authority (``OPRA''), which, in
turn, disseminates them to vendors. Recently, due to increased overall
options volume and significant increases in the number of quotations
generated, OPRA has, at times, been unable to disseminate quotation
traffic on a timely basis. To address the capacity constraints, the
Commission recently adopted a formula to allocate among the options
exchanges a specific allotment of bandwidth capacity for messages
transmitted to, and received from, OPRA during peak usage periods.\5\
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\5\ See Securities Exchange Act Release No. 43621 (November 27,
2000), 65 FR 75564 (December 1, 2000) (``Capacity Allocation Formula
Release'').
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The proposed rule is intended to enhance the Exchange's ability to
manage quote traffic while various solutions to quote capacity issues
are being implemented. Currently, one long-standing method the Exchange
has used to manage quote traffic is ``throttling,'' or capping outbound
quote message traffic to OPRA. For many years, the Exchange's options
trading systems have had the ability to throttle outbound message
traffic to OPRA by limiting the amount of messages sent to OPRA in a
given second. This is accomplished by withholding some Auto-Quote
generated messages from dissemination each second until the next
second. Throttling may result in some quotations being overridden by
subsequent quotations and, thus, prevent older quotations-in-waiting
from ever being disseminated.
The proposed rule will allow the Chairman, if the Exchange's
options trading systems throttle quotations for at least three minutes,
to mandate that Auto-Quote be set to update quotations based on a
certain minimum movement
[[Page 82436]]
in the underlying security.\6\ For example, Auto-Quote may be set to
update options quotations based on a price change in the underlying
security of an eighth of $1.00. Thus, each time the price of the
underlying security increased or decreased by an eighth or more, Auto-
Quote would update the quotation on the overlying option to reflect
such a change.\7\ The proposed rule will allow the Chairman to mandate
that Auto-Quote be set to update options quotations based on, for
example, a price change of a quarter of $1.00 in the underlying
security, meaning that Auto-Quote would not update quotations on the
overlying option until the price of the underlying security increases
or decreases by a quarter.\8\ Increasing the incremental price change
in the underlying security required for an Auto-Quote update would
result in fewer quotes generated and, thus, fewer messages queuing to
be sent to OPRA.
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\6\ Under the proposal, the restrictions to Auto-Quote could
continue for a period of 15 minutes and could be continued every 15
minutes thereafter, provided that the Exchange's options trading
systems were throttling quotations at the end of each such 15-minute
period.
\7\ Auto-Quote will aggregate consecutive changes in price for
purposes of the proposed rule. Thus, two consecutive increases of
one sixteenth in the price of the underlying security would be
considered an increase of an eighth. Telephone conversation between
Richard S. Rudolph, Counsel, Phlx, and Michael Gaw, Attorney-
Adviser, Division of Market Regulation (``Division''), Commission,
on December 18, 2000.
\8\ In practice, a threshold below which a price change in the
underlying security would not result in a new price generated by
Auto-Quote for the overlying option already exists, because the
Exchange has set a minimum trading increment of an eighth for
options contracts trading at $3.00 per share per option or higher
and one sixteenth in option contracts trading under $3.00 per share
per option. See Phlx Rule 1034(i). Thus, a price change in the
underlying security would not result in a shift in the spread for
the overlying option unless that price change triggered a shift in
that option's spread of one eighth or greater (assuming the option
was trading over $3.00). The proposed rule will merely give the
Chairman the authority to raise the threshold.
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The Chairman could exercise the authority described in the proposed
rule change with respect to certain securities but not others, or cause
Auto-Quote to raise the threshold to different amounts for different
underlying securities (e.g., one quarter for Stock A and one half for
Stock B).\9\
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\9\ Telephone conversation between Richard S. Rudolph, Counsel,
Phlx, and Michael Gaw, Attorney-Adviser, Division, Commission, on
December 18, 2000.
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III. Discussion
The Commission has determined that the proposed rule change is
consistent with the Act and the rules and regulations thereunder
applicable to a national securities exchange.\10\ In particular, the
Commission believes that the proposal is consistent with Sections
6(b)(5) and 6(b)(8) of the Act.\11\ Section 6(b)(5) requires, among
other things, that the rules of an exchange be designed to promote just
and equitable principles of trade, to facilitate transactions in
securities, to remove impediments to and perfect the mechanisms of a
free and open market and a national market system, and, in general, to
protect investors and the public interest. Section 6(b)(5) also
requires that those rules not be designed to permit unfair
discrimination between customers, issuers, brokers, or dealers.
Finally, Section 6(b)(8) of the Act requires that the rules of an
exchange not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Act.
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\10\ In approving this rule, the Commission has considered the
proposed rule's impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
\11\ 15 U.S.C. 78f(b)(5) and 78f(8).
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As the Commission has previously noted,\12\ the amount of market
data generated by the options markets has, at times, exceeded OPRA's
capacity to disseminate it publicly on a real-time basis. When this
occurs, the only market participants with up-to-date quote and trade
information are those present on the floor of an exchange. Market
participants not physically present on the floor are at an
informational disadvantage, which reduces market transparency, impedes
efficient pride discovery, and is inconsistent with the goal of fair
competition.
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\12\ See Capacity Allocation Formula Release, supra note 5, at
75564.
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As discussed above, because OPRA has not been able to increase its
systems capacity in the short-term sufficiently and because the
participants in OPRA have not been able to agree how to allocate
existing capacity amongst themselves, the Commission recently adopted
certain amendments to the OPRA Plan to allocate among the options
exchanges OPRA's peak-period message handling capacity.\13\ In its
Order, the Commission asserted its expectation that the options
exchanges would continue to ``consider and implement other quote
message mitigation strategies as both long-term and short-term
solutions.'' \14\ The Commission also noted that ``the allocation
formula should encourage each individual exchange to establish and
utilize quote reduction methods based on the amount of message capacity
it has been allocated, thereby promoting efficiency of the market data
dissemination process.'' \15\
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\13\ See Capacity Allocation Formula Release, supra note 5. The
Commission intended for the capacity allocation formula to be a
short-term solution to OPRA capacity shortages. As a more permanent
solution, as part of their settlement of an enforcement action with
the Commission, the American Stock Exchange, the Chicago Board
Options Exchange, the Pacific Exchange, and the Phlx have consented,
among other things, to modify the organization structure and
operation of OPRA so that each exchange will independently determine
the amount of capacity it will obtain. See Securities Exchange Act
Release No. 43268 (September 11, 2000).
\14\ Capacity Allocation Formula Release, supra note 5, at
75565.
\15\ Id. at 75574.
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Phlx's proposed rule change is one such quote reduction method.
Upon implementation of the new rule, the Chairman of the Exchange's
Board of Directors (or his designee) could require Auto-Quote to be set
to update options quotations only if the price of the underlying
security were to move more than a designated amount. If Auto-Quote were
set in this manner, the options prices determined by Auto-Quote would
remain static if the price of the underlying security moved by less
than the designated increment. The result of Auto-Quote's reduced
sensitivity to changes in the price of the underlying security would be
fewer new quotations generated by Auto-Quote and, consequently, fewer
quote messages to be sent to OPRA.
The Commission recognizes that the proposal could affect price
competition because, as a result of the restrictions to Auto-Quote, the
options prices generated may not reflect the price that otherwise would
be dictated by the pricing model used by a Phlx specialist or a
specialist or market-maker on another options exchange. As a result,
the proposed rule change may increase the likelihood that the prices
offered by Phlx specialists--as displayed on OPRA--will differ from
those displayed on other options exchanges. These disparities could
result in an increased occurrence of locked and crossed markets across
the options markets.
However, the Commission believes that this minimal impact on
competition is necessary and appropriate in furtherance of the purposes
of the Act and, thus, is consistent with Section 6(b)(8) of the
Act.\16\ Given that the Exchange is allocated only a defined percentage
of OPRA's capacity during peak usage periods, it must take steps to
ensure that the message traffic it generates does not exceed that
allocation.\17\ To address this problem,
[[Page 82437]]
the Exchange for many years has had the ability to ``throttle''
outgoing message traffic by preventing the dissemination to OPRA of
certain quotes that have been generated by Auto-Quote. The current
proposal takes a slightly different tack by restricting the generation
of new quotes rather than ``throttling'' the transmission to OPRA of
new quotes that have been generated. On the whole, the Commission
believes that both are reasonable means by which to address the problem
of the limited capacity of the OPRA system and, as such, are consistent
with the Act.
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\16\ 15 U.S.C. 78f(b)(8).
\17\ See Capacity Allocation Formula Release, supra note 5, at
75573 (``The Commission recognizes that there are always costs
associated with allocating a finite resource among users'').
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The Commission believes, though, that the proposed rule change may
offer a more effective tool to restrain message traffic than throttling
and, thus, may have a more minimal effect on competition. Presently,
the throttling function is applied indiscriminately to all quotes
generated by Auto-Quote. The approach described in the proposed rule
change, however, may be used selectively. Thus, Phlx could choose to
continue updating quotes for certain options classes continuously while
restraining the generation of new quotes in other options classes. As a
result, Phlx would be able to determine--based on competitive factors--
which options classes should have a greater share during peak usage
periods of the bandwith allocated to it by OPRA. Therefore, the
Commission believes the proposal promotes just and equitable principles
of trade, facilitates transactions in securities, and removes certain
impediments to a free and open market, consistent with Section 6(b)(5)
of the Act.\18\
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\18\ 15 U.S.C. 78f(b)(5).
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IV. Conclusion
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\19\ that the proposed rule change (SR-Phlx-00-62) is approved.
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\19\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\20\
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\20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-33124 Filed 12-27-00; 8:45 am]
BILLING CODE 8010-01-M