Self-Regulatory Organizations; Order Granting Accelerated Approval of Proposed Rule Change by Pacific Exchange, Inc., Relating to the Implementation of a New Order Audit Trail System, 2443-2444 [E5-126]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 70, Number 9 (Thursday, January 13, 2005)]
[Notices]
[Pages 2443-2444]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-126]



[[Page 2443]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50998; File No. SR-PCX-2004-122]


Self-Regulatory Organizations; Order Granting Accelerated 
Approval of Proposed Rule Change by Pacific Exchange, Inc., Relating to 
the Implementation of a New Order Audit Trail System

January 7, 2005.

I. Introduction

    On December 14, 2004, the Pacific Exchange, Inc., (``PCX'' or 
``Exchange'') filed with 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 creation of an 
electronic order audit trail. The proposed rule change was published 
for comment in the Federal Register on December 22, 2004 for a 15-day 
comment period, which expired on January 6, 2005.\3\ The Commission 
received no comments on the proposed rule change. This order approves 
the proposed rule change on an accelerated basis.
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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. 50866 (December 14, 
2004), 69 FR 76808.
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II. Background

    The proposed rule change is intended to fulfill certain of the 
undertakings contained in an order issued by the Commission relating to 
the settlement of an enforcement action against the American Stock 
Exchange LLC, Chicago Board Options Exchange, Inc., PCX, and 
Philadelphia Stock Exchange, Inc., (collectively ``Options Exchanges'') 
for failure to comply with their own rules and to enforce compliance 
with their own rules by their members and persons associated with their 
members \4\ as is required by Section 19(g) of the Act.\5\ The Order 
found that the Options Exchanges impaired the operations of the options 
market by: (1) Following a course of conduct under which they refrained 
from multiply listing a large number of options; and (2) inadequately 
discharging their obligations as self-regulatory organizations by 
failing adequately to enforce compliance with (a) certain of their 
rules, including order handling rules, that promote competition as well 
as investor protection, and (b) certain of the rules prohibiting 
anticompetitive conduct, such as harassment, intimidation, refusals to 
deal and retaliation directed at market participants who sought to act 
competitively. In addition, the Commission found that the Options 
Exchanges failed to enforce compliance with their trade reporting 
rules, which promote transparency of the market and facilitate 
surveillance and enforcement of other exchange rules and the Federal 
securities laws.
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    \4\ See Order Instituting Public Administrative Proceedings 
Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, 
Making Findings and Imposing Sanctions, Securities Exchange Act 
Release No. 43268 (September 11, 2000) and Administrative Proceeding 
File 3-10282 (the ``Order'').
    \5\ 15 U.S.C. 78s(g).
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    As part of the Order, the Options Exchanges agreed to, and were 
ordered to comply with, a variety of undertakings. Among other things, 
they agreed to, and were ordered to, design and implement an accurate, 
time-sequenced, consolidated options audit trail system (``COATS'') 
that would enable the Options Exchanges to reconstruct markets 
promptly, effectively surveil them, and enforce order handling, firm 
quote, trading reporting and other rules. The Options Exchanges were 
required to complete this undertaking in five phases. The Options 
Exchanges have completed the first four phases. The final phase of the 
undertaking to implement COATS requires that each exchange incorporate 
into its audit trail all non-electronic orders. This proposed rule 
change addresses that aspect of the undertaking.

III. Description of Proposed Rule Change

    The Exchange proposes to adopt new PCX Rule 6.67(c), which would 
require that every OTP Holder or OTP Firm that receives an order for 
execution on the Exchange immediately records the details of the order 
(including any modification of the terms of the order or cancellation 
of the order) into its Electronic Order Capture (``EOC'') system, 
unless such order has been entered into the Exchange's other electronic 
order processing facilities (e.g., orders sent electronically through 
the Exchange's MFI). OTP Holders and OTP Firms would have two ways to 
record the details of an order into EOC prior to representation in the 
trading crowd: (1) Direct entry into the EOC system, or (2) entry to an 
Electronic Tablet that enables the user to hand-write the order 
information onto the tablet, which converts the information into an 
electronic format.
    The details of each order that would be required to be recorded 
upon receipt if directly entered into the EOC system include the 
following: \6\ (1) CMTA information/Clearing OTP Holder or OTP Firm; 
(2) Option symbol, expiration month, exercise price, and type of option 
(call or put); (3) Side of market (buy or sell); (4) Quantity of option 
contracts; (5) Any limit price, stop price, or special conditions; (6) 
Opening or closing transaction; (7) Time in force; (8) Account origin 
code; and (9) Solicited or unsolicited.
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    \6\ The Exchange represents that the order entry time and 
identification number are automatically assigned upon entry into 
EOC.
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    The details of each order that would be required to be recorded 
upon receipt if entered into the Electronic Tablet include the 
following: \7\ (1) CMTA information/Clearing OTP Holder or Firm; (2) 
Option symbol, expiration month, exercise price, and type of option 
(call or put); (3) Side of market (buy or sell); (4) Quantity of option 
contracts; (5) Any limit price, stop price, or special conditions; and 
(6) Opening or closing transaction.
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    \7\ The Exchange also represents that the order entry time and 
identification number are automatically assigned upon entry into the 
Electronic Tablet.
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    The Exchange also proposes to add interpretive language to make it 
clear that EOC and the Electronic Tablet are approved formats for 
transmitting orders for purposes of this Rule. In addition, proposed 
PCX Rule 6.67(b) requires that orders sent to the Exchange for 
execution must comply with the order format requirements established by 
the Exchange relating to, among other things, option symbol, expiration 
month, exercise price, type of option (call or put), quantity of option 
contracts, clearing member organization, whether the order is to buy or 
sell, and whether the order is market or limit.
    An exception to the requirement for recording order information 
into EOC or the Electronic Tablet is contained in proposed PCX Rule 
6.67(d). Under this proposed rule, if a disruption or malfunction to 
EOC or the Electronic Tablet or any other Exchange electronic order 
processing system occurs, the EOC or the Electronic Tablet entry 
requirement would be suspended upon the approval of two Trading 
Officials, and the EOC/Electronic Tablet Contingency Reporting 
Procedures will be in effect pursuant to PCX Rule 6.67(d)(1)(A).\8\ If 
the Exchange is still able to process and disseminate quotes

[[Page 2444]]

accurately, then any orders received by the Exchange would be processed 
manually through the use of paper tickets. In such circumstances, all 
other Exchange rules governing options trading would remain in effect. 
Accordingly, the Exchange proposes to retain its existing rules that 
are applicable to the manual processing of order tickets.
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    \8\ Under the proposed rule, OTP Holders and OTP Firms must use 
a backup supply of tickets to record the details of the order 
received through non-electronic means and time stamp the order of 
events. Once the disruption or malfunction has been corrected, as 
determined by one Floor Official, OTP Holders and OTP Firms must 
input all orders into an EOC device using the ``as-of'' field.
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    Current PCX Rule 6.68(a) requires OTP Holder and OTP Firms to 
maintain and preserve certain information items relating to the terms 
of each option order. The Exchange proposes to make minor technical 
changes to the text by renaming and renumbering certain information 
items enumerated in the Rule for clarity. The Exchange also proposes 
language to specify that the Exchange would be required to maintain and 
preserve all electronic orders on behalf of OTP Holders and OTP Firms. 
The proposed rule change does not replace existing requirements for 
recording orders contained in this Rule. The Exchange further proposes 
to amend PCX Rule 6.68(b) to make it clear that OTP Holders and OTP 
Firms would be required to comply with their recordkeeping obligations 
for orders excepted from the EOC/Electronic Tablet requirements.
    Finally, the Exchange proposes to add a Commentary .01 to PCX Rule 
6.67, which provides that Cabinet Trades and FLEX options are exempt 
from the EOC and Electronic Tablet Entry Requirements as set forth in 
PCX Rule 6.67(c). However, such trades would be required to be 
processed using manual time stamped order tickets. The PCX would 
maintain a separate record of quotes, orders and transactions related 
to such trades in the same format as the COATS data and would make such 
information available upon Commission request.
    The system entry requirement proposed in this rule change would 
become completely operative on January 10, 2005.

IV. Discussion

    After careful consideration, the Commission finds that the proposed 
rule change is consistent with Act and the rules and regulations 
thereunder applicable to a national securities exchange.\9\ In 
particular the Commission finds that the proposed rule change is 
consistent with Section 6(b)(5) of the Act,\10\ which requires among 
other things, that the Exchange's rules be designed to promote just and 
equitable principles of trade, to remove impediments and to perfect the 
mechanism of a free and open market and a national market system, and 
in general, to protect investors and the public interest.
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    \9\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition and capital 
formation. 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the rules as proposed should allow the 
Exchange to comply with its obligations under the Order in that they 
should result in the creation of an audit trail that incorporates 
manual orders sent to PCX. Specifically, the proposed rule change 
requires that PCX members enter certain details immediately upon 
receipt, prior to representation of the order, into either EOC or the 
Electronic Tablet, which the Commission believes should result in an 
accurate, time-sequenced record of orders.
    The Commission also believes that the Exchange's plan for recording 
order details in the event of a systems outage or malfunction is 
reasonable. In the event of a systems outage or malfunction, floor 
brokers would revert to the use of trade tickets and would record on 
those tickets the times that various events occur in the life of the 
order. Further, the Exchange would ensure that the information recorded 
on trade tickets is entered into the Exchange's electronic systems in a 
timely manner so that it can be incorporated into the electronic audit 
trail.
    The Commission notes that the Exchange has acknowledged the need 
for effective and proactive surveillance for activities such as trading 
ahead and front-running in connection with the creation of its audit 
trail. The Exchange represents that it will implement proactive and 
effective surveillance procedures for violations of Exchange rules and 
Federal securities laws, including, but not limited to, rules 
prohibiting trading ahead and front running, related to the entry of 
customer orders into the EOC system. The Commission views effective 
surveillance as critical to the integrity of COATS and expects that the 
Exchange will inform the Commission of any problems it encounters in 
conducting effective surveillance.
    The Commission finds good cause for accelerating approval of the 
proposed rule change prior to the thirtieth day after the date of the 
publication of notice thereof in the Federal Register. The Commission 
notes that the proposed rule change was noticed for a 15-day comment 
period and that no comments were received. The Commission believes that 
it is appropriate to accelerate approval of the proposed rule change so 
that the proposal may be implemented on a timely basis to ensure prompt 
compliance with the undertakings contained in the Commission's Order.

V. Conclusion

    For all of the aforementioned reasons, 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.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\11\ that the proposed rule change (SR-PCX-2004-122) is approved on 
an accelerated basis.
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    \11\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E5-126 Filed 1-12-05; 8:45 am]
BILLING CODE 8010-01-P