Self-Regulatory Organizations; Order Approving Proposed Rule Change by the Pacific Exchange, Inc. Relating to Statistical Reports Provided to Market Makers

I. Introduction

On October 5, 1999, the Pacific Exchange, Inc. (“Exchange” or “PCX”), filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, a proposed rule change relating to statistical reports provided to market makers. The Exchange filed Amendment No. 1 to the proposed rule change on January 11, 2000. The proposed rule change, as amended, was published for comment in the Federal Register on February 15, 2000. The Commission received no comments on the proposal. This order approves the proposal, as amended.

II. Description of the Proposal

The Exchange proposes to furnish its market makers with statistical reports designed to measure trading volume and participation in trading activity in each option issue traded on the Exchange. The reports will identify which order flow providers currently are bringing trades to the PCX and how those orders are being executed. Specifically, the reports will include monthly trading information that describes, by order flow provider, the issue and number of contracts traded, the Lead Market Maker post where the issue is traded, the contra and executing broker symbols, and whether the trade was executed through the Exchange's Automatic Execution System, through the Limit Order Book, or manually in the trading crowd.

The Exchange believes these reports will help market makers develop marketing plans specific to order flow providers that the market makers can use to help increase order flow to the PCX. In addition, the reports are designed to help market makers support their business relationships and encourage further business development with order flow providers. Furthermore, these reports will help the market makers identify specific customers to whom they should direct their marketing efforts. The Exchange believes that these reports will help the market makers focus on specific business needs of their customers, so that they can attract more business to the PCX. Finally, the Exchange believes the reports will help the Exchange compete for order flow in multiple traded issues.

III. Discussion

After careful review, the Commission finds that the proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to a national securities exchange, and, in particular, the requirements of Section 6 of the Act. Specifically, the Commission finds that the proposed rule change is consistent with Section 6(b)(5) of the Act, in that it is designed to facilitate securities transactions and to remove impediments to and perfect the mechanism of a free and open market.

The Commission recognizes the extent to which the proposed rule change may facilitate the practice of market makers offering incentives such as payment for order flow to firms that agree to direct their order flow to the Exchange. Specifically, by providing market makers with firm-specific volume breakdowns, the reports will permit market makers to identify firms that have not historically provided significant order flow to the Exchange. Market makers may in turn seek to attract new orders from these firms by offering payment in exchange for the new order flow. Such arrangements, standing along, are not inconsistent with the purposes of the Act as long as price competition remains vigorous and brokers vigilantly pursue their best execution obligation.

Accordingly, the Commission does not believe the proposal's potential to facilitate payment for order flow arrangements constitutes a barrier to approval. We will, however, monitor the manner in which the reports are used, to ensure that they are used in a manner consistent with the purposes of the Act.

IV. Conclusion

For the above reasons, the Commission finds that the proposed rule change is consistent with the provisions of the Act, and in particular with Section 6(b)(5).

It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-PCX-99-38), as amended, is approved.