Self-Regulatory Organizations; Notice of Filing and Immediate Effectiveness of Proposed Rule Change and Amendment No. 1 Thereto by the Pacific Exchange, Inc. Relating to a New Fee on Market Makers' Transactions in Designated Equity Option Issues

Pursuant to section 19(b)(1) of the Securities and Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, notice is hereby given that on August 18, 2000, the Pacific Exchange, Inc. (“PCX” 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 Exchange. On September 11, 2000, the PCX submitted Amendment No. 1 to the proposed rule change. The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons.

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

The PCX proposes to adopt a new fee to be imposed on transactions of market makers (including Lead Market Makers) at the rate and for the use described below. The text of the proposed rule change is available at the principal offices of the PCX.

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

1. Purpose

The purpose of the proposed new fee is to provide a source of revenue to the Exchange to be used in response to changing competitive circumstances that have arisen and may continue to arise in particular multiply traded equity options issues. These circumstances include the growing practice by some traders on options exchanges of paying brokers for orders in multiply traded issues directed to them. In light of this development and in order to be competitive in multiply traded options, the PCX has determined to impose a new fee on market makers' transactions in designated equity option issues.

All of the funds generated by the new fee will be segregated based upon the trading post where the options subject to the fee are traded. The funds will be made available to the Lead Market Maker (“LMM”) at the trading post where the funds were collected, for the LMM's use in attracting orders in the options traded at that post. This use of funds could include payments from the LMMs to broker-dealers for the orders that the broker-dealers direct to the Exchange. The specific terms governing the orders that qualify for payment and the amount of any payments to be made will be determined by the LMMs in whatever manner they believe is most likely to be effective in attracting order flow to the Exchange in options traded at the LMMs' assigned posts.

LMMs will be obligated to account to the Exchange for the use they make of the funds that the Exchange makes available to them for this purpose, but all determinations concerning the amount the LMMs may pay for orders and the types and sizes of orders that qualify for payment will be made exclusively by the LMMs and not by the Exchange. The Exchange may provide administrative support to the LMMs in such matters as keeping track of the number of qualified orders each firm directs to the Exchange, and making the necessary debits and credits to the accounts of the LMMs and the firms to reflect the payments that are to be made.

The amount of the new fee will be set initially at $0.40 per market maker contract for all equity option issues and will be effective as of July 31, 2000. Market maker to market maker trades and trades between a market maker and an LMM will not be part of the program, although fees will be collected for these trades and then rebated. Any changes to the option issues to which the fee applies, to the rate or rates at which the fee is assessed, or to the Exchange's disposition of funds generated by the fee will be the subject of separate filings with the Commission made pursuant to Section 19(b)(3)(A)(ii) of the Act.

As described above, the proposed fee will be imposed on all Exchange market makers (including LMMs) in the options that are subject to the fee. The PCX believes that, because these same persons will be able to participate in the order flow derived from the program, there will be a fair correlation between those members who pay the costs of the program funded by the new fee and those who receive the benefits of the program.

In accordance with this program involving payment for order flow that may be funded by the Exchange's proposed fee, the Exchange intends to provide PCX order flow providers with objective data on the executions of their option orders so that they can assess the quality of executions they receive on the PCX.

2. Statutory Basis

The PCX believes that the new fee and the program it will fund will serve to enhance the competitiveness of the Exchange and its members. Accordingly, the PCX believes that this proposal is consistent with and furthers the objectives of the Act, including Section 6(b)(5) thereof, which requires the rules of exchanges to be designed to remove impediments to and perfect the mechanism of a free and open market and a national market system, and Section 11A(a)(1)(C) thereof, which reflects the finding of Congress that it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure fair competition among brokers and dealers and among exchange markets.

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

Because the foregoing rule change establishes or changes a due, fee, or other charge imposed by the Exchange, it has become effective pursuant to Section 19(b)(3)(A)(ii) of the Act and Rule 19b-4(f)(2) thereunder. At any time within 60 days of the filing of such proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act.

IV. Solicitation of Comments

The Commission has frequently raised serious concerns about payment for order flow and internalization. Payment for order flow is of concern because brokers who are paid to send their customers' orders to one exchange have a conflict of interest that may reduce their commitment to the duty they owe their customers to find the best execution available. While payment for order flow has been a common practice in the equities markets for some time, only recently has payment for order flow developed in the options markets. Despite these concerns, however, the PCX's proposal involves the imposition of a fee and the Act gives exchanges wide latitude to establish, revise, and collect fees and other charges without prior Commission approval. The Commission invites interested persons to submit written data, views and arguments concerning the foregoing, including whether the proposed rule is consistent with the Act. In particular, the Commission asks persons who submit comments whether the payment for order flow facilitated by the PCX's proposal raises greater or different concerns than payment for order flow at other options exchanges. After receiving comments, and at any time within 60 days from the date the PCX filed its proposal, the Commission can decide to require the PCX to stop collecting the fee, refile the proposal, and await Commission approval before reinstituting the fee.

Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. 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. Copies of such filing will also be available for inspection and copying at the principal office of the PCX. All submissions should refer to File No. SR-PCX-00-30 and should be submitted by October 12, 2000.