SECURITIES EXCHANGE ACT OF 1934
Rel. No. 50324 / September 7, 2004
Admin. Proc. File No. 3-11383
|
In the Matter of the Application of LEK SECURITIES CORP. and SAMUEL F. LEK For Review of Disciplinary Action Taken by the PHILADELPHIA STOCK EXCHANGE, INC. |
OPINION OF THE COMMISSION
NATIONAL SECURITIES EXCHANGE -- REVIEW OF DISCIPLINARY PROCEEDING
Orders Eligible for Entry into the Exchange's Automated Options Market ("AUTOM") System
Conduct Inconsistent with Just and Equitable Principles of Trade
National securities exchange's rule, which generally stated that only "agency orders" were eligible for entry into order execution system, failed to articulate clearly that orders entered by a member organization acting as an agent for its broker-dealer customers were not permissible. Held, the exchange's findings of violations and sanctions it imposed are set aside.
APPEARANCES:
Dixie L. Johnson and Kevin J. Harnisch, of Fried, Frank, Harris, Shriver & Jacobson LLP, for Lek Securities Corp. and Samuel F. Lek.
Robert A. Intartaglio and Mark Schepps, for the Philadelphia Stock Exchange, Inc.
Appeal filed: January 23, 2004
Last brief received: April 26, 2004
I
Lek Securities Corp. ("LSC") and Samuel F. Lek (collectively the "Applicants") appeal from Philadelphia Stock Exchange, Inc. ("PHLX" or the "Exchange") disciplinary action. The PHLX found that, during the summer of 2000, the Applicants sent ninety-eight broker-dealer orders to the Exchange's Automated Options Market ("AUTOM") system, in violation of PHLX Rule 1080(b). The PHLX also found that the Applicants' conduct was inconsistent with just and equitable principles of trade, in violation of PHLX Rule 707. The PHLX censured and fined the Applicants $1,000, jointly and severally. We base our findings on an independent review of the record.
II.
AUTOM is the PHLX's electronic order delivery and reporting system for Exchange-listed equity option and index option orders. AUTOM provides for the automatic entry and routing of eligible orders to the Exchange trading floor.1 Orders entered into AUTOM may be executed manually. In addition, certain orders are eligible for execution through AUTOM's Automatic Execution ("AUTO-X") system.2
PHLX Rule 1080 sets forth the provisions governing the use of the AUTOM and AUTO-X systems. During the relevant period, Rule 1080(b) provided:
Generally, only agency orders may be entered. With respect to U.S. Top 100 Index options ("TPX"), broker-dealer orders may be entered into AUTOM and are eligible for AUTO-X up to a maximum of 50 contracts.3
Options orders entered by members into AUTOM are routed to the appropriate specialist unit on the Exchange trading floor.4 When a member enters an options order into AUTOM, the member must identify whether the order is for a "customer" or a "firm." In the summer of 2000, the system was configured to reject incoming orders that were marked as "firm" orders, and to route them to the appropriate floor broker on the Exchange or to the point of origin of the order.5
LSC is a broker-dealer and PHLX member organization. Lek is LSC's chief executive officer. LSC applied for access to AUTOM in early 2000. In connection with the AUTOM application process, the PHLX staff indicated to the Applicants that AUTOM was limited to "public customer" (non-broker-dealer) orders, and that PHLX Rule 1080(b) generally prohibited orders for a broker-dealer from being sent through AUTOM.6 The Applicants admitted that they were told by at least one PHLX staff member that they could not send orders on behalf of broker-dealers to AUTOM. The Applicants state that they believed that the PHLX had incorrectly interpreted its rule. They thought that Rule 1080 allowed any agency order to be entered into the system, regardless of whether LSC was acting as an agent for a public customer or for a broker-dealer customer.
On July 19, 2002, the Exchange granted LSC access to AUTOM. That same day, the Applicants began transmitting agency orders for their customers that were broker-dealers to AUTOM. Between July 19, 2000 and September 15, 2000, the Applicants sent ninety-eight orders for broker-dealer customers to AUTOM. They acknowledge that they marked each order as a "customer" order. They also included the message, "This is a B/D Order," in the free text field of each order. Because the orders submitted by the Applicants were identified as "customer" orders, AUTOM allowed the orders to pass through the system without being rejected. Forty-five of the orders sent by the Applicants were automatically executed through AUTO-X.7 The remaining orders were executed manually by the relevant specialists.
The PHLX's Board of Governors ("Board") determined that the Applicants "did not intend to hide the fact they were submitting broker-dealer orders over AUTOM." The Board found that the Applicants believed that the Exchange's rules "were being misinterpreted," and that they submitted agency orders on behalf of broker-dealers to AUTOM in order "to force the issue of their interpretation of 'agency orders.'"
III.
The PHLX contends that the Applicants were given guidance concerning its interpretation of "agency orders." It argues that the Applicants had specific notice, prior to their transmission of the orders in question, that the PHLX staff had interpreted the phrase "agency orders" in Rule 1080(b) as excluding orders for broker-dealers. The PHLX asserts that the Applicants were required to follow the staff's interpretation of its rule.
The Applicants contend that the PHLX staff's interpretation ignored the plain meaning of the term "agency orders" used in the Rule. In the Applicants' view, an "agency order" includes any order entered in an agency capacity. The Applicants state that they acted as an agent with respect to all of the orders in question. Consequently, those orders constituted "agency orders," and therefore were eligible for entry into AUTOM.
We believe that, considering the language and history of PHLX Rule 1080(b), it was not clear that the term "agency orders" did not encompass agency orders for broker-dealer customers. On its face, Rule 1080 contained no prohibition on members' routing orders for the accounts of broker-dealer customers through AUTOM. Instead, Rule 1080 broadly authorized "agency orders" to be sent over the system.
The Applicants observe that, in May 1997, the PHLX proposed that Rule 1080 define "agency orders" to mean agency orders for "public customers" only and to exclude agency orders for broker-dealers.8 The PHLX subsequently deleted this definition of "agency orders" from its rule proposal.9 We stated, in the June 1997 release approving Rule 1080, that the term "public customer" as used in Rule 1080's proposed definition of "agency orders" "would have restricted use of the AUTOM system in a manner not necessarily consistent with the definition of 'public customer' contained in [the] PHLX's Guaranteed Quote rule for options."10 Thus, Rule 1080, as approved by the Commission, did not contain a definition that limited the term "agency orders" due to concerns expressed by Commission staff unrelated to the question in dispute.11
The Applicants' interpretation that "agency orders" could include agency orders for both public customers and broker-dealer customers also finds support in the language and history of PHLX Rule 229, governing PACE, the PHLX's automatic execution system for equity securities. PHLX Rule 229, in its original form, generally limited orders on PACE to "agency orders," but it did not define the term "agency orders." In 1989, the Exchange wanted to restrict the PACE system to public customer orders.12 The Exchange recognized that, unless otherwise defined, the term "agency orders" could be "defined broadly to include not only public customer orders, but also orders entered by broker-dealers or their affiliates."13 Given the PHLX's acknowledgment, in the Rule 229 amendment process, that the term "agency orders" includes orders for broker-dealers, and given the PHLX's deletion of a limiting definition of "agency orders" from the final version of Rule 1080, it is not clear that, in the AUTOM context, the term "agency orders" did not include any order executed on an agency basis, including an order for a member's broker-dealer customer.
The deletion of the definition of "agency order" in Rule 1080 and the use of that term in Rule 229 could be read as lending support for the Applicants' conclusion that the term "agency orders" was intended to be read to include all agency orders, including orders for broker-dealer customers. However, in the June 1997 adopting release, we explained that many of Rule 1080's provisions were designed to clarify existing Exchange procedures and did not alter the PHLX's prior interpretations and policies governing AUTOM.14 The June 1997 release stated, in pertinent part:
The Commission notes that many of the proposed provisions consist of rules that either previously were approved explicitly by the Commission or codify existing practice that has developed pursuant to approved guidelines. The Commission believes that such provisions of the proposal do not substantially alter the Exchange's current interpretations and policies governing AUTOM, but rather, clarify existing operational procedures and codify into the Exchange's rules improvements that have been made to the AUTOM system. These provisions include the types of orders eligible for AUTOM and AUTO-X, respectively.15
Prior to 1997, the AUTOM system was restricted to public customer orders. Thus, the reference to the provision governing the types of orders eligible for the AUTOM and AUTO-X systems appears to reflect the expectation that the Exchange's interpretation of this provision, including the term "agency orders," continued to apply notwithstanding the amendments to Rule 1080.
The PHLX suggests that subsequent Commission releases made clear that the term "agency orders" in Rule 1080 referred only to public customer orders. For example, in a 1998 proposing release concerning unrelated amendments to Rule 1080, the PHLX cited to the Commission's June 1997 release as support for the proposition that AUTOM was limited to public customer orders. However, given the fact that the June 1997 release specifically deleted the definition of "agency order" from Rule 1080, the language in the 1998 proposing release regarding "agency orders" did not clearly indicate that AUTOM was reserved for public customer orders only.16
In sum, we believe that the term "agency orders," as used in Rule 1080, is too ambiguous a term to warrant the PHLX's finding that the Applicants violated PHLX Rule 1080(b).17 Accordingly, we have determined to set aside the PHLX's findings of violations and the sanctions that it imposed against the Applicants.18
IV.
The Applicants object that the PHLX received additional submissions into the record. They contend that once they waived their right to a hearing on the charges by failing to request a hearing in the Answer,19 the PHLX's rules limited the PHLX's review of the record to the Statement of Charges and the Answer. We agree with the PHLX that an applicant should not be permitted to limit the record for review by waiving his right to a hearing. Here, the PHLX's rules grant the PHLX discretion to determine the manner of proceeding in light of a respondent's failure to request a hearing.20
Section 6(b)(7) of the Securities Exchange of 1934 requires the Exchange to provide a "fair procedure."21 The PHLX, when confronted with the Applicants' waiver of a hearing, permitted both parties to file additional pleadings, and thereby to expand the record for review. It allowed the staff to submit a Request for Decision and the Applicants to submit a response. Both parties availed themselves of the opportunity to provide additional material. The PHLX acted in a fair and even-handed manner. We find that this method of proceeding was fair.
An appropriate order will issue.22
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID, and ATKINS); Commissioner CAMPOS not participating.
Jonathan G. Katz
Secretary
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 50324 / September 7, 2004
Admin. Proc. File No. 3-11383
|
In the Matter of the Application of LEK SECURITIES CORP. and SAMUEL F. LEK For Review of Disciplinary Action Taken by the PHILADELPHIA STOCK EXCHANGE, INC. |
ORDER SETTING ASIDE DISCIPLINARY ACTION TAKEN BY NATIONAL SECURITIES EXCHANGE
On the basis of the Commission's opinion issued this day, it is
ORDERED that the findings of violations and the sanctions imposed by the Philadelphia Stock Exchange, Inc. in this action against Lek Securities Corp. and Samuel F. Lek be, and they hereby are, set aside.
By the Commission.
Jonathan G. Katz
Secretary
Endnotes
The PHLX also cites additional releases. To the extent that these releases, both of which postdate Rule 1080, refer to Rule 229 for the argument that agency orders are limited to public customer orders, they ignore the express language of Rule 229 confining its application to PACE. See Notice of Filing of Proposed Rule Change and Amendments Nos. 1 through 7 thereto by the Philadelphia Stock Exchange, Inc. Relating to Electronic Interface with AUTOM for Phlx Specialists and Registered Options Traders, Exchange Act Rel. No. 46095 (June 20, 2002), 77 SEC Docket 2910; Order Granting Approval to Proposed Rule Change and Amendments No. 1 through 7 thereto and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 8 Relating to Electronic Interface with AUTOM for Specialists and Registered Options Traders, Exchange Act Rel. No. 46763 (Nov. 1, 2002), 78 SEC Docket 2711.