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Notice

Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 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

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Information about this document as published in the Federal Register.

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Start Preamble November 1, 2002.

I. Introduction

On January 15, 2002, the Philadelphia Stock Exchange, Inc. (“Phlx” 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 an electronic interface with the Exchange's Automated Options Market (“AUTOM”) [3] for specialists and Registered Options Traders (“ROTs”).[4] On March 6, 2002, the Exchange filed Amendment No. 1 to the proposed rule change.[5] On March 14, 2002, the Exchange filed Amendment No. 2 to the proposed rule change.[6] On March 26, 2002, the Exchange filed Amendment No. 3 to the proposed rule change.[7] On April 2, 2002, the Exchange filed Amendment No. 4 to the proposed rule Start Printed Page 68899change.[8] On May 16, 2002, the Exchange filed Amendment No. 5 to the proposed rule change.[9] On June 12, 2002, the Exchange filed Amendment No. 6 to the proposed rule change.[10] On June 19, 2002, the Exchange filed Amendment No. 7 to the proposed rule change.[11]

The proposed rule change and Amendments No. 1-7 were published for comment in the Federal Register on June 27, 2002.[12] No comments were received on the proposed rule change or Amendments No. 1-7. The Exchange filed Amendment No. 8 to the proposed rule change on November 1, 2002.[13]

II. Description of the Proposal

The Exchange proposes to amend Phlx rule 1080 to enable a ROT or specialist to improve the Phlx bid or offer by enabling ROTs and specialists to place limit orders on the electronic limit order book [14] through an electronic interface with AUTOM (“Price Improving ROT/Specialist”).

Currently, Phlx rule 1080 provides that, generally, only agency orders [15] may be entered into AUTOM and only Exchange options specialists may access the limit order book electronically. A Phlx ROT (or a floor broker on the ROT's behalf) may only place an order for an ROT's account on the limit order book maintained by the specialist by requesting the specialist to do so. In addition, Phlx ROTs cannot improve the Phlx's displayed bid or offer, except by asking the specialist to do so. Specifically, under existing Phlx rules, Phlx ROTs are able to improve the Phlx market with respect to a given option series only by verbally announcing their trading interest in a loud and audible fashion. The specialist is then required by Phlx rules to reflect this trading interest in the displayed quote.

The proposal would limit the need for specialist involvement by providing that on-floor orders for the proprietary account(s) of ROTs, up to 1,000 contracts, are eligible for delivery via AUTOM, through the use of Exchange approved proprietary systems. To be displayed, on-floor orders for the proprietary accounts of ROTs delivered via AUTOM would be required to be for a minimum size of, at least, the lesser of: (i) The AUTO-X guarantee for the option that is the subject of such an order, or (ii) 20 contracts.[16]

Proposed paragraph (g) of Phlx rule 1014 provides that a Price-Improving ROT/Specialist that enters an order through an electronic interface with AUTOM that results in an improvement in the then-prevailing market disseminated by the Exchange (i.e., raises the bid or lowers the offer) must announce, loudly and audibly in the crowd, that he has improved the displayed market. The proposal also requires that an ROT or specialist that posts a bid or offer through electronic interface with AUTOM, and subsequently elects to cancel such a bid or offer, cancel such bid or offer through the electronic interface.

In addition, the proposal would allow specialists to improve the prevailing market by placing price-improving orders via a similar electronic interface with AUTOM as that used by ROTs. The use of a specific electronic interface is intended to distinguish the specialists' price improving orders under the instant proposed rule from their general two-sided quoting obligations, including quotes generated by Auto-Quote or specialized quote feed.[17]

Inbound orders eligible for execution against ROT or specialist orders entered into AUTOM via electronic interface would be executed by the specialist and allocated, initially, by the individual responsible for allocating trades under existing Exchange rules.[18] No later than January 2004, the Exchange will modify the AUTO-X system [19] and will automatically execute incoming orders against ROT and specialist orders that improve the disseminated price, as well as orders that match such price-improving orders.

Price-Improving, “Matching,” and Special Parity Rule

The other crowd participants (including the specialist) may match a price-improving order through an electronic interface with AUTOM, but must loudly and audibly announce their intention to do so, as well as their size. If Auto-Quote or Specialized Quote Feed matches a price-improving order, the specialist and crowd participants on that quote would be deemed to be matching the price-improving order. In such a situation, the “Special Allocation” would entitle the Price Improving ROT/Specialist to receive the largest number of contracts among all crowd participants that have matched a price-improving order, subject to size.[20] Start Printed Page 68900Any partial contracts would be rounded up in favor of the Price Improving ROT/Specialist. In no event would a Price Improving ROT/Specialist or crowd participant that matches a price-improving order be required to participate in a trade above that Price Improving ROT/Specialist's size.

The Special Allocation would remain in effect until: (1) The lesser of 20 contracts or the AUTO-X guarantee for the option that is the subject of the price-improving quote have been executed against the price-improving quotes eligible to receive an allocation; (2) the ROT or specialist who improved the price cancels the price-improving order; or (3) the original price-improving order is superseded by a new price-improving order, unless the new price-improving order is cancelled before at least one contract executes at the price of the new price-improving order.[21] If any of those conditions are satisfied, the Special Allocation would no longer be in effect, and crowd members with orders that have not been filled would be considered to be on parity. If the specialist were one of the crowd members, the specialist would, consistent with applicable exchange rules, be entitled to receive the specialist guarantee.[22]

Finally, the Exchange represents that it has determined to develop a proposal for an alternative model for ROT access, which would involve giving ROTs the ability to electronically post their own quotations in competition with the specialist and to have their own quotation generation models, as opposed to having their electronic access be limited to sending limit orders on a strike-by-strike basis.[23]

III. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning Amendment No. 8, including whether Amendment No. 8 to the proposed rule change is consistent with the Act. 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 Phlx. All submissions should refer to File No. SR-Phlx-2002-04 and should be submitted by December 4, 2002.

IV. Discussion

After careful review, the Commission finds that the proposed rule change, as amended by Amendments No. 1 through 8, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.[24] The Commission finds that the proposed rule change, which provides a mechanism for members of the trading crowd who improve the disseminated market, or match a price-improved market, to be directly allocated Auto-X order flow, is designed to remove impediments to and perfect the mechanism of a free and open market, promote just and equitable principles of trade, and in general, to protect investors and the public interest, is consistent with section 6(b)(5) of the Act.[25]

The Commission believes that the proposed rule change, once fully implemented,[26] should substantially enhance incentives to quote competitively by automating the process by which trading crowd participants can improve the disseminated quote and by ensuring that the price-improving ROT is rewarded with incoming order flow.[27] Specifically, the Phlx's proposal will allow ROTs to improve the disseminated quote by placing limit orders directly on the limit order book through an electronic interface with Exchange systems. Moreover, the Phlx has represented that it has determined to develop the capability to allow ROTs to electronically post their own quotations in competition with the specialist.

In addition, the Phlx proposal will ensure that price-improving ROTs are rewarded with incoming order flow. The Phlx proposal provides an incentive to improving the disseminated quote by providing the price-improving ROT with an execution of at least 40%, up to 20 contracts, of an incoming order, regardless of whether other market participants, including the specialist, match the price-improving order. For these reasons, the Commission believes that the Phlx's proposal, once fully implemented, will satisfy section IV.B.h.(i)(aa) of the Settlement Order.

Finally, the Commission finds good cause for approving Amendment No. 8 to the proposed rule change prior to the thirtieth day after the date of publication in the Federal Register. Amendment No. 8 eliminates language requiring a person responsible for the allocation of efforts to use best efforts to allocate orders to price-improving ROTs. The Exchange represents that this language is unnecessary because Phlx's system would identify the source of a price-improving order placed on the limit order book. If, for some reason, a specialist experienced any difficulty allocating an order to a price-improving ROT, the identity of the price-improving ROT could readily be determined by the system. Accordingly, there are no novel issues of regulatory concern and the Commission finds good cause for approving Amendment No. 8 to the proposed rule change on an accelerated basis. Start Printed Page 68901

V. Conclusion

It is therefore ordered, pursuant to section 19(b)(2) of the Act [28] that the proposed rule (SR-Phlx-2002-04), as amended by Amendments No. 1 through 7, is approved and Amendment No. 8 is approved on an accelerated basis.

Start Signature

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[29]

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble

Footnotes

3.  AUTOM is the Exchange's electronic order delivery and reporting system, which provides for the automatic entry and routing of equity option and index option orders to the Exchange trading floor. Orders delivered through AUTOM may be executed manually, or certain orders are eligible for AUTOM's automatic execution feature (“AUTO-X”). Equity option and index option specialists are required by the Exchange to participate in AUTOM and its features and enhancements. Option orders entered by Exchange members into AUTOM are routed to the appropriate specialist unit on the Exchange trading floor.

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4.  A ROT is a regular member or a foreign currency options participant of the Exchange located on the trading floor who has received permission from the Exchange to trade in options for his own account. See Phlx rule 1014(b).

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5.  See letter from Richard S. Rudolph, Director and Counsel, Phlx, to Nancy J. Sanow, Assistant Director, Division of Market Regulation (“Division”), Commission, dated March 5, 2002 (“Amendment No. 1”).

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6.  See letter from Richard S. Rudolph, Director and Counsel, Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, dated March 13, 2002 (“Amendment No. 2”).

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7.  See letter from Richard S. Rudolph, Director and Counsel, Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, dated March 25, 2002 (“Amendment No. 3”).

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8.  See letter from Richard S. Rudolph, Director and Counsel, Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, dated April 1, 2002 (“Amendment No. 4”).

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9.  See letter from Richard S. Rudolph, Director and Counsel, Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, dated May 15, 2002 (“Amendment No. 5”).

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10.  See letter from Richard S. Rudolph, Director and Counsel, Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, dated June 11, 2002 (“Amendment No. 6”).

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11.  See letter from Richard S. Rudolph, Director and Counsel, Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, dated June 18, 2002 (“Amendment No. 7”).

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12.  See Securities Exchange Act release No. 46095 (June 20, 2002), 67 FR 43372.

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13.  See letter from Richard S. Rudolph, Director and Counsel, Phlx, to Deborah Lassman Flynn, Assistant Director, Division, Commission, dated October 31, 2002 (“Amendment No. 8”). In Amendment No. 8, the Phlx proposes to eliminate the language contained in proposed Phlx rule 1014(g)(i)(B)(5) regarding the use of “best efforts” in the allocation of orders. The Phlx has determined that the proposed language is unnecessary because the price-improving ROT's identification information will be input into the system at the time the ROT's order is placed on the limit order book and, therefore, will be available to the person responsible for the allocation of orders at the time that an execution occurs at that price.

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14.  The electronic “limit order book” is the Exchange's automated specialist limit order book, to which all unexecuted limit orders routed to the Exchange through AUTOM are displayed on the basis of price-time priority. Orders not delivered through AUTOM also may be entered onto the limit order book. See Phlx rule 1080, commentary.02.

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15.  The Exchange has defined an agency order as any order entered on behalf of a public customer, and does not include any order entered for the account of a broker-dealer, or any account in which a broker-dealer or an associated person of a broker-dealer has any direct or indirect interest. See, e.g., Phlx rule 229.02. See also, Securities Exchange Act release No. 40970 (January 25, 1999), 64 FR 4922 (February 1, 1999) (File No. SR-Phlx-98-44).

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16.  This requirement applies only to Phlx ROT and specialist orders entered via electronic interface.

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17.  A specialist may establish a specialized connection with AUTOM, known as a specialized quote feed, which enables the specialist to provide quotations based on a proprietary pricing model, by-passing the Exchange's Auto-Quote System. See Phlx rule 1080, Commentary. 01(c).

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18.  Currently, under the Exchange's Option Floor Procedure Advice (“OFPA”) F-2, the largest participant in a trade is responsible for allocating contracts to crowd participants. In a separate rule proposal, the Exchange has proposed amendments to OFPA F-2 and rule 1014(g) regarding who is responsible for allocating a trade. Under that proposal, if a trade involved a floor broker, the floor broker would be responsible for allocating contracts among crowd participants but could delegate the responsibility to the specialist or an assistant to the specialist under the specialist's direct supervision (“Assistant”), provided that the specialist (or Assistant) agrees to be responsible for allocating the trades. In all other cases where the specialist is a participant, the specialist or Assistant would allocate the trade. If neither the specialist nor floor broker is involved, but there is more than one buyer or seller, the largest participant would be responsible for allocating trades. If neither the specialist nor floor broker is involved, and there is only one buyer and seller, the seller would be responsible for allocating trades. See File no. SR-Phlx-2001-28.

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19.  The Exchange will deploy the modified system over a 15-month period. Proposed commentary .04 to Phlx rule 1080.

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20.  Proposed Phlx rule 1014(g)(i)(B)(1) would entitle a Price Improving ROT/Specialist to participate in at least 60% of the contracts in the transaction if matched by one single crowd participant. If the Price Improving ROT/Specialist's order is matched by two or more crowd participants (including the specialist), the Price Improving ROT/Specialist would be entitled to participate in at least 40% of the contracts in the transaction; a matching specialist would be entitled to participate in 30%, and other crowd participants on parity with the Price Improving ROT/Specialist would be entitled to participate in 30% of the contracts in the transaction, in the aggregate. If matched by two or more crowd participants (but not the specialist), the Price Improving ROT/Specialist would be entitled to participate in 40% of the contracts in the transaction, and the other crowd participants would be entitled to participate in 60% of the transaction, in the aggregate.

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21.  See proposed Phlx rule 1014(g)(i)(B)(2). The Exchange represents that the purpose of this third condition is to eliminate the possibility that a crowd participant could, by placing and then immediately canceling a price-improving order, cause a Price Improving ROT/Specialist to lose its entitlement under the Special Allocation.

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22.  Pursuant to Phlx rule 1014(g)(ii), the specialist is entitled to receive an allocation of up to 40% of an incoming order, when the specialist is on parity with the best quote.

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23.  Under this approach, the Exchange would adopt a new trade allocation rule similar to that of the International Securities Exchange rule 713. Subject to approval under the governance requirements set forth in the Exchange's rules and in the Act, the Exchange would submit the proposal for Commission approval as the permanent solution to compliance with section IV.B.h.(i)(aa) of the Settlement Order.

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24.  In approving the proposed rule change, the Commission notes that it has considered its impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

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26.  The Phlx plans to file for Commission approval a plan to fully implement the proposed rule change. See letter from Lanny A. Schwartz, Executive Vice President and General Counsel, Phlx, to Elizabeth King, Associate Director, Commission, dated October 31, 2002.

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27.  The Exchange filed this proposed rule change pursuant to the requirements of section IV.B.h.(i)(aa) of the Commission's September 11, 2000, Order Instituting Administrative Proceedings Pursuant to section 19(h)(1) of the Act, which required the Phlx (as well as other floor-based options exchanges) to adopt new, or amend existing rules to substantially enhance incentives to quote competitively and substantially reduce disincentives to act competitively (“Settlement Order”). See Securities Exchange Act release no. 43268 (September 11, 2000), Administrative Proceeding file no. 3-10282.

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[FR Doc. 02-28747 Filed 11-12-02; 8:45 am]

BILLING CODE 8010-01X-P