On June 2, 2003, the Philadelphia Stock Exchange, Inc. (“Phlx” or “Exchange”), filed with the Securities and Exchange Commission (“Commission” or “SEC”) a proposed rule change pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”)
On August 1, 2003, the Exchange submitted Amendment No. 2 to the proposed rule change.
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., Pacific Exchange, Inc. and Phlx (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
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 will 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.
The Exchange proposes to effect rule changes on a permanent basis to support the implementation of its new system, known as FBMS. FBMS would create an accurate, time-sequenced electronic options order audit trail for manual orders received by the Exchange's floor brokers
FBMS is a component of AUTOM
Specifically, proposed Phlx Rule 1063(e) sets forth the requirement that a floor broker or such floor broker's employees must, contemporaneously upon receipt of an order and prior to the representation of such an order in the crowd, record the required information regarding all option orders represented by such floor broker onto the System. Additionally, the proposed rule change provides that upon the execution of such an order, the floor broker would be required to enter the time of execution of the trade.
Proposed Phlx Rule 1063(e) would require floor brokers or their employees to record the following specific information onto the System upon receipt of an order: (i) The order type (
With regard to FLEX, Foreign Currency, and Customized Foreign Currency Options, under proposed Phlx Rule 1063(f), floor brokers or their employees would be required to enter the above-described data elements into the Exchange's electronic audit trail in the same electronic format as the required information for equity and index options. Floor brokers or their employees must enter the required information for FLEX, Foreign Currency and Customized Foreign Currency Options into the electronic audit trail on the same business day that a specific event surrounding the lifecycle of an order in FLEX, Foreign Currency, or Customized Foreign Currency Options (including, without limitation, orders, price or size changes, execution or cancellation) occurs.
Currently, various Exchange rules require floor brokers to mark trade tickets with certain notations, depending on the type of trade and the crowd participants involved. The Exchange is proposing to amend its rules concerning the ticket marking requirements so that floor brokers would be required to enter similar notations onto the System. For example, the Exchange is proposing to amend Phlx Rule 1015 and corresponding OFPA A–11 to require that a floor broker or his employees make the appropriate notice in the FBMS when an order is for the account of a broker/dealer. Also, by way of example, the Exchange is proposing to amend Phlx OFPA C–3 to require in the situation in which a floor broker represents an order for a market maker on another national securities exchange, such floor broker or his employees must so indicate on the FBMS and must ensure that the order is represented in the trading crowd as a “BD” order for the purposes of the Exchange's yielding requirements.
Proposed Phlx Rule 1063 would require that, in the event of a malfunction in the FBMS, floor brokers would be required to record the required information on trade tickets, and would not be permitted to represent an order for execution which has not been time stamped with the time of entry on the trading floor. Such trade tickets would be required to be time stamped upon the execution of such an order. This reflects the current practice of recording information concerning orders represented and executed by options floor brokers onto trade tickets, and using time stamps to record the time of receipt of an order, and the time of execution. Once it is determined that such malfunction no longer exists, floor brokers or their employees would be required to enter the required information that is recorded on such trade tickets into AUTOM, using the FBMS, for inclusion in the electronic audit trail.
Proposed Phlx Rule 1063(e) would require floor brokers or their employees to enter clearing information onto the FBMS no later than five minutes after the execution of a trade. Such clearing information would be required to include the account number(s) of each contra-side participant to the floor broker's trade in the crowd and the number of contracts bought or sold, which would be immediately reported via AUTOM to the clearing firm of each crowd participant involved in the trade. Once the clearing information is reported, crowd participants involved in the trade would receive a position update, enabling them to know their respective positions on a real-time basis and to make appropriate, informed and timely hedging and transactional decisions.
Currently, Exchange members or member organizations that initiate an options transaction are required to report the execution of such trades within 90 seconds of the execution.
The Exchange is also proposing amendments to Phlx Rule 1051 and OFPA F–2 in order to address the situation in which a floor broker who initiates a transaction executes all or a portion of the transaction against a contra-side limit order on the specialist's limit order book.
The proposed amendment would require that when an order represented by a floor broker is executed against a limit order on the book, the specialist must report or ensure that the portion of the transaction represented by such specialist is reported to the tape. The purpose of this provision is to address the situation in which an order represented by a floor broker executes a booked limit order is executed by the specialist, in which case AUTOM automatically reports the execution of the booked limit order. Thus, the floor broker in this situation would not be required to report that portion of the transaction on the System, despite the fact that the floor broker involved may have in fact “initiated” the transaction. If the booked limit order represents the entire contra-side to the order represented by the floor broker, the specialist would be required to report the entire transaction. If the booked limit order represents a portion of the transaction, the specialist would be required to report that portion of the transaction, while the floor broker initiating the transaction would be responsible for reporting the remaining portion of the transaction he or she initiated.
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
The Commission believes that the rules as proposed should allow the Exchange to comply with its obligations under the Order in that they will result in the creation of an audit trail that incorporates manual orders sent to Phlx. Specifically, the proposed rules would require that Phlx floor brokers enter certain order details contemporaneously upon receipt and prior to representation into the FBMS. Once an order is entered into the FBMS, the System would automatically timestamp the order as received by the Exchange and assign it a unique order identification number, which allows the system to track the order through its life on the floor up to the point of execution. Upon execution, the floor broker would enter the time the execution took place. Floor brokers or their employees would then be required to enter clearing information onto the FBMS no later than five minutes after the execution of a trade.
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 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 AUTOM so that it can be incorporated into the electronic audit trail.
Finally, the Commission notes that the Exchange acknowledges the need for effective and proactive surveillance for activities such as trading ahead and front-running. The Exchange represents that it currently conducts automated surveillance for such activities and will incorporate a review of order entry into the System as part of such surveillance. Further, the Exchange states that it also intends to implement supplementary surveillance and examination programs related to the requirement to enter order information into the FBMS, which will be designed to address, among other things, trading ahead and front-running. The Commission views effective surveillance relating to the use of the FBMS 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 approving Amendments No. 2, 3, 4, and 5 to the proposed rule change, prior to the thirtieth day after the date of the publication of notice thereof in the
Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods:
• Use the Commission's Internet comment form
• Send an E-mail to
• Send paper comments in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549–0609. All submissions should refer to SR–Phlx–2003–40. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site
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,
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.