[Federal Register Volume 64, Number 62 (Thursday, April 1, 1999)]
[Notices]
[Pages 15857-15866]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-8061]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41210; File No. SR-Phlx-96-14]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Order Approving Proposed Rule Change and Notice of Filing and Order 
Granting Accelerated Approval to Amendment Nos. 3 and 4 to Proposed 
Rule Change Relating to the Establishment of a Daily Pre-Opening 
Session for the Matching of Orders at the Volume Weighted Average Price

March 24, 1999.

I. Introduction

    On April 29, 1996, the Philadelphia Stock Exchange, Inc. 
(``Exchange'' or ``Phlx'') submitted to the Securities and Exchange 
Commission (``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 that would establish a daily pre-
opening order matching session (``Session'') for the execution of 
large-sized stock orders at the volume weighted average price 
(``VWAPTM'').\3\ The Session would be conducted through the 
VWAP Trading System (``VTSTM''), which would be operated as 
a facility of the Exchange. The VTS is a system module of the Universal 
Trading System (``UTSTM'') \4\ that was developed by 
Universal

[[Page 15858]]

Trading Technologies Corporation (``UTTC'').\5\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ VWAPTM is a registered trademark of the Dover 
Group, Inc.
    \4\ The VTSTM and UTSTM trademarks are the 
property of Universal Trading Technologies Corporation.
    \5\ UTTC is a subsidiary of the Ashton Technology Group. UTTC 
has developed three electronic trading system modules as part of its 
UTS architecture: (i) the VWAP Trading System 
(``VTSTM''); (ii) the Electronic Auction System 
(``eASTM''); and (iii) the Electronic Public Limit Order 
Book (``ePLOBTM''). This proposed rule change relates 
only to the VTS.
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    On July 26, 1996, the Exchange submitted Amendment No. 1 to the 
proposed rule change.\6\ The proposed rule change, including Amendment 
No. 1, was published for comment in the Federal Register on September 
11, 1996.\7\ No comments were received on the proposal or Amendment No. 
1. The Exchange submitted Amendment No. 2 to the proposed rule change 
on October 29, 1997.\8\ The proposed rule change, as modified by 
Amendment No. 2, was published for comment in the Federal Register on 
December 31, 1997.\9\ No comments were received on Amendment No. 2. On 
December 14, 1998, the Exchange submitted Amendment No. 3 to the 
proposed rule change.\10\ Finally, on February 12, 1999, the Exchange 
submitted Amendment No. 4.\11\ This order approves the proposed rule 
change, as amended, and Amendment Nos. 3 and 4 on an accelerated basis.
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    \6\ Amendment No. 1 discussed then proposed reporting procedures 
and mechanisms relating to Nasdaq Stock Market issues that would be 
matched during the Session. See Letter from Gerald D. O'Connell, 
Senior Vice President, Market Regulation and Trading Operations, 
Exchange, to Jennifer Choi, Attorney, Division of Market Regulation 
(``Division''), Commission, dated July 26, 1996. Amendment No. 1 is 
of no import because the proposed rule change has been revised such 
that Nasdaq Stock Market issues are no longer eligible for matching 
during the Session.
    \7\ Securities Exchange Act Release No. 37640 (Sept. 4, 1996), 
61 FR 47993 (Sept. 11, 1996).
    \8\ In Amendment No. 2, the Exchange: (1) clarified the 
responsibilities and functions of the Exchange and the VTS; (2) 
excluded over-the-counter securities (i.e., Nasdaq Stock Market 
issues) from matching during the Session; (3) proposed that a VTS 
terminal be located on the Exchange's equity trading floor; (4) 
prohibited Exchange floor members from VTS matching in non-specialty 
issues; (5) revised and detailed matching priority provisions; (6) 
updated order types and order entry procedures; (7) clarified 
participation and subscriber access; (8) defined the ``extraordinary 
circumstances'' under which the Exchange may modify the order entry 
time period; and (9) specified the liability of the Exchange with 
respect to the operation of the VTS. See Letter and attachment from 
Philip H. Becker, Senior Vice President and General Counsel, 
Exchange, to Belinda Blaine, Associate Director, Division, 
Commission, dated October 28, 1997.
    \9\ Securities Exchange Act Release No. 39481 (Dec. 22, 1997), 
62 FR 68339 (Dec. 31, 1997).
    \10\ In Amendment No. 3, the Exchange represented that UTTC 
agreed to operate the VTS through UTTC's wholly-owned broker-dealer 
subsidiary, REB Securities (``REB''), and that REB would be 
responsible for conducting compliance activities relating to the 
VTS. In addition, the Exchange: (1) agreed to operate the VTS as a 
facility of the Exchange for a one year pilot period; (2) agreed to 
limit the securities eligible for matching through the VTS to 300 of 
the most highly-liquid and highly-capitalized issues listed on the 
New York Stock Exchange; (3) proposed to delete the required 
dissemination of a single volume print at 9:20 A.M.; (4) clarified 
the proposed definition of ``institution''; (5) committed to prepare 
a report regarding the number of tape corrections and how they 
affect the VWAP values calculated by the Exchange; and (6) modified 
from 4:02 P.M. to 4:01:30 P.M. the cut-off time that is designed to 
capture trade reporting run-off and any sales that occur at the 
close of regular trading. See Letter and attachment from Edith 
Hallahan, First Vice President and Deputy General Counsel, Exchange, 
to Michael Walinskas, Deputy Associate Director, Division, 
Commission, dated December 11, 1998.
    \11\ In Amendment No. 4, the Exchange agreed to report pre-
opening VWAP volumes for each eligible security in which matches had 
been effected during the Session. The Exchange also separately 
submitted confidential surveillance procedures. See Letter from 
Adrienne Y. Hart, Vice President, Market Surveillance, Exchange, to 
Michael Walinskas, Deputy Associate Director, Division, Commission, 
and John A. McCarthy, Assistant Director, Office of Compliance 
Inspections and Examinations (``OCIE'', Commission, dated February 
8, 1999; and letter from Kenneth J. Meaden, Senior Vice President, 
Exchange, to John McCarthy, OCIE, Commission, dated February 1, 
1999.
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    Under separate cover, the Exchange has requested from the 
Commission exemptive and interpretive relief regarding Rules 10a-1, 
10b-18, 11a2-2(T), 11Aa3-2, and 11Ac1-1 under the Act.\12\ The 
Commission has issued a letter separate from this order that grants the 
Exchange exemptive relief from Rule 10a-1 and provides interpretive 
relief regarding Rule 11a2-2(T).\13\ In Section III of this order, the 
Commission addresses the Exchange's interpretive requests regarding 
Rules 11Aa3-2 and 11Ac1-1. With respect to the Exchange's request 
concerning Rule 10b-18, the Commission will respond to the Exchange at 
a later date.
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    \12\ See Letter from Edith Hallahan, Associate General Counsel, 
Exchange, to Larry E. Bergmann, Associate Director, Division, 
Commission, dated June 5, 1998.
    \13\ See Letter from Larry E. Bergmann, Associate Director, 
Division, Commission, to Edith Hallahan, Associate General Counsel, 
Exchange, dated March 24, 1999 (``Exemptive Relief Letter'').
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II. Description of the Proposal

    The Exchange seeks to adopt proposed Exchange Rule 237, ``The 
Universal Trading System Morning Session,'' to govern the operation of 
the VTS or ``System'' \14\ for a one year pilot period. During the 
Session, the System will electronically accept large-sized stock orders 
and match the orders for execution according to an algorithm developed 
by UTTC. The matched and executed orders will be assigned a final VWAP 
after the close of regular trading. UTTC developed the System pursuant 
to an agreement with the Exchange. The System will operate as a 
facility of the Exchange under Section 3(a)(2) of the Act.\15\ 
Specifically, the System will utilize Exchange equipment and 
personnel,\16\ floor trader participation, and the Stock Clearing 
Corporation of Philadelphia (``SCCP'') to process System trades. 
Matches performed during the Session will be regulated and reported as 
Exchange trades. In addition, matches performed by the System will be 
subject to transaction and access fees as established in the Exchange's 
fees schedule.\17\
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    \14\ For ease of reference, the term ``System'' shall be used in 
place of VTS and UTS.
    \15\ 15 U.S.C. 78c(a)(2).
    \16\ UTTC technical personnel will assist the Exchange in 
operating the System.
    \17\ Apart from adopting proposed Exchange Rule 237, the 
Exchange also seeks to make a conforming change to Exchange Rule 
101, ``Hours of Business'' to include the Session as an exception to 
regular trading hours.
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A. Stocks Eligible for Matching During the Session

    Approximately 300 of the most highly-capitalized and highly-liquid 
securities that trade on the New Stock Exchange (``NYSE'') will be 
eligible for matching during the Session. To select these stocks, the 
Exchange will use Standard and Poor's market data to identify the top 
400 NYSE-listed issues in terms of market capitalization. Each stock 
selected must have a market price below $200 per share. Next, the 
Exchange will rank the 400 stocks according to their average dollar 
volumes over the previous 20 days of trading. The Exchange will 
designate the top 300 stocks as eligible for matching during the 
Session. The Exchange will repeat this screening process every six 
months to ensure that the stocks eligible for matching by the System 
are highly-capitalized and highly-liquid.

B. System Participants

    Access to the System will be limited to ``Committers'' and 
``Users'' (collectively ``Participants''). Committers will be permitted 
to enter ``Commitments'' while Users will be allowed to enter 
``Orders.'' Although Exchange members may participate as either 
Committers or Users, they may not participate as both Committer and or 
Users, they may not participate as both Committer and User in the same 
security for the same account during the same Session.
1. Committer
    ``Committer'' status will be restricted to Exchange members that 
are: (i) Phlx Floor Traders (i.e, Phlx Specialist or Phlx Alternate 
Specialist in the eligible stock that is the subject of the

[[Page 15859]]

Commitment); or (ii) Phlx Off-Floor Liquidity Providers (members that 
commit to provide contra-side liquidity). Committers agree to provide 
on a proprietary basis contra-side liquidity by specifying their 
Committments; however, Off-Floor Liquidity Providers can only engage as 
Committers for their proprietary accounts.
    Exchange members must register with the Exchange prior to acting as 
a Committer. Committers will be permitted to designate the eligible 
issues for which they wish to make Commitments. For each eligible issue 
selected, Committers will be required to provide a minimum volume 
guarantee of 2,500 shares for each side of the market.\18\ All 
Commitments must be entered in 500 share increments.
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    \18\ Although the minimum Commitment size on each side of the 
market is 2,500 shares, a Committer need to make identical 
Commitments on both sides of the market. For example, a Committer 
could agree to buy 2,500 shares and sell 5,000 shares at VWAP.
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    Commitments must be entered directly by System subscribers or 
through the System's trading floor terminal at the Exchange.\19\ 
Commitments may be entered and modified during the ``Order Entry Time 
Period'' (5:00 A.M. to 9:15 A.M.).\20\ and during any other periods the 
Exchange may specify.\21\ Commitments may be entered as ``day-
Commitments'' or ``good-till-canceled (``GTC'') Commitments.'' GTC 
Commitments remain in effect for each Session until canceled and must 
be established (and canceled) through the enrollment process.\22\
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    \19\ To facilitate Floor Trader participation, the Exchange 
proposes to install a System terminal on the equity trading floor 
for the entry and reporting of Orders and Commitments.
    \20\ Unless otherwise indicated, all times referenced throughout 
this order are Eastern Standard Times.
    \21\ For example, the Exchange may allow the entry and 
modification of Commitments during certain times the previous day, 
effective for the next day's Session. Because matching occurs only 
during the Session, the additional period would simply provide extra 
time for the entry of Commitments.
    \22\ The enrollment process is the formal mechanism by which 
Participants enter into a contractual arrangement to use the System. 
System activation is dependent upon completing the enrollment 
process and submitting the requisite agreements and forms. 
Enrollment parameters, including GTC commitments, may be modified 
through procedures established by the Exchange. Prior to activation, 
all Users and Committers must provide proof of the review and 
approval of their enrollment parameters by their compliance officer.
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    Commitments may be restricted to execution against non-members 
only. At no time will Commitments may be matched with other 
Commitments. Commitments are executable only through the System.
2. User
    ``User'' status would be available to Exchange members and non-
members. However, Exchange floor members could participate as Users 
only in their specialty issues. Under the proposal, Orders may only be 
placed by and for enrolled Users. Users may enter Orders for customer 
or proprietary (dealer or principal) accounts.
    Orders will be eligible for matching by the System only on the day 
the Order is entered. The minimum size for individual Orders is 5,000 
shares. Like Commitments, all Orders must be entered in 500 share 
increments.
    Users may enter Orders directly into System terminals as 
subscribers or through subscribing brokers; subscribing brokers may be 
members or non-members. The Exchange has noted, however, that 
participation through subscribing brokers may affect matching priority.
    All non-member Orders entered through a broker must be entered 
through an Exchange member or through a non-member broker with the 
appropriate ``give-up agreement'' \23\ and ``three-way agreement'' \24\ 
in place. Non-member Orders also may be entered directly by subscribing 
non-members who have in place with an Exchange member give-up and 
three-way agreements.\25\
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    \23\ A clearing agreement or ``give-up agreement'' is intended 
to ensure that a SCCP member, who must also be an Exchange member, 
has assumed responsibility for the order. Give-up agreements with 
non-members must be submitted in advance to the Exchange's 
Examinations Department and must define the credit limits for the 
customer.
    \24\ The Exchange, the Exchange/SCCP member, and the non-member 
User are the parties to a ``three-way agreement.'' Under the 
agreement, the Exchange member must agree to be jointly and 
severally liable for actions of the non-member User through the 
System. In return, the non-member User must agree to adhere to all 
applicable by-laws and rules of the Exchange. The Exchange clarified 
that neither it nor the SCCP approves credit limits established by 
an Exchange/SCCP member for its non-member customer as part of a 
three-way agreement. See Letter from Philip H. Becker, Senior Vice 
President and Chief Regulatory Officer, Exchange, to Ivette Lopez, 
Assistant Director, Division, Commission, dated December 10, 1996. 
The letter also clarified that an Exchange ``clearing member'' is an 
Exchange member that also is a member of the SCCP.
    \25\ The Exchange submitted to the Commission a letter stating 
that the Exchange did not intend for the sample three-way agreement, 
which was previously provided to the Commission, to be considered 
part of the Exchange's proposed rule change. See Letter from Edith 
Hallahan, First Vice President and Deputy General Counsel, Exchange, 
to Michael Walinskas, Deputy Associate Director, Division, 
Commission, dated March 24, 1999. The letter also represented that 
the Exchange will withdraw from any final three-way agreement 
language stating that the Exchange has the right to terminate a 
User's access to the System ``without prior notice for any reasons 
or no reason whatsoever.'' The Commission notes that such language 
raises important issues concerning appropriate access to the System.
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    As with all Exchange trades, System matches will require both a 
Phlx and SCCP member to be involved. Therefore, all Committers and 
Users must specify both an executing and clearing account during the 
enrollment process. The Exchange and the SCCP will perform trade 
reconciliation and confirmation functions. System trades will then be 
forwarded to the National Securities Clearing Corporation (``NSCC'') 
for clearance and settlement.\26\
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    \26\ The Exchange recently restructured the clearance and 
settlement business offered through its wholly owned subsidiary, 
SCCP. The SCCP no longer maintains its continuous net settlement 
system for conducting settlements between the SCCP and its members. 
As a result, the SCCP ceased providing the cash settlement services 
attendant to the settlement process of the Philadelphia Depository 
Trust Company. However, the SCCP continues to offer limited clearing 
and settlement services to Exchange members. See Securities Exchange 
Act Release No. 39444 (Dec. 11, 1997), 62 FR 66703 (Dec. 19, 1997).
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C. Entry of Orders and Commitments

    Only Orders and Commitments that are entered through the System 
will be eligible for matching and execution by the System during the 
Session. Under no circumstances will Orders or Commitments migrate to 
the Exchange's regular equity trading session. Because all Orders and 
Commitments remain anonymous, the identity of Users and Committers will 
not be revealed to other Participants.
    Orders and Commitments will only be accepted into the System from 
5:00 A.M. to 9:15:00 A.M. (``Order Entry Time Period''). The Order 
Entry Time Period ends approximately 15 minutes prior to the opening of 
the Exchange's regular trading session (9:30 A.M.-4:00 P.M.). However, 
as previously mentioned, the Exchange may establish a different period 
for the entry of Orders and Commitments into System's equity trading 
floor terminal.\27\ Orders and Commitments may be canceled \28\ or 
modified before the end of the Order Entry Time Period. Confirmation of 
the placement and cancellation of an Order

[[Page 15860]]

or Commitment will occur electronically through the System.
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    \27\ If the Exchange establishes any alternative time period for 
the entry of Orders and Commitments, the alternative time period 
should not allow Orders and Commitments placed through the System's 
equity trading floor terminal to be entered at a time after which 
all other methods of access to the System have been closed. For 
example, it would not be permissible to establish a general cut-off 
time for Order and Commitment entry of 9:15 A.M. but allow Orders 
and Commitments to be entered through the System's equity trading 
floor trading terminal until 9:16 A.M.
    \28\ Orders and Commitments may be canceled through the System 
until 9:15:00 A.M. by using the appropriate designator (``CXL'').
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    When entering Orders or Commitments, Participants will be required 
to provide a description of the Order or Commitment, as well as account 
identification information needed to determine priority and 
eligibility. Participants must provide the following information when 
entering an Order or Commitment:
     Buy/Sell designation;
     Volume (number of shares). As previously stated, the 
minimum size for Commitments is 2,500 shares and the minimum size for 
Orders is 5,000 shares. All Commitments and Orders must be entered in 
500 share increments;\29\
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    \29\ The Exchange's Floor Procedures Committee may determine 
whether to establish: (i) alternative minimum sizes for Commitments 
and Orders; or (ii) alternative minimum increment sizes. Any 
adjustments to Order, Commitment, or increment sizes are required to 
be based on market and participant need, and are subject to prior 
written notice.
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     Stock symbol;
     Participant status: Committer or User;
     Committer account status: Off-Floor Liquidity Provider, 
Specialist, or Alternate Specialist;
     User account status: Member or non-member, and Order type 
(basic, cross, facilitation, also including any constraints or 
restrictions);
     Clearing account number;
     Trade account information (Exchange executing account 
number); and
     Subscriber identification number.

D. Types of Orders

    Users may enter three types of Orders: (i) basic; (ii) cross; and 
(iii) facilitation. A User may designate its basic and facilitation 
Orders as either unconstrained (meaning executable to the extent 
possible) or constrained.
1. Constraints
    Two constraints are available to Users in connection with basic and 
facilitation Orders: all-or-none (``AON'') and minimum-or-none 
(``MON''). The AON constraint means that the User wants to execute all 
shares of the Order or none at all. The MON constraint means that the 
User wants to execute at least a specified number of shares of the 
Order or none at all.
2. Basic Order
    A basic Order is a standard, one-sided Order to buy or sell. A 
basic Order may be restricted, meaning it is executable against non-
members only.
3. Cross Order
    A cross Order is a two-sided Order, with both sides comprised of 
non-member interest, with instructions to match the identified buy-side 
with the identified sell-side. The two sides making up a cross can be 
entered separately, with the contra-side identified. If the sizes do 
not match, the remainder is left unexecuted.
4. Facilitation Order
    A facilitation Order is a two-sided Order, with an identified Phlx 
member on the contra-side to act as a facilitator for that Order, and 
is known as a ``Guarantor.'' The contra-side may be entered together 
with, or separate from, the facilitation Order; if the sizes do not 
match, the remainder is left unexecuted. Facilitation Orders can be 
submitted on behalf of Phlx members or non-members. Unlike basic 
orders, facilitation Orders may not be restricted.
    Three types of facilitation orders are available to Users: (i) 
Unconditional facilitation: execute against an identified Guarantor or 
not at all. This Order is a type of cross involving a Phlx member 
Guarantor; (ii) conditional facilitation: execute against an identified 
Guarantor after attempting to be executed against non-members to the 
extent possible; and (iii) last resort facilitation: execute against an 
identified Guarantor only after attempting to execute against all other 
Orders and Commitments to the extent possible.

E. Execution Priority Rules

    Orders and Commitments will be matched for execution by the System 
at approximately 9:16 a.m. Trades matched and executed through the 
System are printed and cleared as Exchange transactions, executed on 
the Exchange and processed through SCCP.
1. Orders
    Generally, Orders are afforded priority by: (i) Account type 
(account types are based on status as a Phlx member or non-member, type 
of non-member account, constraints, and direct subscription versus 
broker access); (ii) Order size (largest first); and (iii) 
chronological basis measured by time-of-entry (for Orders of the same 
account type and size).
2. Commitments
    Commitments are prioritized based on: (i) Sub-account types (Phlx 
Off-Floor Liquidity Providers first, then Specialists, and Alternate 
Specialists); and (ii) Commitment size (largest first). For Commitments 
of the same size, priority rotates among Committers with the fewest 
aggregate shares (in all eligible securities) matched through the 
System at that time.
3. Liquidity Rotation Parameter
    Although priority is generally based on size, the ``Liquidity 
Rotation Parameter'' (``LRP'') provides that Order and Commitment 
participation will rotate in 25,000 share increments, as opposed to 
filling the largest Order or Commitment first. The LRP is intended to 
ensure fair allocation. The LRP operates within each matching step 
(after Step 1) to match Orders/Commitments in 25,000 share increments, 
moving to the next Order/Commitment after 25,000 shares have been 
matched, and then, after all other Orders/Commitments have received 
their first 25,000 share match, returning to the unfilled portion of 
the first Order/Commitment. Under the proposal, the Exchange's Floor 
Procedure Committee may establish a different LRP size based on 
operational experience, practicality, and demonstrated market need.

F. The Matching Algorithm

    Execution priority is determined in accordance with the matching 
algorithm that consists of 23 matching steps. In step 1, two-sided 
Orders are matched in the following order:
     Non-member/Non-member cross Orders.
     Non-member/Member unconditional facilitation Orders.
     Member/Member unconditional facilitation Orders.
     Any unmatched ``residue'' due to the excess size entered 
by one side remain unexecuted. It is important to remember that Step 1 
matches unconditional facilitation Orders.
    In step 2, non-member unconstrained Orders (basic and facilitation) 
are matched with non-member unconstrained Orders. As with all matching 
steps, priority is determined based on size and time of entry.
    In step 3, remaining non-member unconstrained Orders are matched 
with non-member constrained (AON and MON) Orders. Any non-member 
constrained Orders not matched with the unconstrained Orders left over 
from step 1 are then matched with other non-member constrained Orders.
    In step 4, remaining non-member Orders are matched with non-member 
institutions' \30\ Orders participating

[[Page 15861]]

through a broker. Such non-member institutions' Orders are then matched 
with each other. (Non-member institutions entering Orders directly 
would have participated in steps 2 and 3). It should be noted that 
constraints are not relevant to determining priority in step 4 among 
institutions participating through a broker.
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    \30\ The proposal defines an institution as ``an entity not 
registered as a broker-dealer or doing business as a hedge fund that 
serves in a fiduciary capacity.'' The Exchange believes such 
entities include, but are not limited to: qualified pension plans, 
investment companies registered under the Investment Company Act of 
1940, bank trust departments, corporations that purchase securities 
for corporate purposes, and insurance companies.
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    In step 5, remaining non-member Orders are matched with non-member 
non-institution Orders participating through a broker. After non-member 
non-institution Orders participating through a broker are matched 
against the unmatched Orders of non-members, such non-member non-
institution Orders are matched with each other. (Non-member non-
institution Orders include non-member broker-dealer Orders as well as 
non-member, non-broker-dealer, non-institution Orders, such as retail 
customers).
    In step 6, remaining non-member Orders are matched with Orders of 
non-member broker-dealers that subscribe directly. Orders of non-member 
broker-dealers that subscribe directly are then matched with each 
other. Thus, step 6 matches non-member Orders (both constrained and 
unconstrained) for non-member broker-dealers. (As opposed to dealer 
activity, if a non-member broker-dealer is acting as a broker, the 
Order would already be matched in steps 4 and 5).
    By step 7, the matching process is ended with respect to non-member 
Orders. Any remaining non-member Orders that are restricted to matching 
with other non-members only are removed. The removed unmatched Orders 
may be matched later according to step 23.
    In step 8, remaining non-member conditional facilitation Orders are 
matched with their conditional Guarantors (facilitating members). These 
conditional Orders--which were first subject to matching against other 
non-member Orders in prior steps--are now eligible for matching against 
the identified Guarantor (a Phlx member).
    In step 9, remaining non-member Orders are matched with member 
Orders participating through brokers. Any unmatched member Orders 
participating through brokers are removed.
    In step 10, remaining non-member Orders are matched with Orders of 
off-floor members. Any unmatched off-floor members' Orders are removed.
    In step 11, remaining non-member Orders are matched with Orders of 
Exchange floor members. Any unmatched Exchange floor members' Orders 
are removed. This includes one-sided Orders (as opposed to Commitments) 
of Specialists and Alternate Specialists.
    In step 12, remaining non-member Orders are matched with 
Commitments of Exchange Off-Floor Liquidity Providers. Any unmatched 
Commitments of Exchange Off-Floor Liquidity Providers are removed.
    In step 13, remaining non-member Orders are matched with 
Commitments of Specialists. Any unmatched Specialist Commitments are 
removed.
    In step 14, remaining non-member Orders are matched with 
Commitments of Alternate Specialists. Any unmatched Alternate 
Specialist Commitments are removed.
    In step 15, remaining non-member Orders are matched with member 
facilitation Orders (those with conditional or last resort Guarantors). 
Note that unconditional facilitation Orders previously were matched in 
step 1.
    In step 16, non-member last resort facilitation Orders are matched 
with their identified last resort Guarantors.
    In step 17, non-member matching ends. Any remaining non-member 
Orders are unmatched, except as provided in step 23.
    In step 18, Exchange member conditional facilitation Orders are 
matched with their identified conditional Guarantors.
    In step 19, all remaining Exchange member Orders are matched with 
each other, provided they are not restricted to matching against non-
members only. This includes the following Phlx member Orders: Phlx 
member Orders participating through brokers, Phlx off-floor member 
Orders, Phlx floor member Orders, and Phlx member last resort 
facilitation Orders.
    In step 20, remaining Exchange member Orders are matched with 
Commitments that have not been restricted to matching against non-
members only. First, remaining Exchange member Orders are matched with 
Commitments of Off-Floor Liquidity Providers, and then with Commitments 
of Specialists and Alternate Specialists. Unmatched Commitments are 
removed.
    In step 21, Exchange member last resort facilitation Orders are 
matched with their identified last resort Guarantors.
    In step 22, the whole matching ``round'' in an eligible security 
ends. Any remaining Exchange member Orders and Commitments are 
unmatched, except as provided in step 23.
    In step 23, if any unmatched Orders remain, the largest unsatisfied 
constrained Order is permanently removed, the matches after step 1 are 
unmatched and the matching process starts again. Among unsatisfied 
Orders of the same size, Exchange member Orders would be removed before 
non-member Orders. Among two Exchange members, or among two non-
members, the last in time would be removed first. Additional matching 
rounds would occur, each removing another unsatisfied constrained 
Order, until no unsatisfied constrained Orders remained. Matching 
rounds are intended to maximize the number of executions.

G. Calculation of VWAP

    The exchange shall calculate a final VWAP value for each eligible 
security by: (i) using all regular way trades (including sold sales and 
late sales)\31\ reported by the appropriate reporting authority from 
the opening of the regular trading session and printed prior to 4:15:00 
P.M.,\32\ (ii) multiplying each respective reported price by the total 
number of shares traded at that price; (iii) adding together each of 
these calculated values to compile an aggregate sum; and (iv) dividing 
the aggregate sum by the total number of reported shares that appear in 
the prints included in step (i) of the VWAP calculation process. The 
resulting VWAP value will be reported in the form of a fraction and 
will be rounded to the nearest 1/256th.\33\ Any proposed changes that 
impact the manner in which the official VWAP is calculated are required 
to be submitted to the Commission for review under Section 19(b) of the 
Act.\34\
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    \31\ A ``late sale'' is a transaction which is a correct last 
sale but is publicly disseminated later than is required. Generally, 
transactions are required to be publicly disseminated within 90 
seconds of execution. A ``sold sale'' refers to a transaction 
appearing on the CTS out of its proper sequence.
    \32\ It should be noted that prints representing trades executed 
after regular trading hours (9:30 A.M. to 4:00 P.M.), such as prints 
reflecting trades executed during the Exchange's Post Primary 
Session, will only be included in the VWAP calculation until 4:01:30 
P.M.
    \33\ The System software also allows Participants to convert 
VWAP prices into decimal form.
    \34\ 15 U.S.C. 78s(b).
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    The exchange shall calculate and assign a final VWAP value to each 
security subject to a match during the Session.\35\ The final VWAP 
value that the Exchange calculates and assigns to each eligible 
security shall be reported and publicly disseminated at 4:20 P.M. 
promptly following calculation. The

[[Page 15862]]

final VWAP value will be available through the System to all 
Participants that had a commitment or Order matched during the Session.
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    \35\ In addition, the Exchange will continuously calculate a 
non-final VWAP value throughout the trading day for each eligible 
issue.
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    The final VWAP value calculated and reported by the Exchange shall 
be the official VWAP value. Unless the Exchange directs otherwise, 
every VWAP value as initially reported by the reporting authority is 
conclusively presumed to be accurate and deemed to be final, even if 
the VWAP value is revised or subsequently determined to have been 
inaccurate.
    Generally, all System matches create a binding contract. However, 
in the case where a match occurs during the Session in an eligible 
security that has not opened for primary market trading by 3:00 P.M., 
the match will be voided and a report to that effect will immediately 
be sent through the System to the Participants to the voided match. If 
an eligible security opens for trading but is the subject of a trading 
halt and does not resume trading for the remainder of the day, the 
final VWAP value for any match in that eligible security on that day 
will be based on the prints that occurred before the trading halt.

H. Reporting of System Transactions and VWAP

    All System matches will first be reported to the reporting 
authority (i.e., Consolidated Tape System or ``CTS'') at 9:20 A.M. as 
separate volume prints for each eligible security in which matching 
occurred. The morning print for all System matches will occur by way of 
an administrative message over the CTS reflecting the VWAP volume in 
each of the eligible securities. The morning print is intended to 
provide market participants with VWAP volumes before regular trading 
commences.
    Under normal circumstances, Users and Committers will be notified 
of their matches by 9:20 A.M. System matches will be reported to the 
entering subscriber in the form of automated reports reflecting the 
number of shares matched for each Participant by the System in each 
issue.
    Once the Exchange calculates and assigns a final VWAP value, each 
Session match constitutes a completed transaction for the purpose of 
reporting the trade to the appropriate reporting authority. End-of-day 
prints will normally be reported at 4:20 P.M. following calculation of 
the final VWAP at 4:15 P.M. The end-of-day prints will be printed on a 
trade-by-trade basis representing all matches made that morning. Each 
print will reflect a matched trade and the corresponding VWAP. These 
trades will be reported to the CTS with the sale condition ``B'' to 
indicate volume weighted average pricing (the ``B'' will distinguish 
VWAP trades from other transactions that may possibly be reported after 
the close such as after-hours, crossing session, or late sales 
transactions). The Exchange has represented that VWAP trades matched 
and executed through the System will not impact the determination of 
the last sale price in an eligible security listed on the NYSE.
    The System will not disseminate or disclose Orders or Commitments, 
including System bid/ask sizes, prior to the Session match, nor System 
imbalances remaining after the Session match, except to entering 
Participants.
    Because reporting is performed on a trade-by-trade basis, if no 
System match occurs in an eligible security, a final VWAP for that 
particular security will not be reported to the CTS for that day.

I. Access to the System

    Access to the System for subscribers (both direct subscribers and 
subscribers acting as brokers) will be available by dial-up into the 
System utilizing software and log-on procedures that vary depending on 
whether the subscriber is accessing the System through a personal 
computer or a main-frame system. System access may include various 
types of computer hardware, software, and handheld devices.

J. Resolutions of Disputes

    Disputes regarding Session participation or the eligibility of 
Orders, Commitments, or Participants will be resolved by the Exchange 
in accordance with Exchange Rule 124.

K. Liability of the Exchange

    The Exchange shall not be liable for any damages, claims, losses or 
expenses sustained by a member or member organization caused by any 
errors, omissions or delays resulting from any act, condition or cause 
beyond the reasonable control of the Exchange, including but not 
limited to, an act of God; fire; flood; extraordinary weather 
conditions; war; insurrection; riot; stride; accident; action of 
government; communications or power failure; equipment or software 
malfunction arising from the use of the System, the calculation of the 
VWAP or any and all other matters respecting the operation of the 
System or Session.

L. Trading Halts in Eligible Securities

    The proposed rule change does not limit the ability of the Exchange 
to otherwise halt or suspend trading in any eligible stock matched 
through the System.

M. Extraordinary Circumstances

    In the case of ``extraordinary circumstances,'' the Exchange's 
Floor Procedure Committee may determine to adjust or modify any of the 
times relating to Order Entry Time Period, the matching period, or any 
aspect of the transaction reporting procedures. The proposal defines 
``extraordinary circumstances'' to include fast market conditions, 
systems malfunctions, and other circumstances that limit the Exchange's 
ability to receive, disseminate, or report System information in a 
timely and accurate manner.

N. Short Sales

    Orders and Commitments must be appropriately marked pursuant to 
Exchange Rule 455 to indicate whether they are short sales. In 
addition, Orders and Commitments will be exempt from the short sale 
``tick test'' restrictions of Exchange Rule 455. Positions resulting 
from Session matches will be effective for the purpose of determining 
long or short status for the remainder of the trading day, immediately 
upon notification of the Participant to a System match, notwithstanding 
that the VWAP has not yet been determined.

III. Discussion

    For the reasons discussed below, 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, and with the requirements of Sections 6(b) and 11A 
under the Act.\36\ In particular, the Commission believes the proposed 
rule change is consistent with the Section 6(b)(5) requirements that 
the rules of an exchange be designed to promote just and equitable 
principles of trade, remove impediments to and perfect the mechanism of 
a free and open market and a national market system, and, in general, 
protect investors and the public interest.\37\
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    \36\ 15 U.S.C. 78f(b) and 78k-1.
    \37\ In approving this proposed rule change, the Commission has 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
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    The Commission believes the Exchange's proposed System will serve 
as an innovative complement to the Exchange's existing auction market. 
The Commission historically has encouraged innovation and the creation 
of new electronic trading systems so that investors are provided access 
to a variety of execution alternatives. At the

[[Page 15863]]

same time, the Commission believes it is important to ensure that a 
trading system which operates as a facility of a national securities 
exchange complies with the Act's standards regarding investor 
protection and fair and orderly markets. The Commission believes that 
the Exchange's proposal achieves this objective.
    Some aspects of the proposal raise complicated regulatory issues. 
For example, the matching of Orders and Commitments during the Session 
includes some characteristics of a unitary call market and, therefore, 
represents a departure from the traditional auction market trading 
conducted on the Exchange floor. In addition, the System allows non-
Exchange members to enter Orders. Other aspects of the proposal raise 
concerns regarding surveillance, reporting, transparency, control and 
access, and priority principles of an auction market. After careful 
review, and for the reasons discussed in more detail below, the 
Commission believes the proposal adequately addresses the areas of 
concern and is consistent with the maintenance of free and open markets 
and investor protection in accordance with Section 6(b)(5) of the 
Act.\38\
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    \38\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission believes that the System is properly regulated as a 
facility of the Exchange.\39\ The System will use Exchange equipment 
and personnel, involve the participation of Exchange floor traders, and 
rely on the SCCP to clear System trades. Furthermore, matches performed 
during the Session will be regulated and reported as Exchange trades. 
The Commission believes that because the System will be using the 
Exchange's premises, property, and services for effecting and reporting 
System matches, it will be using the facilities of an exchange as 
defined in Section 3(a)(2) of the Act.\40\
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    \39\ Section 3(a)(2) of the Act states that ``[t]he term 
`facility' when used with respect to an exchange includes its 
premises, tangible or intangible property whether on the premises or 
not, any right to the use of such premises or property or any 
service thereof for the purpose of effecting or reporting a 
transaction on an exchange (including, among other things, any 
system of communication to or from the exchange, by ticker or 
otherwise, maintained by or with the consent of the exchange), and 
any right of the exchange to the use of any property or service.'' 
15U.S.C. 78c(a)(2).
    \40\ Regulating the System as a facility of the Exchange is 
consistent with the Commission's approach towards similar electronic 
matching systems. For example, the Chicago Stock Exchange (``CHX'') 
operated the Chicago Match as a facility of the CHX. See Securities 
Exchange Act Release No. 35030 (Nov. 30, 1994), 59 FR 63141 (Dec. 7, 
1994). The Chicago Match, which integrated an electronic order match 
system with a facility for brokering trades, no longer operates as a 
facility of the CHX.
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    The Commission notes that the Exchange's use of UTTC personnel and 
equipment in operating the System does not alter the Commission's 
determination that the System is properly regulated as a facility of 
the Exchange. The Exchange retains regulatory control over the System 
and is fully responsible for ensuring that the System complies with the 
federal securities laws and all applicable rules and regulations. 
Although UTTC personnel shall assist the Exchange in operating the 
System, these assistants will be acting as agents of the Exchange. 
Therefore, the Exchange will maintain control of the System and will 
exercise authority over the non-Exchange employees that help operate 
the System.
    The Commission believes that operation of the System as a facility 
of the Exchange raises important issues regarding surveillance of the 
System,\41\ UTTC personnel, and Exchange personnel. The Commission 
believes the Exchange has adequately addressed these surveillance 
issues. In particular, the Exchange's surveillance group will be 
equipped with technology to create detailed audit trails that will 
track Orders and Commitments from entry to the confirmation of 
matching. The Exchange also will use technology to track Orders and 
Commitments through the matching algorithm; this will identify the 
exact point at which Orders and Commitments are matched, or 
alternatively, not matched. In addition, a corrections alert mechanism 
will provide notice of all corrections that occur in the CTS after the 
VWAP calculation period. Finally, Exchange surveillance personnel will 
use an electronic surveillance system to identify aberrant trading 
behavior in any eligible stock matched through the System.
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    \41\ The System will link off-floor and on-floor computer 
terminals to the System's communications base unit. This unit will: 
(i) accept Orders and Commitments; (ii) match buyers with sellers; 
(iii) give execution reports to matched Participants; (iv) calculate 
the back-up VWAP for each matched security (separate Exchange 
systems will calculate the official VWAP; (v) report VWAP matches to 
the entering Participants (separate Exchange systems will report 
VWAP matches to the appropriate reporting authorities); and (vi) 
create an audit trail by recording Order and Commitment entry and 
execution.
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    The Commission also believes that operation of the System as a 
facility of the Exchange raises unique concerns regarding access to, 
and control of, the System.\42\ For several reasons, the Commission 
believes that the Exchange the UTTC have adequately addressed these 
access and control concerns. First, the Commission notes that the 
Exchange will retain regulatory control over the System and that the 
Exchange will remain fully responsible for ensuring that the System 
complies with the federal securities laws and all applicable rules and 
regulations. Although the Exchange will use UTTC personnel and 
equipment to assist in operating the System, such UTTC assistance will 
be provided on an agency basis. More specifically, this assistance will 
be provided by REB securities, a wholly owner broker-dealer subsidiary 
of UTTC. REB will be assigned certain responsibilities for ensuring 
compliance with the monitoring and reporting of System access and 
control parameters. The Exchange represented that REB has developed a 
special compliance program to address these issues. Second, REB will 
not conduct any other securities business outside of its oversight of 
System access and control. This limitation on business activity will 
help focus REB's scrutiny on important compliance issues. This 
limitation on business activity will help focus REB's scrutiny on 
important compliance issues. The Exchange will require REB to conduct 
annual independent audits regarding the System compliance program. 
Finally, because REB is a broker-dealer registered under the Act, the 
Commission will have the authority to inspect and examine REB. For 
these reasons, the Commission believes the Exchange and UTTC have 
adequately addressed issues relating to control and access.
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    \42\ The VTS is the first electronic system offering VWAP that 
will operate as a facility of a national securities exchange. 
Although the Commission previously reviewed electronic systems that 
offered volume weighted average pricing features, they were operated 
as proprietary trading systems. See Letter from Alden S. Adkins, 
Chief, Office of Automation and International Markets, Division, 
Commission, to Charles R. Hood, Vice President and General Counsel, 
Instinet Corporation (Dec. 6, 1991) (providing no-action relief to 
Instinet's Market March crossing service) and letter from Alden S. 
Adkins, Chief, Office of Automation and International Markets, 
Division, commission, to Lloyd H. Feller, Morgan, Lewis & Bockius 
(Oct. 28, 1991) (providing no-action relief to POSIT regarding its 
volume weighted average pricing mechanism).
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    The Commission believes that in providing non-Exchange members 
limited access to the System, the Exchange's proposal does not 
contravene the Act. The Act contemplates that transactions on a 
national securities exchange will be conducted by ``members.'' \43\ In

[[Page 15864]]

addition, Section 6(c)(1) of the Act states that a national securities 
exchange shall deny membership to any natural person who is not, or is 
not associated with, a registered broker or dealer.\44\ The Commission 
believes the Exchange has established adequate controls over non-member 
access to the System. Specifically, a non-member may enter Orders 
through the System only after entering into a ``give-up'' agreement 
with an Exchange clearing member (i.e., such Exchange member also is a 
SCCP member). The give-up agreement requires the Exchange clearing 
member to assume legal responsibility for the Orders of the non-member. 
The Exchange clearing member must submit the give-up agreement to the 
Exchange in advance of any activity by the non-member and must also 
specify the credit limits for the non-member.
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    \43\ Section 3(a)(3)(A) of the Act describes a member in terms 
of effecting transactions on a national securities exchange. The 
pertinent text defines a member as ``any natural person permitted to 
effect transactions on the floor of the exchange without the 
services of another person acting as broker.'' 15 U.S.C. 
78c(a)(3)(A).
    \44\ 15 U.S.C. 78f(c)(1).
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    Moreover, prior to obtaining permission to enter Orders through the 
System, each non-member must enter into a ``three-way agreement'' with 
the Exchange and an Exchange clearing member. The three-way agreement 
requires the non-member to agree to adhere to the applicable rules of 
the Exchange. Because the access of non-member Users is limited by the 
requirement that such Users be parties to valid give-up and three-way 
agreements,\45\ and because the behavior of non-member Users is 
governed by the affirmative obligations contained in the mandated give-
up and three-way agreements, the Commission believes the participation 
of non-members in the System does not violate the Act.
---------------------------------------------------------------------------

    \45\ If a non-member User's give-up or three-way agreement was 
terminated, the non-member User would not be permitted to access the 
System.
---------------------------------------------------------------------------

    The Commission also believes that the Exchange's proposal is 
consistent with Section 11A of the Act.\46\ Specifically, the 
Commission believes that the System will further the purposes of 
Section 11A and the development of a national market system by 
promoting economically efficient execution of securities transactions, 
fair competition among markets, best execution of customer orders, and 
an opportunity for orders to be executed without the participation of a 
dealer. The System provides a new and potentially efficient way to 
match and execute trading interests. It is principally designed to meet 
the demands of institutional traders and other market professionals 
that desire VWAP-based transactions. Use of the System may result in 
enhanced liquidity for investors and increase the ability of investor 
orders to interact directly with other investor orders.
---------------------------------------------------------------------------

    \46\ 15 U.S.C. 78k-1.
---------------------------------------------------------------------------

    The Commission believes the System may provide benefits to market 
participants, especially those who trade in large blocks. Specifically, 
Participants will enjoy complete end-to-end anonymity in their Orders 
and Commitments; as a result, their proprietary trading strategies will 
not be revealed to other market participants. Furthermore, because 
Participants receive notice of Order and Commitment matches before the 
NYSE opens for trading, those Participants not receiving matches will 
have the opportunity to enter orders during regular trading hours.
    The Commission believes the proposal is consistent with Rule 11Aa3-
1 of the Act.\47\ Promptly after the System matches Orders and 
Commitments, each Participant will be notified of the issues and number 
of shares matched for that Participant. The Exchange also will report 
to the CTS at 9:20 A.M. the VWAP transaction volume in each eligible 
issue. For example, if during the Session matches were effected in all 
300 eligible securities, the Exchange would report to the CTS the 
matched volume for each of the 300 securities (i.e., 300 separate 
volume prints). Although the Final VWAP value for each eligible 
security will not be calculated until after the closing of trading, the 
Commission believes it is important that market participants have 
access to matched VWAP volume before regular trading begins.\48\ Once 
of the final VWAP value has been calculated, each transaction will 
immediately be reported on a trade-by-trade basis, including the size 
and final VWAP value, over the Tape B network of the CTS \49\ and to 
the Participants. Thus, the Exchange will provide for the collection 
and dissemination of transaction reports containing, among other 
things, the price of the security. The display of Orders and 
Commitments prior to matching would be impractical; in particular, it 
would counter the benefits of anonymity afforded by the System.\50\ The 
Commission believes that the System's reporting mechanisms will provide 
investors with adequate transaction price information in accordance 
with Rule 11Aa3-1 under the Act.
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    \47\ Rule 11Aa3-1, ``Dissemination of Transaction Reports and 
Last Sale Data with Respect to Transactions in Reported 
Securities,'' governs the dissemination of transaction reports that 
contain price and volume information with respect to purchase or 
sale transactions involving one or more round lots of a security. 
See 17 CFR 240.11Aa3-1.
    \48\ The Exchange has informed the Commission that the operator 
of the CTS, the Consolidated Tape Authority (``CTA''), will not 
permit trade messages to be delivered over the CTS prior to the 
start of regular trading on the U.S. equities markets (i.e., before 
9:30 A.M.). Therefore, the pre-opening VWAP volumes reported over 
the CTS must take the form of administrative messages. The 
Commission urges the Exchange to work with the primary information 
vendors to ensure that the vendors disseminate the VWAP volumes as 
administrative message before the opening of trading.
    \49\ As presently configured, the CTS consists of two tape 
systems: Tape A and Tape B. The Tape A network displays only NYSE 
symbol information while Tape B displays information for issue 
listed on all other exchanges. Although each of the securities 
eligible for matching during the Session are listed on the NYSE, the 
VWAP matches will be reported on the Tape B network due to 
programming difficulties and project priorities.
    \50\ Cf. The OptiMark System. See Securities Exchange Act 
Release No. 39086 (Sept. 17, 1997), 62 FR 50036 (Sept. 24, 1997).
---------------------------------------------------------------------------

    In response to the Exchange's request for interpretive relief, the 
Commission confirms that the Exchange will not violate Rule 11Aa3-2 
under the Act \51\ if the Exchange disseminates last sale data for 
System matches at 4:20 P.M. Rule 11Aa3-2(d) requires self-regulatory 
organizations to comply with the terms of any effective national market 
system plan of which it is a sponsor or participant. The Commission 
believes that the Exchange will continue to comply with the terms of 
the CTS national market system plan if the Exchange disseminates 
reports containing price and volume information for System matches at 
4:20 P.M. The Commission notes that a national market system plan is 
designed to ensure timely dissemination of last sale data. The 
Commission believes that the Exchange has reporting procedures in place 
to ensure the timely dissemination of preliminary and last sale data 
for System matches. In particular, as soon as the matching process has 
been completed at the end of the Session, the Exchange will report to 
the CTS the matched VWAP volumes for each eligible security. 
Furthermore, immediately after the final VWAP values have been 
determined and assigned, the Exchange will report to the CTS each 
transaction on a trade-by-trade basis, including the final VWAP value. 
In each instance, the Exchange has committed to make timely 
dissemination of important market information. Because the Exchange has 
arranged for the timely dissemination of preliminary and last sale 
data, the Commission believes the Exchange will remain in compliance 
with the CTS national market system plan and will not violate Rule 
11Aa3-2.
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    \51\ 17 CFR 240.11Aa3-2.
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    The Commission believes that the System does not violate Rule 
11Ac1-1

[[Page 15865]]

under the Act (``Quote Rule'').\52\ The Quote Rule requires a national 
securities exchange to collect bids, offers, quotation sizes, and 
aggregate quotation sizes from ``responsible brokers or dealers,'' \53\ 
for each reported security listed or admitted to unlisted trading 
privileges and to make them available to quotation vendors.\54\ A bid 
or offer is defined in the Quote Rule as the ``bid price and offer 
price communicated by an exchange member or OTC market maker to any 
broker or dealer, or to any customer.'' \55\ To constitute a bid or 
offer, therefore, the underlying trading interest must have been 
communicated to at least one other potential counterparty. Bids and 
offers are intended to attract other parties to deal with the person 
publishing the bid or offer at the quoted price. In contrast, the 
essence of the System is its anonymity. Only the System is aware of the 
expressed trading interest until the matching and trade execution 
occur. Therefore, the System is not a mechanism by which Participants 
broadcast prices to other Participants and trade with one another at 
those prices. Accordingly, the Commission believes that the System does 
not violate the Quote Rule.
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    \52\ 17 CFR 240.11Ac1-1.
    \53\ Rule 11Ac1-1 defines the term ``responsible broker or 
dealer,'' when used with respect to bids or offers communicated on 
an exchange, to mean ``any member of such exchange who communicates 
to another member on such exchange, to the location (or locations) 
designated by such exchange for trading in a covered [period] 
security, a bid or offer for such covered [reported] security, as 
either principal or agent.'' The Rule provides, however, that if 
``two or more members of an exchange have communicated on such 
exchange bids or offers for a covered [reported] security at the 
same price, each such member shall be considered, a `responsible 
broker or dealer' for that bid or offer, subject to the rules of 
priority and precedence then in effect on that exchange.'' 
Furthermore, if a member of the exchange represents as agent the 
transmitted bid or offer of another exchange member, only the member 
representing the bid or offer as agent shall be considered the 
``responsible broker or dealer'' for that bid or offer. 17 CFR 
240.11Ac1-1(a)(21)(i).
    \54\ See 17 CFR 240.11Ac1-1(b).
    \55\ See 17 CFR 240.11Ac1-1(a)(4).
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    The Commission also believes that the matching algorithm and 
Liquidity Rotation Parameter are appropriate ways to ensure that Orders 
and Commitments are matched in accordance with the priority principles 
of an auction market. The Commission believes that the priority 
principles of the matching algorithm will not give rise to practices 
that are inconsistent with Section 11(a) of the Act.\56\ Specifically, 
the matching algorithm is designed to provide public order preference 
and public order protection such that Exchange members must yield 
priority to non-members. Moreover, the Exchange has represented that 
Exchange Specialists will not be permitted to trade ahead of customers 
because Exchange Floor Traders will be last in terms of priority (e.g., 
Off-Floor Liquidity Providers receive priority over Floor Traders). In 
addition, the Liquidity Rotation Parameter, or ``anti-bully'' rule is 
designed to ensure that order flow is fairly allocated. The LRP will 
include more Participants in the matching process because the largest 
Orders and Commitments will be filled in the course of several 
rotations rather than a single match.
---------------------------------------------------------------------------

    \56\ 15 U.S.C. 78k(a).
---------------------------------------------------------------------------

    The Commission believes the market characteristics of the eligible 
stocks will make it difficult to influence their intra-day prices and 
thus their final VWAP values. Specifically, the 300 stocks eligible for 
System matching during the one year pilot are among the most highly-
capitalized and highly-liquid stocks listed on the NYSE. The 
significant daily transaction activity in each eligible stock should 
help to make it difficult and economically impractical to influence 
their prices. As a caveat, the Commission observes that manipulation 
concerns would be heightened in the VWAP transaction volume in an 
eligible security came to represent a substantial portion of the 
overall transaction volume in such security. The Commission expects the 
Exchange to closely monitor the VWAP trading volumes for each eligible 
security in relation to their overall trading volumes. The Commission 
believes that legitimate manipulation concerns would arise if the VWAP 
transaction volume in an eligible security exceeded 20% of the 
security's daily transaction volume.
    Finally, the Commission believes it is appropriate that Orders and 
Commitments will be exempt from the short sale ``tick test'' 
restrictions of Exchange Rule 455. Separate from this approval order, 
the Commission has granted the Exchange exemptive relief from Rule 10a-
1 under the Act.\57\ Under the terms of the Rule 10a-1 exemptive 
relief, Participants may enter Commitments and Orders to sell short 
eligible securities provided that certain conditions are satisfied. 
Therefore, the Commission believes it is appropriate for the Exchange 
to likewise exempt Participants from the short sale restrictions that 
appear in Exchange Rule 455.
---------------------------------------------------------------------------

    \57\ See Exemptive Relief Letter supra note 13.
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    For the reasons discussed above, the Commission believes it is 
appropriate to approve the Exchange's proposal for a one year pilot 
period. As part of the pilot process, the Commission expects the 
Exchange to collect information pertaining to the operation and 
effectiveness of the System. The Commission requests that the Exchange 
use its ongoing research and surveillance to prepare a comprehensive 
report that: (i) addresses the overall reliability of the System and 
identifies any System outages or other technical problems, (ii) 
provides a summary of the Exchange's surveillance efforts regarding the 
System and identifies any Exchange investigations or enforcement 
actions involving the System; (iii) discusses the strategies employed 
by Users and Committers and evaluates whether the System is useful to 
market participants; (iv) provides feedback from Exchange members and 
non-members regarding their experiences with the System; and (v) 
measures the System's impact and effect on trading in the primary 
market of the eligible securities. In addition, because the Exchange 
has independently committed to prepare a report regarding the number of 
tape corrections and how they affect the final VWAP values calculated 
by the Exchange, that analysis should be included in the report. The 
Exchange is requested to submit its report on the System no later than 
two months before the end of the pilot period.
    The Commission finds good cause for approving proposed Amendment 
Nos. 3 and 4 prior to the thirtieth day after the date of publication 
of notice of filing thereof in the Federal Register. The Commission 
notes that Amendment No. 3 revised the proposed rule change in several 
ways. First, the Exchange agreed to operate the System as a facility of 
the Exchange for a one year pilot period. The Commission believes it is 
appropriate for the Exchange to operate the System on a pilot basis for 
one year. The pilot period will provide the Exchange with the time 
necessary to evaluate the effectiveness of the System and to identify 
and remedy any problems or difficulties that may develop in its 
operation. Based on the results of the pilot period, the Exchange may 
propose an extension of the pilot period or seek permanent approval of 
the System. Second, the Exchange agreed to limit the securities 
eligible for matching through the System to 300 of the most highly-
liquid and highly-capitalized issues listed on the NYSE. The Commission 
believes it is reasonable for the Exchange to limit the universe of 
eligible securities to highly-liquid and highly-capitalized securities. 
The Commission believes that the prices of large, actively traded 
securities are difficult to impact, and that as a result, the System's 
VWAP values should be

[[Page 15866]]

less susceptible to manipulation. Third, the Exchange clarified the 
definition of an ``institution,'' committed to prepare a report 
regarding the number of tape corrections and how they affect the VWAP 
values calculated by the Exchange, and modified from 4:02 P.M. to 
4:01:30 P.M. the cut-off time designed to capture trade reporting run-
off and sales that occur at the close of regular trading. Because each 
of these revisions strengthens the proposal, the Commission believes 
they are appropriate modifications.
    In Amendment No. 4, the Exchange agreed to report pre-opening VWAP 
volumes for each eligible security in which matches have been effected 
during the Session. The Commission believes it is appropriate for the 
Exchange to report VWAP volumes for eligible securities individually 
before the start of regular trading. Despite the absence of a final 
price, the Commission believes that pre-opening volume prints will 
improve transparency and provide valuable information to market 
participants. The Commission continues to believe that a single, 
aggregate VWAP volume print encompassing all eligible securities, as 
previously proposed by the Exchange, provides little benefit to market 
participants. Amendment No. 4 also provided improved surveillance 
procedures. Although the surveillance measures cannot be discussed in 
specific terms because of their confidential nature, the Commission 
believes the measures will strengthen the oversight of the System and 
improve the proposal.
    Based on the above, the Commission believes good cause exists, 
consistent with Sections 6(b) and 19(b) of the Act,\58\ to accelerate 
approval of Amendment Nos. 3 and 4 to the proposed rule change.
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    \58\ 15 U.S.C. 78f(b) and 78s(b).
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 3 and 4 to the proposal, including 
whether the proposed rule change as amended 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 submissions, all 
subsequent amendment, 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 persons, 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 Section, 450 Fifth Street, NW., Washington, DC 20549. Copies 
of such filing will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to File 
No. SR-Phlx-96-14 and should be submitted by April 22, 1999.

V. Conclusion

    The Commission believes the Exchange's proposal satisfies the 
standards of the Act that apply to national securities exchanges. The 
Commission recognizes that investors desire to trade large blocks of 
securities anonymously and free of the price movements that often 
accompany such transactions. By operating a facility that allows 
investors to anonymously effect block-sized trades at the day's volume 
weighted average price, the Exchange will be able to better accommodate 
the needs of investors.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\59\ that the proposed rule change (SR-Phlx-96-14), as amended, is 
approved for a pilot period ending March 24, 2000.
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    \59\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\60\
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    \60\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-8061 Filed 3-31-99; 8:45 am]
BILLING CODE 8010-01-M