[Federal Register Volume 65, Number 42 (Thursday, March 2, 2000)]
[Notices]
[Pages 11402-11407]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-4978]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42456, File No. 4-429]


Joint Industry Plan; Notice of Filing of Proposed Option Market 
Linkage Plans by the American Stock Exchange, Chicago Board Options 
Exchange, Pacific Exchange, and Philadelphia Stock Exchange

February 24, 2000.

I. Introduction

    On January 19, 2000, pursuant to Rule 11Aa3-2 under the Securities 
Exchange Act of 1934 (``Act'')\1\ and an order issued by the Securities 
and Exchange Commission (``SEC'' or ``Commission''),\2\ the American 
Stock Exchange LLC (``Amex''), Chicago Board Options Exchange, Inc. 
(``CBOE''), Pacific Exchange, Inc. (``PCX''), and Philadelphia Stock 
Exchange, Inc. (``Phlx'') filed with the Commission proposed plans for 
the purpose of creating and operating an inter-market option linkage 
(``plans'').\3\ As discussed below, Amex and CBOE filed identical plans 
(the ``Amex/CBOE plan'') and PCX and Phlx filed separate plans. 
Although the four exchanges achieved consensus on the majority of 
issues pertaining to a linkage, disagreement remains on several 
significant matters. Specifically, the exchanges failed to agree about 
whether the linkage should require routing of orders based on price/
time priority,\4\ who should have access to the linkage, and the 
appropriate remedy owed when one market trades at a price inferior to 
that displayed on another market (known as a ``trade-through''). 
Pursuant to Rule 11Aa3-2(c)(1), the Commission is publishing this 
notice of, and soliciting comments on, the Amex/CBOE plan. The 
Commission is also publishing this notice of the PCX and Phlx plans, 
which differ from the Amex/CBOE plan with respect to certain elements 
which the Commission is considering including in a linkage plan\5\ and 
as to which the Commission therefore also seeks comments.
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    \1\17 CFR 240.11Aa3-2.
    \2\On October 19, 1999, the Commission issued an Order directing 
the exchanges to file a national market system plan for linking the 
options markets within 90 days. Securities Exchange Act Release No. 
42029 (October 19, 1999), 64 FR 57674 (October 26, 1999) (``October 
19, 1999 Order'').
    \3\The Commission's October 19, 1999 Order also requested the 
International Securities Exchange (``ISE'') to participate with the 
options exchanges in the development of an inter-market linkage 
plan. The ISE has filed an application with the Commission to 
register as a national securities exchange. See Securities Exchange 
Act Release No. 41439 (May 24, 1999) 64 FR 29367 (June 1, 1999). The 
ISE submitted a plan identical to that filed by Amex and CBOE. 
Because the Commission has not approved the ISE's application for 
registration as a national securities exchange, however, the ISE may 
not be a signatory to a linkage plan at this time.
    \4\Both PCX and Phlx propose price/time priority as an element 
of the linkage. Price/time priority generally requires that if an 
exchange receives an order but it is not the first exchange to 
display the best price, that exchange must route the order to the 
exchange that was first at the best price. PCX and Phlx propose a 
number of textual distinctions from the Amex/CBOE plan to 
incorporate price/time priority. In the Phlx plan, many of the 
proposed modifications to the Amex/CBOE plan relate to an expanded 
role for the facilities manager. Although the term ``facilities 
manager'' is not defined in the plans, it is presumed by the plans 
to be an outside vendor who may be selected to build and operate a 
system linking the options exchanges' existing systems.
    \5\Rule 11Aa3-2 specifically provides that the Commission may 
approve a proposed national market system plan ``with such changes 
or subject to such conditions as the Commission may deem necessary 
or appropriate.''
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II. Background

    In 1975, Congress directed the Commission to oversee the 
development of a national market system.\6\ At the time, the trading of 
standardized options was relatively new.\7\ As a result, the Commission 
deferred applying to the options markets many of the national market 
system initiatives that applied to the equity markets to give options 
trading an opportunity to develop. Nevertheless, since the 
establishment of the options exchanges, the Commission has repeatedly 
called for market integration facilities for the options markets.\8\ In 
1991, in response

[[Page 11403]]

to these calls, four of the five options exchanges submitted a proposal 
for the development of a linkage.\9\ The plan was never adopted, in 
part, because a consensus among the exchanges could not be achieved 
regarding the feasibility of implementing a single linkage plan.
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    \6\Pub. L. No. 94-29 Stat. 97 (1975).
    \7\The trading of standardized options on securities exchanges 
began in 1973, with the organization of CBOE as a national 
securities exchange. See Securities Exchange Act Release No. 9985 
(February 1, 1973) 1 S.E.C. Doc.11 (February 13, 1973). 
Subsequently, the Commission approved options pilot programs at 
Amex, Phlx, PCX, and the Midwest Stock Exchange (``MSE''). The New 
York Stock Exchange (``NYSE'') began trading options in 1985. See 
Securities Exchange Act Release No. 11144 (December 19, 1974) 40 FR 
3258 (January 20, 1975); Securities Exchange Act Release No. 11423 
(May 15, 1975) 6 S.E.C. Doc. 894 (May 28, 1975); Securities Exchange 
Act Release No. 12283 (March 30, 1976) 41 FR 14454 (April 5, 1976); 
Securities Exchange Act Release No. 13045 (December 8, 1976) 41 FR 
54783 (December 15, 1976); and Securities Exchange Act Release No. 
21759 (February 14, 1985) 50 FR 7250 (February 21, 1985). The MSE's 
options program was merged into the CBOE's program in 1979. The NYSE 
sold its options business to CBOE in 1997. Currently, Amex, CBOE, 
PCX, and Phlx are the only national securities exchanges that trade 
standardized options.
    \8\See Report of the Special Study of the Options Markets to the 
Securities and Exchange Commission, 96th Cong., 1st Sess. (Comm. 
Print No. 96-IFC3, December 22, 1978) (examining the major issues of 
market structure in standardized options markets, including multiple 
trading); Securities Exchange Act Release No. 16701 (March 26, 1980) 
45 FR 21426 (April 1, 1980) (deferring expansion of multiple trading 
to afford the options exchanges an opportunity to consider the 
development of market integration facilities); Securities Exchange 
Act Release No. 22026 (May 8, 1985) 50 FR 20310 (May 15, 1985) 
(urging options market participants to consider the development of 
market integration facilities); Directorate of Economic and Policy 
Analysis, ``The Effects of Multiple Trading on the Market for OTC 
Options'' (November 1986); Office of the Chief Economist, 
``Potential Competition and Actual Competition in the Options 
Market'' (November 1986); Securities Exchange Act Release No. 26871 
(May 26, 1989) 54 FR 24058 (June 5, 1989) (requesting comment on 
three measures, including an inter-market linkage). In 1989, the 
Commission adopted Rule 19c-5, which generally prohibits any 
exchange from adopting rules limiting its ability to list any stock 
option class because that option class is listed on another 
exchange. See Securities Exchange Act Release No. 26870 (May 26, 
1989) 54 FR 23963 (June 5, 1989). In proposing Rule 19c-5, the 
Commission acknowledged that market integration facilities were 
unlikely to be built voluntarily if they were a prerequisite to 
multiple trading. See Securities Exchange Act Release No. 24613 
(June 18, 1987) 52 FR 23849 (June 25, 1987). In 1990, then Chairman 
Breeden requested that the options exchanges develop an inter-market 
linkage plan. See Letter from Chairman Breeden to the Registered 
Options Exchanges dated January 9, 1990.
    \9\See Securities Exchange Act Release No. 30187 (January 14, 
1992) 57 FR 2612 (January 22, 1992) (soliciting comments on an 
inter-market linkage plan submitted by four out of five options 
exchanges).
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    In February of 1999, Chairman Levitt wrote to the options exchanges 
expressing the need to develop system linkages and data processing 
facilities between the options markets.\10\ On October 1, 1999, the 
Chairman again wrote to the options exchanges requesting their 
cooperation and consensus on an inter-market linkage plan.\11\ On 
October 19, 1999, with no substantial progress having been made by the 
options markets to develop a linkage, the Commission ordered the 
markets to submit a linkage plan within 90 days.\12\ The Commission 
required that, at a minimum, any plan submitted under the October 19, 
1999 Order must include uniform trade-through rules and an expanded 
definition of public customer to include agency orders presented by 
competing exchanges.\13\ On January 19, 2000, Amex and CBOE submitted 
the Amex/CBOE plan and PCX and Phlx filed separate plans. The plans 
diverge on several fundamental issues, the details of which are 
discussed below.
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    \10\See Letters from Arthur Levitt, Chairman, SEC, to Richard F. 
Syron, Chairman and Chief Executive Officer, Amex; William J. 
Brodsky, Chairman and Chief Executive Officer, CBOE, Robert M. 
Greber, Chairman and Chief Executive Officer, PCX; and Meyer S. 
Frucher, Chairman and Chief Executive Officer, Phlx; dated February 
10, 1999.
    \11\See Letters from Chairman Levitt, to Salvatore Sodano, 
Chairman and Chief Executive Officer, Amex; William J. Brodsky, 
Chairman and Chief Executive Officer, CBOE; Philip D. DeFeo, 
Chairman and Chief Executive Officer, PCX; and Meyer S. Frucher, 
Chairman and Chief Executive Officer, Phlx; dated October 1, 1999.
    \12\See note 2, supra.
    \13\Id.
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III. Description of the Plans

    The three different plans submitted by the respective exchanges 
reflect numerous areas of agreement between the exchanges.\14\ A brief 
summary of each section of the plans, highlighting their distinctions, 
is provided below. The full text of the separate plans submitted by the 
options exchanges is available on the Commission's website at 
www.sec.gov, at the principal offices of the options exchanges, and at 
the Commission.
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    \14\As previously noted, Amex and CBOE filed identical plans and 
ISE has stated its intent to execute the Amex/CBOE plan as a 
signatory should the Commission grant the ISE's application for 
registration as a national securities exchange. See notes 3 and 4 
and accompanying text, supra.
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A. Definitions

    Section 2 of each of the plans defines specific terms for purposes 
of the plans.\15\ With minor exceptions, the definitions proposed in 
each of the plans are generally consistent. For example, the plans 
define three types of ``linkage orders'': (1) ``Principal acting as 
agent (``P/A'') order,'' defined as an order for the principal account 
of a ``market maker'' authorized to represent customer orders 
reflecting the terms of a related unexecuted customer order for which 
the market maker is acting as agent; (2) ``principal order,'' defined 
as an order for the principal account of an ``eligible market maker'' 
that is not a P/A order; and (3) ``satisfaction order,'' defined as an 
order for the principal account of an exchange member who initiated a 
trade-through that is sent through the ``linkage'' to satisfy the 
trade-through liability.
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    \15\Section 1 of the each plan contains a non-substantive 
preamble.
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    As discussed below, the plans differ on the extent to which market 
makers should get access to the linkage with respect to proprietary 
business. The definition of ``eligible market maker'' is important 
because it delineates which market makers are eligible to participate 
in the linkage for their proprietary accounts. An ``eligible market 
maker'' is defined in the plans of Amex, CBOE, and PCX with respect to 
an ``eligible options class,'' as a ``market maker'' that: (i) Is 
assigned to, and is providing two-sided quotations in, the eligible 
option class; (ii) is participating in its market's automatic execution 
system in such eligible option class; and (iii) is not prohibited from 
sending ``principal orders'' in such eligible option class through the 
linkage pursuant to the plan. These prohibitions are discussed below. 
Phlx would delete item (iii) of the definition to indicate its support 
for broader access to the linkage.
    The term, ``firm customer quote size,'' is defined in each of the 
plans. Under the plans submitted by Amex, CBOE, and Phlx, the exchange 
that receives a linkage order that is for a customer (i.e., non-broker-
dealer) account must guarantee automatic execution for at least ten 
contracts and up to the number of contracts guaranteed automatic 
execution for orders entered directly on the exchange. PCX's plan would 
require that a market be firm for at least 20 contracts for linkage 
orders for customer accounts up to the same maximum as the others. All 
of the plans define ``firm principal quote size'' as the number of 
contracts for principal orders that a receiving exchange will guarantee 
to execute. This number is 10 contracts under all of the plans.

B. New Parties to the Plan

    Section 4 of each of the plans contains an identical, self-
effecting provision for the admission of new participants, in which 
eligible exchanges\16\ may become a party to the plan by: (1) Executing 
a copy of the plan, as then in effect; (2) effecting an amendment to 
the plan reflecting the addition of the new participant's name; and (3) 
paying the applicable fee, as discussed below.
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    \16\The plans define an ``eligible exchange'' as a national 
securities exchange registered with the Commission pursuant to 
Section 6(a) of the Act, 15 U.S.C. 78f(a), that is a participant in 
the Options Clearing Corporation (``OCC'') and a party to the 
Options Price Reporting Authority (``OPRA'') Plan.
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C. Administration of the Plan

    Each of the plans provides, in Section 5, for an Operating 
Committee, to be composed of one representative of each participating 
exchange, responsible for: (1) Overseeing the development and 
implementation of the linkage; (2) monitoring the exchanges' use of the 
linkage; and (3) advising the participant exchanges regarding the 
operation of the linkage. The plans also uniformly provide for the 
creation of a Member Advisory Committee, to be composed of between one 
and three members from each participating exchange, to advise the 
Operating Committee on linkage matters. Each participating exchange 
would have one vote on all matters considered by the Operating 
Committee and the Member Advisory Committee, respectively. Votes, 
except as otherwise specified in the plan, would be decided by a 
majority of a quorum of the Operating Committee.
    The plans uniformly propose that amendments to the plan, other than 
with respect to the addition of new participants, as discussed above, 
may be effected only with the unanimous approval of the participating 
exchanges, and the approval of the Operating Committee and the 
Commission. The plans also provide a mechanism for dispute resolution, 
as discussed below.

D. Linkage Overview

    Section 6 of each of the plans sets forth the responsibilities of 
each participating exchange for providing a linkage supervisory 
function to oversee

[[Page 11404]]

the linkage and resolve inter-market trade problems. Administrative 
messages, either in free form or fixed format, could be sent through 
the linkage under all of the proposals. The Operating Committee would 
be authorized to determine how the linkage should be built and 
operated, including whether to select a facilities manager. The 
Operating Committee's decisions with respect to the selection of a 
facilities manager would require an affirmative vote of at least two-
thirds of the members of the entire Operating Committee.
    With respect to the implementation of the linkage, the Amex/CBOE 
plan and the Phlx plan would grant the Operating Committee the 
authority to phase in the implementation of the linkage. The PCX, 
however, specifically proposes a multiple phase implementation, as 
discussed further below. Under the PCX plan, the participating 
exchanges would conduct a study to assess the impact of the linkage 
during Phase I and, based on that study, develop an amendment to the 
plan for a second phase.

E. Linkage Operations

    In Section 7 of the plans, the exchanges set forth the specific 
mechanics of the linkage. With respect to eligible option classes, each 
participating exchange would be required to furnish to OPRA the current 
bid-ask quotation emanating from its market. These quotations would be 
considered ``firm'' to the extent provided in the plans.\17\
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    \17\The plans also uniformly propose procedures for the minimum 
information to be included in a linkage order, order validation, 
routing, responses, and partial executions.
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1. Amex/CBOE Linkage Plan
    The Amex/CBOE linkage plan proposes that the linkage be used for 
either customer orders, where the market maker chooses not to ``step-
up'' to match a better price displayed on an away market, or principal 
orders.
(a) P/A Orders Eligible for Automatic Execution
    The Amex/CBOE linkage plan would permit the transmission of a P/A 
order for execution in the automatic execution system of a 
participating exchange at the best price (``NBBO'')\18\ if the size of 
the P/A order is no larger than the firm customer quote size. The 
exchange receiving the P/A order through the linkage must execute it in 
its automatic execution system, if available, if its disseminated 
quotation is equal to or better than the limit price attached to the 
linkage order by the sending exchange (``reference price'')\19\ when 
the order arrives at the receiving exchange. The receiving exchange 
must immediately report the trade to OPRA. Except in limited 
circumstances, the proposal would not permit customer orders larger 
than the firm customer quote size to be broken up into multiple orders. 
Members would be prohibited from sending P/A orders eligible for 
automatic execution at a price inferior to the NBBO.
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    \18\The plans uniformly define the term ``NBBO'' as the national 
best bid and offer in a series of an eligible option class 
calculated by a participating exchange.
    \19\Except with respect to a ``satisfaction order,'' defined 
above, the reference price is equal to the quotation disseminated by 
the receiving exchange at the time the linkage order is transmitted. 
With respect to a ``satisfaction order,'' the reference price is the 
price to which the member in the sending exchange is entitled 
pursuant to the linkage plan.
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(b) P/A Orders not Eligible for Automatic Execution
    With respect to P/A orders not eligible for automatic execution in 
the receiving market because the size of the order is larger than the 
firm customer quote size, the Amex/CBOE linkage plan provides two 
alternatives. First, a P/A order representing the entire customer order 
may be sent through the linkage. If the receiving exchange's 
disseminated quotation is equal to or better than the reference price 
of the incoming linkage order, the receiving exchange must execute that 
order for at least the firm customer quote size. Within 15 seconds of 
receipt of the order, the receiving exchange must inform the sending 
exchange of the amount of the order that was executed and the amount, 
if any, that was canceled. In the alternative, the sending exchange may 
send an initial P/A order for the firm customer quote size. If the 
receiving exchange executes that order and continues to disseminate the 
same quote at the NBBO 15 seconds after reporting the execution of the 
initial P/A order, the sending exchange may send a second P/A order. If 
it chooses to send the second order, that order must be for the lesser 
of 100 contracts or the entire remainder of the customer order the 
sending exchange is representing. Under either alternative, if the 
receiving exchange does not execute the entire P/A order, it must move 
its quote to a price inferior to the reference price of the P/A order.
(c) Handling of Principal Orders
    For principal orders, the Amex/CBOE proposal would allow eligible 
market makers, as defined above, to send orders on behalf of their 
principal trading accounts as principal orders at the NBBO. If the 
principal order is not larger than the ``firm principal quote size,'' 
the receiving exchange must execute the order in its automatic 
execution system, if available, if its disseminated quotation is equal 
to or better than the reference price when the order arrives at the 
receiving exchange. If the principal order is larger than the firm 
principal quote size, the receiving exchange must execute the order in 
its automatic execution system for at least the firm principal quote 
size and within 15 seconds of receipt of such order, inform the sending 
exchange of the amount of the order that was executed and the amount, 
if any, that was canceled. If the receiving exchange does not execute 
the entire principal order, it must move its quote to a price inferior 
to the reference price of the principal order. The sending exchange is 
not permitted to send a second principal order in the same eligible 
option class for at least 15 seconds after it sent the first principal 
order unless the receiving exchange changes its price and the price is 
at the NBBO. After the 15 second period, and until there is a change in 
the receiving exchange's disseminated quote, the exchange that 
initially sent the principal order for automatic execution may send 
only principal orders for greater than the firm principal quote size. 
The restriction on sending principal orders for automatic execution 
would expire one minute after the automatic execution of the first 
principal order.
(d) Obligations for Failure to Respond to Linkage Orders
    A member that sends a P/A order or principal order through the 
linkage and who does not receive a reply within 30 seconds may reject 
any response received thereafter purporting to report a total or 
partial execution of that order. The member that sent the original 
order must inform the receiving exchange that it is rejecting the 
response within 15 seconds of receiving it. Upon receiving the 
rejection, the receiving exchange must report a cancellation to OPRA.
2. PCX Linkage Plan
    The PCX proposal would incorporate a price/time priority feature 
into a phased implementation schedule for customer orders for 20 
contracts or less.\20\ Specifically, the PCX proposes

[[Page 11405]]

that during Phase I, customer orders for 20 contracts or less may be 
automatically executed by the exchange initially receiving the order 
only if that market is disseminating a quotation with price and time 
priority or, if the market is at the NBBO (although not first in time) 
and provides price improvement for that order.\21\ If the exchange 
initially receiving the order is not at the NBBO when it receives the 
order, that exchange must automatically generate a P/A order and send 
it for execution to the away market that is disseminating a quotation 
with price and time priority, so long as the away market provides a 
firm customer quote size of at least 20 contracts in that particular 
eligible option class.
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    \20\On November 10, 1999, Chairman Levitt requested the options 
exchanges and ISE to submit within thirty days a detailed statement 
of their views on whether incorporating price/time priority into an 
inter-market linkage plan would be beneficial to investors and the 
options markets. See Letters from Chairman Levitt, to Salvatore 
Sodano, Chairman and Chief Executive Officer, Amex; William J. 
Brodsky, Chairman and Chief Executive Officer, CBOE; Philip D. 
DeFeo, Chairman and Chief Executive Officer, PCX; and Meyer S. 
Frucher, Chairman and Chief Executive Officer, Phlx; dated November 
10, 1999. The options exchanges and the ISE set forth their 
positions on this issue in their response letters, dated December 
10, 1999. See Letters to Chairman Levitt, from Salvatore F. Sodano, 
Chairman and Chief Executive Officer, Amex; William J. Brodsky, 
Chairman and Chief Executive Officer, CBOE; Philip D. DeFeo, 
Chairman and Chief Executive Officer, PCX; and Meyer S. Frucher, 
Chairman and Chief Executive Officer, Phlx; dated December 10, 1999.
    \21\If the exchange receiving the order is at the NBBO but does 
not have time priority and is not willing to provide price 
improvement, it must send a P/A order to the away market that is at 
the NBBO with time priority.
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    The PCX plan virtually mirrors the Amex/CBOE proposal with respect 
to the handling, during Phase I, of P/A orders not eligible for 
automatic execution in the receiving market (i.e., orders for more than 
20 contracts), principal orders, and other matters, such as 
restrictions on breaking up customer orders that are larger than the 
firm customer quote size. The PCX plan, however, differs from the other 
plans with respect to locked and crossed markets. The Amex/CBOE and 
Phlx plans propose language stating that the dissemination of locked 
and crossed markets must be avoided and that the participating 
exchanges will file with the Commission for approval uniform rules for 
unlocking and uncrossing markets. The PCX, conversely, would permit 
principal orders to be sent through the linkage for the purpose of 
unlocking or uncrossing markets.\22\
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    \22\In fact, as discussed below, the PCX proposes to permit 
principal access to the linkage only to send orders to unlock or 
uncross markets or to satisfy trade-through liability.
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3. Phlx Linkage Plan
    The Phlx proposal incorporates strict price/time priority, 
requiring each exchange to build a front-end system to route, as P/A 
orders, either directly through the linkage or to the facilities 
manager, all customer orders eligible for automatic execution where the 
exchange initially receiving the order was not the first to disseminate 
the best price. The Phlx proposal parallels the Amex/CBOE and PCX 
proposals with respect to other aspects of handling linkage orders for 
customer accounts, including the obligations on the exchange that 
receives a linkage order.
    The Phlx plan tracks the Amex/CBOE and PCX plans with respect to 
the handling of principal orders, except that the Phlx proposal 
incorporates strict price/time priority and prohibits an eligible 
market maker from sending through the linkage principal orders not only 
at a price inferior to the NBBO, but also at a price equal to or 
inferior to the market quote disseminated on the eligible market 
maker's exchange.
4. ISE Alternative Proposal
    In its transmittal letter, the ISE proposes an alternative plan for 
handling P/A orders. Under the terms of its proposal, member firms 
would be permitted to route orders to the exchange of their choice. If 
an exchange is quoting at the NBBO when it receives an order 
(regardless of whether it was the first market to quote at that price), 
that exchange would be permitted to execute the order and would owe no 
obligation to away markets. If, however, the exchange to which the 
order is initially routed by the member firm is not quoting at the NBBO 
when it receives the order, a market maker on that exchange may step up 
to match the best price and execute the order. If an away market that 
was quoting at the NBBO complains, however, the market that matched the 
NBBO would be required to provide ``specified protection''\23\ to those 
customer limit orders on the book of the complaining away market. If 
the exchange that receives the order from the member firm decides not 
to step up, it must route the order through the linkage based on price-
time priority. The alternative proposal suggested by the ISE is here 
because it is not included in the plans submitted by the exchanges. 
Although the ISE's alternative proposal was not addressed specifically 
by any other exchanges, both Amex and CBOE's transmittal letters stated 
a commitment to further study the issue of customer limit order 
protection.
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    \23\ISE did not define the term ``specified protection'' in its 
transmittal letter. The Commission seeks public comment on how, if 
at all, that term should be defined. See Section IV.
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F. Implementation Obligations

1. Access to the Linkage
    Section 8 of each of the plans sets forth, among other things, 
requirements relating to access to the linkage and order protection. 
With respect to P/A access, all of the plans agree that the linkage 
should not be used as an order delivery system in which all or a 
substantial portion of customer orders are routed through the linkage.
    There are several significant differences between the plans with 
respect to appropriate limitations on principal access to the linkage. 
The Amex/CBOE plan proposes an ``80/20 Test,'' which would be applied 
each calendar quarter and would limit principal access in the 
subsequent calendar quarter based on customer order volume executed on 
the principal's exchange.\24\ Under this test, a market maker that 
effected 20 percent or more of its market maker volume by sending 
principal orders through the linkage in a calendar quarter would be 
prohibited from sending principal orders through the linkage for the 
next calendar quarter (i.e., would not be an ``eligible market maker'' 
for that period). The PCX proposes to prohibit the transmission of 
principal orders, except to unlock or uncross markets or to satisfy 
trade-through liability. Under the Phlx plan, eligible market makers 
would be permitted to send principal orders through the linkage without 
limitation, so long as the market maker meets the Phlx's proposed 
definition of ``eligible market maker.''\25\
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    \24\Incoming P/A orders, but not outgoing P/A orders would be 
included in this calculation.
    \25\As noted above, Phlx defines an ``eligible market maker'' as 
a ``market maker'' that is assigned to, and is providing two-sided 
quotations in, the eligible option class and is participating in its 
market's automatic execution system in such eligible option class.
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2. Order Protection
    The exchanges all propose to prohibit trade-throughs (with certain 
exceptions discussed below), absent reasonable justification and during 
normal market conditions. The plans propose uniform exceptions to 
trade-through liability, including, among other things, systems 
malfunction, failure of the receiving market to respond to a P/A or 
principal order within 30 seconds, failure of the market traded through 
to complain within the specified time period, complex trades (to be 
defined by the Operating Committee), trading rotations, and non-firm 
quotations on the market that was traded through.
    The plans propose identical language with respect to the 
responsibilities and rights of the participating exchanges following 
trade-through complaints and the proposed provisions relating to notice 
and mitigation of damages.

[[Page 11406]]

    With one exception, the exchanges agree on the appropriate 
satisfaction of trade-throughs, either by satisfying the complaining 
market, adjusting the price, or canceling the trade. If customer orders 
constituted either or both sides of the transaction involved in the 
trade-through, each customer order would receive the price of the trade 
that caused the trade-through, or the satisfaction price, if the trade-
through was satisfied, or the adjusted price, if there was an 
adjustment, whichever price is most beneficial to the customer order. 
The member initiating the trade-through is responsible for any 
differences.
    The plans uniformly propose rules regarding the price at which the 
bid or offer that was traded through must be satisfied, yet differ on 
the appropriate size of the satisfaction. The satisfaction price would 
equal the price of the bid or offer, unless the transaction that 
constituted the trade-through was a block trade,\26\ in which case 
satisfaction would be the price of the transaction that caused the 
trade-through. With respect to the appropriate size of satisfaction, in 
the absence of disseminated size, the Amex/CBOE and PCX plans would 
limit the satisfaction of a trade-through to the verifiable number of 
customer contracts in the market of each exchange that was traded 
through that were included in the disseminated bid or offer of that 
exchange subject to certain limitations. In particular, if the number 
of contracts to be satisfied in one or more exchanges exceeds the size 
of the transaction that caused the trade-through, satisfaction will be 
limited to the size of the transaction that caused the trade-through. 
Moreover, if the transaction that caused the trade through was for a 
size larger than the firm customer quote size with respect to any of 
the exchanges traded through, the total number of contracts to be 
satisfied to all exchanges will not exceed the size of the transaction 
that caused the trade through and will be allocated pro rata based on 
the verifiable number of customer contracts traded through on each 
exchange. In the absence of disseminated size, the Phlx proposal would 
require that if the transaction was for a size larger than the firm 
customer quote size, the total number of contracts to be satisfied 
would not exceed the size of the transaction that caused the trade-
through on each exchange that was traded through.
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    \26\The plans uniformly define a ``block trade'' as a trade 
that: (i) Is of block size, defined as 500 or more contracts and a 
premium value of at least $150,000; (ii) is effected at a price 
outside of the NBBO; and (iii) involves either a cross (where a 
member of the exchange represents all or a portion of both sides of 
the trade) or any other transaction that is not the result of an 
execution at the current bid or offer on the exchange.
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G. Trade Comparison; Error Resolution

    The plans submitted to the Commission propose uniform procedures 
for trade comparison and error resolution, set forth in Section 9 of 
the plans.

H. Trading Halts and Suspensions, Non-Firm Quotations, and Hours of 
Operation

    In Section 10 of the plans, the exchanges uniformly propose 
procedures for trading halts and suspensions and non-firm quotations. 
Specifically, each exchange reserves the right to halt or suspend 
trading or declare market conditions to be non-firm in its market. In 
addition, where a particular market is closed, has halted or suspended 
trading, has not yet opened for trading, or has disseminated notice to 
the other linkage plan participants that its quotations are not firm in 
a particular options class, linkage orders may be neither sent to that 
exchange nor accepted by it through the linkage. In a scenario in which 
the exchange sending the linkage order halts or suspends trading, or 
declares its quotations to be non-firm subsequent to the transmission 
of a linkage order, the linkage order must be accepted and handled by 
the receiving exchange pursuant to the provisions of the linkage plan, 
unless the receiving exchange also halts or suspends trading, or 
declares its quotations to be non-firm.

I. Financial Matters

    The plans all propose, in Section 11, to divide the development and 
operating costs of the linkage equally among the participant exchanges, 
while each exchange proposes to be solely responsible for the costs of 
any modifications to its systems needed to accommodate the linkage. The 
exchanges propose that the Operating Committee will, at least once a 
year, establish a participation fee to be charged to any eligible 
exchange that seeks to become a party to the linkage plan. The 
participation fee, which is proposed to reflect a new participant's 
pro-rata share of the costs of developing, maintaining, and enhancing 
the linkage, will be distributed equally to the then-current 
participating exchanges.

J. Withdrawal From the Plan

    Section 12 of the plans provides that any participating exchange 
may withdraw from the plan with at least 30 days prior written notice.

K. Implementation of the Plan

    The participating exchanges stated that the plan would be 
implemented upon the Commission's approval of a plan and related rules 
and the participants' completion of the development of the systems 
necessary to effectuate the linkage approved by the Commission. The 
exchanges propose that the linkage will be operable at any time that 
two or more participating exchanges are open for trading between 9 a.m. 
and 5 p.m. Eastern time.

L. Development and Implementation Phases

    The exchanges expect that there will be a development phase 
subsequent to Commission approval of a plan. During that time, the 
Operating Committee will determine the manner in which to build and 
operate the linkage and whether to select a facilities manager. If the 
Operating Committee determines to select a facilities manager, it will 
issue a request for proposals describing the required functionality of 
the linkage, including a specification that the linkage be developed to 
accommodate the routing of P/A orders on a price-time basis, should the 
Commission determine that price/time priority should be a component of 
the linkage. PCX has proposed a phased implementation schedule, as 
described above. None of the other plans provide for a phased 
implementation schedule.

M. Impact on Competition

    The plans filed by the exchanges provide for the creation of an 
inter-market linkage between the options markets. In its October 19, 
1999 Order, the Commission found that establishing a linkage among the 
options markets would benefit investors by increasing competition among 
markets (and market participants) to provide best execution of customer 
orders. Given the recent increases in the listing of options classes 
that are traded on more than one options exchange, the need for an 
inter-market linkage has become increasingly acute. Without a linkage, 
the possibility of inter-market trade-throughs, discussed above, 
becomes increasingly common, to the detriment of investors and other 
market participants. A linkage between the options exchanges should 
reduce the frequency of inter-market trade-throughs, and provide a 
mechanism for satisfying the markets that are traded through when a 
trade-through occurs.

N. Terms and Conditions of Access

    As described above, Section 4 of each of the plans contains an 
identical, self-effecting provision for the admission of

[[Page 11407]]

new participants, in which any national securities exchange may become 
a party to the plan by agreeing, in an amendment to the plan, to comply 
with the provisions of the plan, and paying the applicable fee.

O. Method of Determination of Imposition, and Amount of Fees and 
Charges

    The plans do not provide for the imposition of any fees or charges 
associated with the use of the linkage. Section 11 of each of the plans 
uniformly proposes the allocation among the exchanges of costs 
associated with the development, implementation, and maintenance of the 
linkage. As described above, the exchanges propose that the Operating 
Committee will, at least once a year, establish a participation fee to 
be charged to any eligible exchange that seeks to become a party to the 
linkage plan. The participation fee, which is proposed to reflect a new 
participant's pro-rata share of the costs of developing, maintaining, 
and enhancing the linkage, will be distributed equally to the then-
current participating exchanges.

P. Method and Frequency of Processor Evaluation

    Under Section 6 of the plans, the Operating Committee may determine 
to select a facilities manager. The selection of a facilities manager 
would require the affirmative vote of at least two-thirds of the 
members of the entire Operating Committee. A decision to remove, or not 
to renew the contract of, a facilities manager would likewise require 
the affirmative vote of at least two-thirds of the members of the 
entire Operating Committee.

Q. Dispute Resolution

    Section 5 of each of the plans provides for a mechanism for the 
resolution of disputes arising under the plan.\27\ The proposals 
provide for a procedure by which a participating exchange may request 
an interpretive opinion of a rule made by another participant on the 
application of the plan. The dispute must pertain to a situation 
involving a minimum loss of $5,000, which must have been established 
pursuant to the plan, including the mitigation provisions of the plan. 
All routine internal exchange surveillance reviews relating to the 
disputed ruling must have been completed prior to the request. Periodic 
reports on the functioning of, and experience under, the dispute 
resolution process will be submitted to the Operating Committee for its 
information and review.
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    \27\The proposed dispute resolution process is essentially the 
same process adopted by the Intermarket Trading System Operating 
Committee and approved by the Commission. See Securities Exchange 
Act Release No. 29194 (May 15, 1991) 56 FR 23318 (May 21, 1991).
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R. Written Understandings or Agreements Relating to Interpretation of, 
or Participation in, the Plan

    Not applicable.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed 
plans are consistent with the Act. In particular, the Commission seeks 
comment on the following issues:
    1. What are the benefits and detriments of requiring that orders be 
routed to competing exchanges based on strict price/time priority? 
Should the plan include price/time priority?
    2. Would a linkage that allows a market maker to step up to match 
the NBBO, but permits an away market to receive an execution if it was 
displaying a customer limit order at the price of the execution on the 
exchange that stepped up, provide desirable protection to customer 
limit orders?
    3. How would a linkage system as described in the above question 
work in practice? Should satisfaction of a ``trade at'' be automatic or 
on a complaint basis? If by complaint, how long should the market whose 
limit order was ``traded at'' have to complain?
    4. In ISE's alternative proposal, the term ``specified protection'' 
is not defined. What would be an appropriate level of satisfaction for 
a ``trade-at''?
    5. What other requirements might be imposed on a linkage that could 
protect customer limit orders on away markets?
    6. Because quote size is not disseminated, the plan establishes a 
firm quote size for customer orders and principal orders and 
establishes different size criteria for satisfying trade-throughs. What 
is the appropriate size for these purposes?
    7. Should the linkage plan require the options markets to 
disseminate quotes with size? If so, what time frame is reasonable to 
implement this proposal? How should the requirement that quote size be 
disseminated be balanced against concerns about constraints on options 
systems capacity?
    8. Who should have access to the linkage?
    9. In what way, if any, should access to the linkage be restricted 
for orders involving principal accounts?
    10. What is an appropriate level of discretion for the proposed 
Operating Committee? In particular, should it have discretion to define 
plan terms such as ``complex trade'' as an exception to trade-through 
liability?
    11. In what way, if any, will a linkage plan between the options 
markets impact competition?
    12. Is it useful to require a unanimous vote in order to amend the 
plan? Would a super-majority (or a simple majority vote) to amend the 
plan be more or less appropriate than a requirement of unanimity? Under 
what circumstances, including those included in the plan, should a 
super-majority be required? Would a simple majority be more appropriate 
in any of those instances?
    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, and 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 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 the filing also will be available at the principal offices of 
the participating exchanges. All submissions should refer to File No. 
4-429 and should be submitted by April 3, 2000.

    Dated: April 3, 2000.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-4978 Filed 3-1-00; 8:45 am]
BILLING CODE 8010-01-P