[Federal Register Volume 65, Number 113 (Monday, June 12, 2000)]
[Notices]
[Pages 36850-36853]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14720]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42894; File No. SR-Amex-99-36]


Self-Regulatory Organizatons: Orders Approving a Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment Nos. 1, 2, and 3 to the Proposed Rule Change by the American 
Stock Exchange LLC Relating to Facilitation, Solicitation, and Crossing 
Transactions

June 2, 2000.

I. Introduction

    On September 2, 1999, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19-4 
thereunder,\2\ a proposed rule change to amend its rules by adopting 
Commentary .02(d) and Commentary .04 to Amex Rule 950(d).\3\ The 
proposed rule change was published for comment in the Federal Register 
on October 15, 1999.\4\ On November 1, 1999, May 26, 2000, and May 31, 
2000, the Amex filed Amendment Nos. 1, 2, and 3, respectively, to the 
proposal.\5\ No comments were received regarding the proposed rule 
change. This order approves the portion of the proposal, as amended, 
adopting Commentary .04 to Amex Rule 950(d); this order also approves 
the portion of the proposal adopting Commentary .02(d) to Amex Rule 
950(d) on a pilot basis until August 31, 2000. Finally, this order 
accelerates approval of Amendment Nos. 1, 2 and 3, and solicits 
comments from interested persons on those amendments.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240 19b-4.
    \3\ The current proposal replaces an earlier proposed (file No. 
SR-Amex-98-19) that the Amex withdrew. See Securities Exchange Act 
Release No. 41864 No. 41864 (September 10, 1999), 64 FR 50843 
(September 20, 1999).
    \4\ See Securities Exchange Act Release No. 41985 (October 7, 
1999), 64 FR 55998.
    \5\ The modifications made by these amendments are incorporated 
in the description of the proposal in Section II below, and are 
further discussed in Section III below.
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II. Description of the Proposal

A. Proposed New Commentary .02(d)

    Commentary .02 to Amex Rule 950(d) generally sets forth the 
procedures by which a floor broker representing the order of a public 
customer of a member firm may cross that order with a contra side order 
from the firm's proprietary account. In these circumstances, the firm 
is said to be ``facilitating'' the customer order, and the transaction 
is called a ``facilitation cross.''
    Under the current version of the rule, a floor broker seeking to 
execute a facilitation cross must first bring the transaction to the 
trading floor and request a market from the trading crowd. After 
receiving bids and offers from the crowd, the floor broker must propose 
a price at which to cross the order that improves upon the price 
provided by the crowd. However, before the floor broker can effect the 
cross, the market makers in the crowd are given the opportunity to take 
all or part of the transaction at the proposed price.
    Under the current rule, if the crowd does not want to participate 
in the trade, the floor broker may proceed with the cross. If the crowd 
wants to take part of the order, however, the crowd has precedence and 
the floor broker may cross only that amount remaining after the crowd 
has taken its portion. If the crowd wants to take the entire order, the 
floor broker will not be able to cross any part of the order.

[[Page 36851]]

    The proposed rule change would add new paragraph (d) to Commentary 
.02 to establish a 90-day pilot program that would apply to 
facilitation cross transactions in equity options.\6\ The proposal 
would entitle the floor broker, under certain conditions, to cross a 
specified percentage of the customer order on behalf of the member firm 
before market makers in the crowd can participate in the transaction. 
This provision would generally apply to orders of 400 contracts or 
more. However, the Exchange would be permitted to establish a smaller 
eligible order size, so long as that size is not smaller than 50 
contracts.\7\
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    \6\ See Amendment No. 2.
    \7\ Amendment No. 2 concerning proposed subsection (d)(2). The 
Exchange would be permitted to adjust the eligible order size on a 
class by class basis. Telephone conversation between Clarie McGrath, 
Vice President and Special Counsel, Derivative Securities, Amex, and 
Ira Brandriss, Attorney, Division of Market Regulation, the 
Commission, on May 26, 2000.
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    The percentage of the floor broker's guarantee would depend upon 
whether the price at which the order is ultimately traded is at the 
crowd's best bid or offer in response to the broker's initial request 
for a market, or at an improved price.
    First, the floor broker would be granted a right under the proposal 
to execute a facilitation cross even at a price that does not improve 
upon the best bid or offer provided by the crowd in response to his 
initial request for a market. The proposed rule change provides that 
where the trade takes place at the market provided by the crowd, all 
public customer orders on the specialist's book or represented in the 
trading crowd at the time the market was established would need to be 
satisfied first. Once these public customer orders are satisfied, the 
floor broker would be entitled to facilitate 20% of the contracts 
remaining in the customer order.\8\
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    \8\ See Amendment No. 1, concerning proposed 
subsection(d)(1)(i).
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    The proposed rule change further provides that if the floor broker 
proposes the facilitation cross at a price between the best bid and 
offer provided by the crowd in response to his initial request for a 
market--and the crowd then wants to take part or all of the order at 
the improved price--the floor broker would be entitled to priority over 
the crowd to facilitate 40% of the contracts.\9\ However, if the floor 
broker has proposed the cross at a price between the best bid and offer 
provided by the crowd in response to his initial request for a market, 
and the trading crowd subsequently improves the floor broker's price, 
and the facilitation cross is executed at that improved price, the 
floor broker would be entitled to priority to facilitate 20% of the 
contracts.\10\
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    \9\ See Amendment No. 2, which reduces the proposed percentage 
guarantee from 50% to 40%.
    \10\ See Amendment No. 2.
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    The proposed rule change also provides that if the facilitation 
transaction takes place at the specialist's quoted bid or offer, any 
participation allocated to the specialist pursuant to Amex trading 
floor practices \11\ would apply only to the number of contracts 
remaining after all public customer orders have been filled and the 
member firm's crossing rights have been exercised. However, in no case 
could the total number of contracts guaranteed to the member firm and 
the specialist exceed 40% of the facilitation transaction.\12\
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    \11\ These practices provide specialists with a greater than 
equal participation in trades that take place at a price at which 
the specialist is on parity with registered options traders in the 
crowd. See Amendment No. 3. The Commission notes that the Amex has 
separately filed a proposal to codify its specialist allocation 
practices. See File No. SR-Amex-00-30, available for inspection in 
the Commission's Public Reference Room.
    \12\ See Amendment No. 3, concerning proposed subsection (d)(3).
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    The proposed rule change makes clear that if the facilitation 
transaction takes place at a price at which the specialist is not on 
parity with registered options traders in the crowd, the specialist 
would not be guaranteed any participation. The proposal also makes 
clear, however, that it is not intended to prohibit either a member 
firm or specialist from trading more than their percentage entitlements 
if the other members of the trading crowd do not choose to trade with 
the remaining portion of the facilitated order.\13\
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    \13\ See Amendment No. 2, concerning proposed subsection (d)(4).
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B. Proposed New Commentary .04

    Proposed new Commentary .04 to Amex 950(d) states that it may be 
considered conduct inconsistent with just and equitable principles of 
trade for any member or person associated with a member, who has 
knowledge of all material terms and conditions of (1) an originating 
order \14\ and a solicited order, (2) an order being facilitated, or 
(3) orders being crossed, the execution of which are imminent, to 
enter, based on such knowledge, an order to buy or sell an option of 
the same class as any option that is the subject of the order, or an 
order to buy or sell the security underlying such class, or an order to 
buy or sell any related instrument until either (1) all of the terms of 
the originating order \15\ and any changes in the terms or conditions 
of the order of which the member or associated person has knowledge are 
disclosed to the trading crowd, or (2) the trade can no longer 
reasonably be considered imminent in view of the passage of time since 
the order was received. For purposes of proposed Amex Rule 950(d), 
Commentary .04, an order to buy or sell a ``related instrument,'' 
means, in reference to an index option, an order to buy or sell 
securities comprising 10% or more of the component securities in the 
index or an order to buy or sell a futures contract on an economically 
equivalent index.
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    \14\ Amex Rule 950(d), Commentary .03 states, in part, that a 
member or member organization representing an order in options 
(``originating order'') may solicit another member, member 
organization, or non-member broker-dealer outside the trading crowd 
(``solicited party'') to participate in the transaction on a 
proprietary basis provided the member or member organization, upon 
entering the trading crowd to execute the transaction, announces to 
the trading crowd the same terms and conditions about the 
originating order as disclosed to the solicited party and bids at 
the price he is prepared to buy from the solicited party or offers 
at the price he is prepared to sell to the solicited party.
    \15\ The proposal as originally filed refers to ``all the terms 
of the order.'' Amendment No. 2 modifies this phrase to refer to 
``all the terms of the originating order,'' defining more clearly 
the disclosure requirement. See Section III.C below.
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    The Amex stated that it seeks to codify and expand its policy 
prohibiting either a member or a person associated with a member from 
using non-public information for the member's or associated person's 
benefit by trading in the underlying stock or any closely related 
instrument. Specifically, proposed Commentary .04 is designed to 
prevent members and associated persons from using undisclosed 
information about imminent solicited, facilitated, or crossed options 
transactions to trade the relevant option or any closely related 
instrument in advance of persons represented in the trading crowd. The 
Amex believes that trading on the basis of undisclosed information 
could threaten the integrity of the auction market or disadvantage 
other market participants.

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the provisions of the Act applicable to a 
national securities exchange, particularly those of Section

[[Page 36852]]

6(b)(5) \16\ and Section 6(b)(8) \17\ of the Act, and the rules and 
regulations thereunder.\18\
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    \16\ 15 U.S.C. 78f(b)(5). Section 6(b)(5) requires that the 
rules of a national securities exchange be designed to, among other 
things, promote just and equitable principles of trade, remove 
impediments to and perfect the mechanism of a free and open market, 
and, in general, to protect investors and the public interest. It 
also requires that those rules not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.
    \17\ 15 U.S.C. 78f(b)(8). Section 6(b)(8) requires that the 
rules of the exchange do not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Act.
    \18\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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A. Proposed New Commentary .02(d)

    The Commission believes that proposed new Commentary. 02(d) to Amex 
Rule 950(d) will enable the Amex to better compete with other options 
exchanges in attracting the order flow of broker-dealer firms seeking 
to facilitate customer orders, without adversely impacting the prices 
those orders receive.
    The Commission finds that the Amex's proposal to grant 
participation rights, under certain conditions, to member firm seeking 
to execute facilitation crosses on the Exchange is reasonable. 
Currently, Amex market makers have priority rights for the full size of 
a customer order over the firm that brings a crossing transaction of 
the Amex floor, as long as the market makers are willing to trade at 
the proposed price.
    While the proposal entitles the member firm to a specified 
percentage of a facilitation transaction when executed at the trading 
crowd's best bid or offer, it does not eliminate the crowd's ability to 
trade with a portion of the order proposed to be crossed, or even so 
substantially reduce that ability so as to raise serious concern that 
the proposal would reduce price competition by the crowd. Moreover, the 
Commission believes that the proposal may contribute to better prices 
for crossing transactions. Specifically, it provides an incentive for 
upstairs firms to improve on the prices quoted by the crowd by offering 
these firms a greater participation in the trade when they better the 
crowd's price. In addition, market makers will always have an 
opportunity to improve the market and compete for a greater portion of 
the trade.
    In evaluating the proposed rule change, the Commission considered, 
among other matters, whether the Amex's proposal to guarantee that a 
member firm could cross up to 40% of an order would reduce the 
incentive of crowds to compete for orders, and thus impair the price 
discovery mechanism of the Exchange's market.
    It is recent approval of the application of the International 
Securities Exchange (``ISE'') for registration as a national securities 
exchange, the Commission discussed the same concern with respect to the 
ISE's proposed ``facilitation mechanism,'' a system designed to effect 
a type of facilitation guarantee in an electronic context. The 
Commission wrote:

    It is difficult to assess the precise level at which guarantees 
may begin to erode competitive market maker participation and 
potential price competition within a given market. In the future, 
after the Commission has studied the impact of guarantees, the 
Commission may need to reassess the level of these guarantees. For 
the immediate term, the Commission believes that 40% is not clearly 
inconsistent with the statutory standards of competition and free 
and open markets.\19\ By the same token, the Commission believes 
that the Amex's proposed rule change,
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    \19\ See Securities Exchange Act Release No. 42455 (February 24, 
2000), 65 FR 11388 (March 2, 2000).

which allocates no more than 40% of an order to the firm seeking to 
facilitate an order, is not inconsistent with the statutory standard. 
The Commission notes, moreover, that for those crossing transactions in 
which a specialist, pursuant to Amex trading floor practices, is 
entitled to an allocation in addition to the proposed allocation for 
the facilitating firm, the Amex has included a provision to limit the 
combined allocations awarded to the firm and the specialist an 
aggregate of no more than 40% of the order.

B. Proposed New Commentary .04

    As described more fully above, proposed Commentary .04 restricts 
trading by a member or associated person who has knowledge of all of 
the material terms of a solicited order, an order being facilitated, or 
orders being crossed. The restriction does not apply however, if either 
(1) all of the terms of the originating order and any changes in the 
terms and conditions of the order of which the member or associated 
person has knowledge are disclosed to the trading crowd; or (2) the 
trade can no longer reasonably be considered imminent in view of the 
passage of time since the order was received.
    According to the Amex, proposed Amex Rule 950(d), Commentary .04 is 
designed to prevent members and associated persons from using 
undisclosed information about imminent solicited, facilitated, or 
crossing transactions to trade the relevant option or any closely 
related instrument in advance of persons represented in the trading 
crowd.
    The Commission believes that it is reasonable for the Amex to 
prohibit, as inconsistent with just the equitable principles of trade, 
transactions by members or associated persons based on the knowledge of 
imminent undisclosed solicited, facilitated, or crossing transactions. 
The Commission believes that such trading could threaten the integrity 
of the auction market or disadvantage other market participants.\20\ 
Accordingly, by restricting trading based on knowledge of an imminent 
undisclosed solicited, facilitated, or crossing transaction, the 
Commission believes that the proposal will help to maintain the 
integrity of the Amex's market. As noted above, a member or associated 
person who has knowledge of all of the material terms of a solicited 
order, an order being facilitated, or orders being crossed may trade 
after disclosing to the trading crowd the terms of the originating 
order and any changes in the terms and conditions of the order.\21\ The 
Commission believes that this disclosure requirement should provide the 
trading crowd with a fair and full opportunity to make informed trading 
decisions.\22\
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    \20\ See Securities Exchange Act Release No. 34959 (November 9, 
1994), 59 FR 59446 (November 17, 1994) (order approving File No. SR-
CBOE-94-15).
    \21\ Under proposed Commentary .04, a member or associated 
person with knowledge of the terms and conditions of a solicited, 
facilitated, or crossing transaction also may trade based on 
knowledge of the order if the trade can no longer reasonably be 
considered imminent in view of the passage of time since the order 
was received.
    \22\ See Securities Exchange Act Release No. 36195 (August 25, 
1995), 60 FR 45753 (September 1, 1995) (order approving File No. SR-
CBOE-95-07) (``1995 CBOE Order'').
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    The Commission notes that proposed Commentary .04 does not relieve 
market participants of the general Amex requirement that their acts and 
practice be consistent with just and equitable principles of trade.\23\ 
Thus, the Commission notes, as it has concluded previously,\24\ that 
disclosing the terms of an order and any change in the terms and 
conditions of the order to the trading crowd prior to effecting a trade 
does not provide a safe harbor from possible violations of front-
running prohibitions.\25\
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    \23\ See Amex Constitution, Article V, Section h(4).
    \24\ See 1995 CBOE Order, supra note 22.
    \25\ See Securities Exchange Act Release No. 25233 (December 30, 
1987), 53 FR 296 (January 6, 1998) (noting the filing and immediate 
effectiveness of frontrunning policies filed by the American Stock 
Exchange, New York Stock Exchange, Pacific Exchange, Philadelphia 
Stock Exchange, Chicago Board Options Exchange, and the National 
Association of Securities Dealers).

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[[Page 36853]]

    The Commission notes that proposed Commentary .04 is substantially 
similar to current Chicago Board Options Exchange (``CBOE'') Rule 
6.9(e). The Commission believes that it is reasonable for the Amex to 
adopt a rule that is substantially similar to CBOE Rule 6.9(e) to 
provide similar protections for the Amex's marketplace. In addition, 
Commission believes that it is reasonable for the Amex to include 
solicited, facilitated, and crossing transactions in Amex Rule 950(d), 
Commentary .04 because solicited, facilitated, and crossing 
transactions could present opportunities for misuse of non-public 
information.

C. Accelerated Approval of Amendments

    The Commission finds good cause, pursuant to Section 19(b)(2)(B) 
\26\ of the Act, for approving Amendment Nos. 1, 2, and 3 to the 
proposal prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register.
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    \26\ 15 U.S.C. 78s(b)(2)(B).
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    Amendment No. 1 adds the provision, described above, that would 
provide an allocation to a member firm seeking to facilitate a customer 
order even when it only matches, but does not improve upon, the prices 
given by the crowd in response to the floor broker's initial request 
for a market. The Commission has already approved rules of the ISE, the 
CBOE, and the Pacific Exchange (``PCX'') that establish participation 
guarantees for firms seeking to facilitate orders even when they only 
match the best prices offered by other market participants.\27\ Thus, 
the addition of this provision to the Amex proposal raises no new 
regulatory issues. Further, it should benefit options market 
participants by allowing for substantially consistent treatment of 
crossing mechanisms under the rules of the various exchanges, and will 
allow the Amex to compete without disadvantage for facilitation orders.
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    \27\ See Securities Exchange Act Release Nos. 42455 (February 
24, 2000), 65 FR 11388 (March 2, 2000) (approving ISE's registration 
as a national securities exchange); 42835 (May 26, 2000) (approving 
File No. SR-CBOE-99-10); and 42848 (May 26, 2000) (approving File 
No. SR-PCX-99-18).
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    Amendment No. 2 reduces the allocation to the member firm seeking 
to facilitate a customer order from 50% to 40% when the firm improves 
the price given by the crowd in response to the floor broker's request 
for a market. It thus limits guaranteed participation to a percentage 
that the Commission has previously found consistent with the Act and 
raises no new regulatory issues. Amendment No. 2 also includes the 
provisions described above concerning specialist allocations, and 
stipulates that the allocations guaranteed to the member firm and the 
specialist in the aggregate may not exceed 40% of the order. It thus 
strengthens the proposal by adding a necessary clarification of 
priority rights pursuant to current trading practices.
    Amendment No. 2 also provides the Exchange the authority to reduce 
the size of orders to which the new guarantee applies from 400 to 50 
contracts. The Commission has already approved ISE and CBOE rules 
permitting guarantees to firms facilitating crosses in order sizes as 
low as 50 contracts.\28\ Thus, this modification of the Amex proposal 
raises no new regulatory issues. Further, it will benefit options 
market participants by allowing for substantially consistent treatment 
of crossing mechanisms under the rules of the ISE, the CBOE, and the 
Amex, and will allow the Amex to compete without disadvantage for 
facilitation orders.
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    \28\ See relevant citations at supra, note 27.
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    Amendment No. 2 also seeks to establish proposed Commentary .02(d) 
to Rule 950(d) as a 90-day pilot program. The Commission finds no 
reason to delay approval of this modification.
    With respect to proposed Commentary .04, Amendment No. 2 clarifies 
that the restriction on trading for a person who has knowledge of the 
terms of a solicited, facilitation, or crossing order no longer applies 
as long as he disclosed all the terms of the originating order.\29\ 
This clarification brings the proposed rule change in conformity with 
the disclosure requirement of CBOE Rule 6.9(e) and raises no new 
regulatory issue.
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    \29\ See supra, note 14.
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    Amendment No. 3 includes several modifications of the proposed new 
rule text that were made for technical purposes \30\ or to clarify its 
meaning, and thus strengthen the proposal.
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    \30\ One modification refers to current trading floor practices 
on the Amex regarding specialist allocations, rather than to the 
Amex proposal that would codify these practices, which is still 
pending before the Commission. See supra, note 11.
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    Accordingly, the Commission finds good cause, consistent with 
Sections 6(b)(5) \31\ and 19(b)(2) \32\ of the Act to accelerate 
approval of Amendment Nos. 1, 2, and 3 to the proposed rule change.
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    \31\ 15 U.S.C. 78f(b)(5).
    \32\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1, 2, and 3, including whether they 
are consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609. Copies 
of the submission, all subsequent amendments, all written statements 
with respect to the proposed rule change that are filed with the 
Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. Sec. 552, will be available for inspection and copying in 
the Commission's Public Reference Room. Copies of such filing will also 
be available for inspection and copying at the principal office of the 
Amex. All submissions should refer to File No. SR-Amex-99-36 and should 
be submitted by July 3, 2000.

V. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act and the rules and regulations 
thereunder.
    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the Act, 
that the portion of the proposed rule change (SR-Amex-99-36), as 
amended, adopting Commentary .04 to Amex Rule 950(d) is approved, and 
the portion of the proposed rule change adopting Commentary .02(d) to 
Amex Rule 950(d) is approved on a pilot basis until August 31, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\33\
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    \33\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-14720 Filed 6-9-00; 8:45 am]
BILLING CODE 8010-01-M