[Federal Register Volume 65, Number 221 (Wednesday, November 15, 2000)]
[Notices]
[Pages 69114-69116]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-29186]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43515; File No. SR-Phlx-99-32]


Self-Regulatory Organizations; Order Granting Approval of 
Proposed Rule Change by the Philadelphia Stock Exchange, Inc. Relating 
to the Maximum Size of Option Orders That May Be Executed Automatically

November 3, 2000.

I. Introduction

    On August 23, 1999, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change amending its rules regarding the 
automatic execution of options orders to increase the maximum number of 
contracts eligible to be executed on the Exchange's automatic execution 
system (``AUTO-X'') from fifty contracts to seventy-five contracts. On 
September 27, 1999 and January 23, 2000, respectively, the Phlx 
submitted Amendments Nos. 1 and 2 to the proposed rule change.\3\ 
Notice of the proposal was published in the Federal Register on June 
21, 2000.\4\ The Commission received no comments on the proposal. This 
order approves the proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange designated the proposal as 
filed pursuant to Section 19(b)(2) of the Act. The Exchange 
originally filed the proposal pursuant to Section 19(b)(3)(A). See 
Letter from Edith Hallahan, Deputy General Counsel, Phlx, to Nancy 
Sanow, Senior Special Counsel, Division of Market Regulation, 
Commission, dated September 23, 1999 (``Amendment No. 1''). In 
Amendment No. 2, the Exchange deleted a provision in the original 
proposal that restricted the increase in maximum order size 
eligibility to 100 options. See Letter from Nandita Yagnik, Phlx, to 
Nancy Sanow, Senior Special Counsel, Division of Market Regulation, 
Commission, dated January 20, 2000 (``Amendment No. 2'').
    \4\ See Securities Exchange Act Release No. 42932 (June 13, 
2000), 65 FR 38621 (June 21, 2000).
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II. Description of the Proposal

    The AUTO-X feature of the Exchange's Automated Options Market 
System (``AUTOM'') automatically executes public customer market and 
marketable limit orders in options at the Exchange's displayed bid or 
offer. Generally, public customer market and marketable limit orders of 
up to fifty contacts may be automatically executed through AUTO-X.\5\ 
Orders are routed

[[Page 69115]]

through AUTOM from member firms directly to the appropriate specialist 
on the trading floor. Orders routed through AUTOM that are eligible for 
AUTO-X are automatically executed at the disseminated quotation price 
on the Exchange and reported back to the originating firm.\6\
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    \5\ See Securities Exchange Act Release No. 36601 (December 18, 
1995), 60 FR 66817 (December 26, 1995) (approving proposal to 
increase order size eligibility limits for AUTO-X from twenty-five 
to fifty contracts).
    \6\ See Phlx Rule 1080(c).
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    The Exchange proposes to amend Phlx Rule 1080(c) to increase the 
maximum order size eligibility for automatic execution through AUTO-X 
from fifty contracts to seventy-five contracts. The Exchange represents 
that AUTO-X affords prompt and efficient automatic executions at the 
displayed price and therefore believes that increasing automatic 
execution levels will provide the benefits of automatic execution to a 
larger number of customer orders. Further, the Exchange notes that this 
increase from fifty contracts to seventy-five contracts is in line with 
prior changes to AUTO-X levels.\7\
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    \7\ See supra note 5; Securities Exchange Act Release Nos. 32906 
(September 15, 1993), 58 FR 49345 (September 22, 1999) (approving 
proposal to increase order size eligibility limits for AUTO-X from 
twenty to twenty-five contracts); and 29837 (October 18, 1991), 56 
FR 55146 (October 24, 1991) (approving proposal to increase order 
size eligibility limits for AUTO-X from ten to twenty contracts).
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    The Exchange represents that its rules contain several safeguards 
to ensure the proper handling of AUTO-X orders. First, Phlx Rule 
1080(f)(iii) states that a specialist is responsible for the remainder 
of an AUTOM order where a partial execution has occurred. Phlx Rule 
1015 governs quotation guarantees and requires the trading crowd to 
ensure that public customer orders are filled at the best market for a 
minimum of ten contracts (``ten-contract guarantee''). Further, Options 
Floor Procedure Advice F-7 provides that the volume guarantees 
(including AUTO-X levels) are deemed to be the stated size in any bid 
or offer voiced or displayed on the Options Floor. Therefore, quoted 
markets are guaranteed up to that size. The Exchange represents that 
violations of any of these provisions could be referred to the Business 
Conduct Committee for disciplinary action.
    Second, the Exchange represents that Registered Options Traders 
(``ROTs'') have discretion to participate on the Wheel that allocates 
AUTO-X trades.\8\ Consequently, an increase in the maximum AUTO-X order 
size does not prevent an ROT from declining to participate on the 
Wheel. The Exchange represents that the Wheel operates by rotating in 
two-lot to ten-lot increments depending upon the size of the order, and 
thus no single ROT will be allocated the entire seventy-five contracts.
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    \8\ Unlike ROTs, specialists are required to participate on the 
Wheel. See Phlx Rule 1080(g).
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    Third, the Exchange represents that its procedures allow a 
specialist to disengage AUTO-X in extraordinary circumstances,\9\ and 
that AUTOM users will be notified of such situations. For example, in 
extraordinary (fast market) conditions, quotations are disseminated 
with an ``F'' and the ten-contract guarantee on the screen markets is 
suspended pursuant to Options Floor Procedure Advice F-10.\10\
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    \9\ See Phlx Rule 1080(e) and Options Floor Procedure Advice A-
13.
    \10\ Options Floor Procedure Advice F-10 states, in relevant 
part, that ``[d]uring the period for which a fast market is in 
effect, displayed quotes for the respective options are not firm and 
volume guarantees of Option Advice A-11 are not applicable. * * *'' 
Options Floor Procedure Advice A-11 provides that ``public customer 
market or marketable limit orders in any options series on the 
Exchange are to be filled at the best market to a minimum of ten 
contracts by floor traders in the crowd. * * *''
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    Finally, the Exchange notes that its rules provide a minimum net 
capital requirement for ROTs.\11\ In addition, a ROTs clearing firm 
performs risk management functions to ensure that the ROT has 
sufficient financial resources to cover positions throughout the day. 
In this regard, the function includes real-time monitoring of 
positions. Further, the Exchange represents that it believes that 
clearing firm procedures address concerns regarding whether an ROT has 
the financial capability to support trading of options orders a large 
as seventy-five contracts.
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    \11\ See Phlx Rule 703.
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    The Exchange represents that it believes that automatic execution 
of orders for up to seventy-five contracts will provide customers with 
quicker, more efficient executions for a larger number of orders, by 
providing automatic rather than manual executions, thereby reducing the 
number of orders subject to manual processing. Further, the Exchange 
represents that increasing the AUTO-X maximum order size should not 
impose a significant burden on operation or capacity of the AUTOM 
System and will give the Exchange better means of competing with other 
options exchanges for order flow.

III. Discussion

    After careful review, 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, in particular, the requirements of Section 6 of the Act.\12\ Among 
other provisions, section 6(b)(5) of the Act requires that the rules of 
an exchange be designed to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating securities transactions; 
remove impediments to and perfect the mechanism of a free and open 
market and a national securities system; and protect investors and the 
public interest.\13\
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    \12\ The Commission has considered the proposed rule's impact on 
efficiency, competition and capital formation. 15 U.S.C. 78c(f).
    \13\ 15 U.S.C. 78f(b)(5).
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    While increasing the maximum order size limit from fifty contracts 
to seventy-five contracts for AUTO-X eligibility by itself does not 
raise concerns under the Act,\14\ the Commission believes that this 
increase raises collateral issues that the Phlx will need to monitor 
and address. Increasing the maximum order size for particular option 
classes will make a larger number of option orders eligible for the 
Exchange's automatic execution system. These orders may benefit from 
greater speed of execution, but at the same time create greater risks 
for market maker participants. Market makers signed onto the AUTO-X 
system will be exposed to the financial risks associated with larger-
sized orders being routed through the system for automatic execution at 
the displayed price. When the market for the underlying security 
changes rapidly, it may take a few moments for the related option's 
price to reflect that change. In the interim, customers may submit 
orders that try to capture the price differential between the 
underlying security and the option. The larger the orders accepted 
through AUTO-X, the greater the risk market makers must be willing to 
accept. The Commission does not believe that, because the Exchange's 
Options Committee determines to approve orders as large as seventy-five 
contracts as eligible for AUTO-X, the Options Committee or any other 
Phlx committee or officials should disengage AUTO-X more frequently by, 
for example, declaring a ``fast'' market. Disengaging AUTO-X can 
negatively affect investors by making it slower and less efficient to

[[Page 69116]]

execute their option orders. It is the Commission's view that the 
Exchange, when increasing the maximum size of orders that can be sent 
through AUTO-X, should not disadvantage all customers--the vast 
majority of which enter orders for less than seventy-five contracts--by 
making the AUTO-X sytstem less reliable.
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    \14\ The Commission notes that it is concurrently approving 
similar proposals filed by the American Stock Exchange, LLP 
(``Amex''), Chicago Board Options Exchange, Inc. (``CBOE''), and the 
Pacific Stock Exchange, Inc. (``PCX''). See Securities Exchange Act 
Release No. 43516 (November 3, 2000) (SR-Amex-99-45); 43517 
(November 3, 2000) (SR-CBOE-99-51); and Securities Exchange Act 
Release No. 43518 (November 3, 2000) (SR-PCX-00-32).
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IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with section 6(b)(5).\15\
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    \15\ 15 U.S.C. 78f(b)(5).
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    It Is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-Phlx-99-32) is approved.
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    \16\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).

      
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-29186 Filed 11-14-00; 8:45 am]
BILLING CODE 8010-01-M