[Federal Register Volume 65, Number 238 (Monday, December 11, 2000)]
[Notices]
[Pages 77413-77416]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-31382]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43645; File No. SR-Phlx-00-92]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc. Concerning Reporting, 
Examination, Recordkeeping, and Disclosure Requirements Related to Off-
Floor Trading Organizations and Their Affiliated Traders

November 30, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on October 11, 2000, the Philadelphia Stock Exchange, Inc. 
(``Phlx'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in

[[Page 77414]]

Items I, II, and III below, which Items have been prepared by the 
Exchange. The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Phlx proposes to adopt new Exchange Rules 641, 642, 643, and 
644 concerning reporting, examination, recordkeeping, and disclosure 
requirements related to off-floor trading organizations and their 
affiliated traders.
    Specifically, the rules would require off-floor member 
organizations for whom the Exchange is the Designated Examining 
Authority (``DEA'') to make affirmative inquiry of their affiliated 
traders regarding the sources of their funding and to disclose to the 
Exchange annually all borrowing, lending, investment, or other 
financing activity relating to the organization.
    For those off-floor traders that are affiliated with off-floor 
member organizations and that are organized as entities other than 
individuals (e.g., corporations or limited liability companies 
(``LLCs'')), the proposed rules also would require that each individual 
trader that trades in the account of such an entity: (i) Be a direct 
shareholder or member of the organization; or (ii)(A) hold his or her 
ownership interest through an intermediate entity (such as a 
corporation or an LLC), (B) be the sole shareholder or member of such 
intermediate entity, and (C) be the sole person authorized to trade for 
the account identified with such individual or intermediate entity. In 
any case, the individual trader would be subject to the examination and 
registration requirements applicable to individual traders.
    In addition, the proposed rules would require off-floor member 
firms to represent that their affiliated traders and trading entities 
are in compliance with certain federal and state laws. Finally, the 
proposed rules would allow the Exchange to conduct examinations of 
affiliated traders of off-floor trading firms, whether natural persons 
or other entities.
    The text of the proposed rule change is set forth below. New 
language is in italics.

Rule 641. Reporting, Record Keeping and Regulatory Requirements for Off 
Floor Traders and Off-Floor Trading Organizations

    All member organizations and participant organizations engaged in 
proprietary or agency trading of securities from off the floor of the 
Exchange for whom the Exchange is the Designated Examining Authority 
(``off-floor firms'') shall:
    (a) not less frequently than annually, make an affirmative inquiry 
of each individual off-floor trader or trading entity affiliated with 
such off-floor firm (each an ``affilliated trader''), concerning (i) 
any and all loan or lending arrangements entered into by the individual 
affiliated trader or trading entity as borrower, including an inquiry 
of the names, addresses, and affiliations of any person or entity 
involved, and dollar amounts borrowed or loaned; (ii) any and all 
investment arrangements entered into by the individual affiliated 
trader whereby any person or entity has an investment or equity 
interest in the affiliated trader or any account over which such 
affiliated trader has trading authority, including an inquiry of the 
names, addresses, and affiliations of any person or entity involved, 
and the dollar amounts invested; (iii) any and all third parties, 
including natural persons or other entities, which share in the profits 
or losses of any account of an affiliated trader of such off-floor 
firm;
    (b) make reasonable investigation as to whether any relationship 
disclosed as a result of the inquiry referred to in rule 641(a) (or 
otherwise coming to the attention of the off-floor firm) is in 
compliance with all the regulations set forth in Rule 641(c) below;
    (c) annually certify to the Exchange, in writing, that based upon 
such inquiry (i) such off-floor firm has made all inquiries required 
pursuant to Rule 641(a); (ii) such off-floor firm and its affiliated 
traders are in compliance with all applicable laws, including, but not 
limited to, the Securities Exchange Act of 1934, the Investment Company 
Act of 1940, the Investment Advisers Act of 1940, and any applicable 
state laws; and (iii) that such off-floor firm or affiliated trader (A) 
carries no customer accounts and (B) does not trade in an account on 
behalf of investors or lenders who share in the profits of such account 
(``de facto customer account''); and
    (d) maintain all records pertaining to affiliated traders and 
accounts of affiliated traders for a minimum of three years in a 
readily accessible location.

Rule 642. Examination of Off-Floor Traders

    The Exchange shall have the right to conduct examinations of all 
off-floor trading firms, and of all affiliated traders of such off-
floor trading firms, whether natural persons or other entities, 
including, but not limited to, affiliated traders, and any person or 
other entity engaged in lending, borrowing, investing, or other 
financing related to the off-floor trading firm and/or its affiliated 
traders. The terms used in this Rule shall have the same meaning as in 
Rule 641.

Rule 643. Ownership of Accounts. Affiliated Members of Off-Floor 
Trading Organizations

    (a) Any affiliated trader of an off-floor trading firm engaged in 
off-floor trading shall be either (i) a natural person; or (ii) if not 
a natural person, an entity, which shall be organized and have its 
registered office in a state or possession of the United States or the 
District of Columbia, and which is 100% owned and controlled by one 
natural person engaged in off-floor trading for the account of such 
entity. With respect to Section (ii) hereof, the natural person shall 
be registered with the Exchange in accordance with Exchange Rule 604, 
and shall be required to be qualified as set forth in Exchange Rule 
604(e).
    (b) With respect to affiliated traders which are not natural 
persons, the off-floor firm shall make an annual, affirmative inquiry 
into the ownership status of such an entity to ensure compliance with 
Section (a)(ii) of this Rule, and shall report the results of such 
annual inquiry in writing to the Exchange. The Exchange may, in its 
discretion, require evidence and identification of the ultimate 
beneficial interest in such an entity. An entity referred to in Section 
(a)(ii) hereof, and any natural person engaged in off-floor trading in 
the account of such an entity, shall be subject to the examination and 
registration requirements set forth in Exchange Rule 604(e).
    (c) Any off-floor firm or affiliated trader may apply for an 
exemption from the provisions set forth in this Rule. The Exchange 
shall have the right to demand the Opinion of Counsel of the off-floor 
firm or affiliated trader regarding the applicant's compliance with 
applicable laws, including, but not limited to, the Securities Exchange 
Act of 1934, The Investment Company Act of 1940, the Investment 
Advisers Act of 1940, and any applicable state laws.

[[Page 77415]]

Rule 644. Disclosure by Off-Floor Trading Organizations

    All off-floor trading firms shall annually disclose to the 
Exchange, in writing:
    (a) All borrowing, lending, investment, or other financing activity 
relating to the off-floor trading organization; and
    (b) the names, addresses, and telephone numbers of all persons or 
other entities which engage in borrowing, lending, investment, or other 
financing activity relating to the off-floor firm.
    (c) The Exchange may, in its discretion, demand written 
certification from off-floor trading organizations of their compliance 
with applicable laws, including, but not limited to, the Securities 
Exchange Act of 1934, The Investment Company Act of 1940, the 
Investment Advisers Act of 1940, and any applicable state laws.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Phlx included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Phlx has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Phlx member firms for which the Exchange is the DEA generally do 
not carry public customer accounts. If a Phlx member firm carries 
customer accounts, it is required to become a member of a national 
securities association (e.g., the National Association of Securities 
Dealers (``NASD'')). Under agreements that the Phlx has entered into 
with other self-regulatory organizations (``SROs'') in accordance with 
Rule 17d-2 under the Act,\3\ any Phlx member that is also a member of 
another SRO (including the NASD) would be assigned to another DEA.
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    \3\ 17 CFR 240.17d-2.
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    Typically, off-floor trading firms that are Phlx members are 
structured as LLCs. In most cases, the individual traders at the firm 
are also ``members'' of the firm and hold equity interests in the firm. 
These traders are not regarded as ``customers'' of the firm. The 
typical Phlx member that is an LLC has a clearing arrangement with 
another member firm whereby the latter clears all transactions for the 
LLC through a single account. Individual off-floor traders and trading 
entities trade as affiliated members of the LLC by way of ``sub-
accounts'' with the LLC.
    One mail purpose of the proposed new rules is to ensure that off-
floor traders and trading entities affiliated with off-floor member 
firms for which the Exchange is the DEA are not trading on behalf of 
customers. The proposed rules would enable the Exchange to determine 
whether such affiliates have certain third-party financing arrangements 
in place which would cause them to be engaged in trading on behalf of 
customers or de facto customers because, for example, the ``lender'' or 
``investor'' shares in the trading profits and losses of traders 
affiliated with the firms.\4\
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    \4\ If an off-floor trading firm were engaged in trading on 
behalf of customers, it would be required to comply with a variety 
of regulatory and procedural requirements, such as Rules 15c3-1 and 
15c3-3 under the Act, 17 CFR 240.15c-3 and 240.15c3-3.
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    The Phlx's proposal would require that, for off-floor firms for 
which the Phlx is the DEA, traders who are also members of the firm (in 
the case of firms organized as LLCs) either hold their membership 
interests directly or indirectly through a legal entity that is wholly 
owned by them, unless the firm has obtained a waiver from the Phlx. To 
allow a member to hold his membership interest in the LLC indirectly 
through a legal entity that, itself, has multiple shareholders could 
result in one individual trading on behalf of an unlimited number of 
co-owners. While the proposed rule does not preclude multiple 
owners,\5\ the main reason why such off-floor firms are Phlx DEA 
members is because such firms do not carry public customer accounts. 
Under certain circumstances, the multiple owners of such affiliated 
trading firms could be deemed ``customers'' of the individual who is 
conducting trading activities on their behalf. In that event, 
regulatory requirements applicable to firms with ``customers'' would 
attach to such a member firm.
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    \5\ Any off-floor firm or affiliated trader may apply for an 
exemption from the single-shareholder requirement pursuant to 
proposed Rule 643(c).
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    In addition, certain other unanticipated legal and regulatory 
problems could arise, such a triggering registration and other 
requirements under the Investment Company Act of 1940, the Investment 
Advisers Act of 1940, or state securities laws.
    The proposed rules would allow the Exchange's Examinations 
Department to monitor more closely the activities of off-floor traders 
and off-floor trading firms for whom the Exchange is the DEA, and would 
require such off-floor trading firms to inquire into, and more closely 
monitor, the activities and financing arrangements of their affiliated 
individual traders and trading entities.
    Another purpose of the proposed rules is to require off-floor 
member firms to represent to the Exchange that they will make inquiries 
concerning investment and other arrangements which, it undertaken by 
the off-floor member firms or by their affiliated traders, could 
legally cause such off-floor member firms or their affiliated traders 
to become an unregistered investment company, investment advisory firm, 
or broker-dealer. For example, the relationship between an individual 
off-floor trader and an investor who shares in the profits and losses 
associated with that off-floor trader's account could be construed as 
an advisory relationship, whereby the off-floor trader makes investment 
decisions on behalf of, or dispenses investment advice to, the 
investor. Although the Exchange does not directly enforce securities 
laws other than those pertaining to the Act,\6\ a failure to comply 
with these other laws could be a threat to customers, investor 
protection, and the soundness of the off-floor firm, and result in 
violations of Exchange rules such as, without limitation, rules 
pertaining to books and records, net capital requirements, supervisory 
procedures, and margin requirements.
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    \6\ See Phlx Rule 960.
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    The proposed rules would require off-floor firms for which the 
Exchange is the DEA to provide annual reports to the Exchange 
concerning such firm's inquiries into its affiliated traders and 
trading entities, and to annually disclose in writing to the Exchange 
its borrowing, lending, investment, or other financing activities 
(including names, addresses, and telephone numbers of all persons or 
other entities who engage in such activities).\7\
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    \7\ Phlx Rule 783 requires members and member organizations to 
report to the Exchange any financial arrangement entered into with 
another member, member organization, foreign currency participant, 
or participant organization, or a general partner, voting 
shareholder, or any associated person thereof, or a non-member. A 
``financial arrangement'' is defined in Rule 783 as: (1) The direct 
financing of a member or participant organization's dealings upon 
the Exchange with the exception of clearing arrangements; (2) any 
direct equity investment or profit sharing arrangement; (3) any 
consideration over the amount of $5000 that constitutes a gift, 
loan, salary, or bonus; and (4) the guarantee of a trading account 
with the exception of clearing arrangements. The proposed rules 
would apply to financial arrangements of affiliated traders and 
trading entities of the off-floor trading firms, and to the 
requirement of off-floor trading firms to conduct examinations of 
such affiliated traders and trading entities, and to report thereon 
to the Exchange. To the extent that an off-floor member firm has 
made a report of a financial arrangement pursuant to Rule 783 which 
is identical to a report required under the proposed rules, no such 
identical report would be required by the off-floor member firm. 
This would eliminate the unnecessary duplication of reporting by the 
off-floor member firm. Notwithstanding this exception, off-floor 
member firms subject to these proposed rules would be responsible 
for any other disclosure, examination, or other reporting required 
by the proposed rules.

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[[Page 77416]]

2. Statutory Basis
    The Phlx believes the proposed rule change is consistent with 
Section 6 of the Act \8\ in general and Section 6(b)(5) \9\ in 
particular in that it is designed to perfect the mechanisms of a free 
and open market and a national market system, and to protect investors 
and the public interest, by requiring diligence on the part of off-
floor member firms for which the Exchange is the DEA in examining the 
financing and investment arrangements of their affiliated traders and 
trading entities, and by requiring off-floor member firms to report the 
results of such examinations to the Exchange. The Exchange believes 
that the proposal will help ensure that the rules and provisions of the 
Act that are designed to promote customer protection and the financial 
soundness of broker-dealers are followed, and should facilitate the 
Exchange's examination and enforcement functions.
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    \8\ 15 U.S.C. 78f.
    \9\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx does not believe that the proposed rule change would 
impose any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or with such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the Exchange consents, the Commission will:
    (A) By order approve such proposed rule change; or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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, 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. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filings will also be 
available for inspection and copying at the principal office of the 
Phlx. All submissions should refer to File No. SR-Phlx-00-92 and should 
be submitted by January 2, 2001.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-31382 Filed 12-8-00; 8:45 am]
BILLING CODE 8010-01-M