[Federal Register Volume 65, Number 241 (Thursday, December 14, 2000)]
[Notices]
[Pages 78237-78240]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-31804]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43684; File No. SR-Phlx-00-93]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Partial Accelerated Approval of Proposed Rule Change and 
Amendments Nos. 1 and 2 Thereto by the Philadelphia Stock Exchange, 
Inc. Relating to Providing Automatic Executions for Public Customer 
Orders at the NBBO

December 6, 2000.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 16, 2000, the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the 
Exchange. On November 22, 2000 and December 1, 2000, the Exchange 
submitted Amendments Nos. 1 \3\ and 2,\4\ respectively, to the proposed 
rule change. The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons and to grant accelerated approval to the portion of the 
proposal allowing AUTO-X eligible orders to be automatically executed 
at the NBBO, provided that the NBBO is not better than the specialist's 
BBO by a predetermined step-up parameter.\5\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Phlx restated its filing in its 
entirety to clarify, in part, (1) the factors used in determining 
which options would qualify as step-up options; (2) when quotes 
would be deemed unreliable in the rule text; and (3) the factors to 
be considered in determining whether quotes previously deemed 
unreliable would be included in the national best bid or offer 
(``NBBO''). Amendment No. 1 also provides for a memoranda listing 
all automatic step-up options to be circulated to Exchange members 
and member organizations. See letter from Richard S. Rudolph, 
Counsel, Phlx, to Nancy J. Sanow, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated November 20, 
2000 (with attached restated 19b-4 filing) (``Amendment No. 1'').
    \4\ In Amendment No. 2, the Phlx restated its filing in its 
entirety to (1) clarify that there may be some circumstances where 
the specialist's best bid or offer (``BBO'') in inconsistent with 
the Exchange's BBO; (2) make conforming changes to its rule language 
to reflect that the specialist's quote may not be the Exchange's 
BBO; and (3) make technical corrections to its rule text. See letter 
from Richard S. Rudolph, Counsel, Phlx, to Nancy J. Sanow, Assistant 
Director, Division, Commission, dated November 30, 2000 (with 
attached restated 19b-4 filing) (``Amendment No. 2'').
    \5\ The Commission is not approving the portion of the proposed 
rule change that would allow the Exchange to determine when 
unreliable quotes would be excluded from the calculation of the 
NBBO. Further, approval of the automatic step-up feature should not 
be interpreted as suggesting that the Commission is predisposed to 
approving the remainder of the proposal.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

A. NBBO Feature

    The Exchange proposes an enhancement to AUTO-X, the automatic 
execution feature of the Exchange's Automated Options Market 
(``AUTOM'') System, that would allow AUTO-X eligible orders to be 
automatically executed at the NBBO, provided that the NBBO is not 
better than the specialist's BBO by a predetermined ``step-up 
parameter.'' The enhancement is known as the ``NBBO Feature.''
    Under proposed Rule 1080(c)(i), the NBBO Feature would execute 
AUTO-X eligible orders at the NBBO for certain options designated by 
the Options Committee as eligible for the NBBO Feature (``automatic 
step-up options''), provided that the NBBO does not differ from the 
specialist's BBO by more than the step-up parameter. The step-up 
parameter for automatic step-up options would be the minimum trading 
increment (one ``tick'') for options in that series established 
pursuant to Exchange Rule 1034, or any greater amount established by 
the Options Committee in respect of specified automatic step-up options 
or series of options.
    The proposal provides that orders that would otherwise qualify as 
automatic step-up options would be executed manually in accordance with 
Exchange rules in three circumstances: (1) Where the specialist's best 
bid or offer \6\ is inferior to the current best bid or offer in 
another market by more than the step-up parameter; (2) where the NBBO 
is crossed (i.e., 2 bid, 2 asked); or locked (i.e., 2 bid, 2 asked); or 
(3) in respect of equity options other than automatic step-up options 
where the specialist's BBO is inferior to the current best bid or offer 
in another market by any amount. The proposed rule would also include a 
provision that an order may also be executed partially by AUTO-X and 
partially manually.
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    \6\ The proposed rule states that there may be some 
circumstances in which the specialist's BBO is inferior to the 
Exchange's BBO. See Amendment No. 2, supra note 4.
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    In addition, under the proposal, the Chairman of the Options 
Committee or his designee \7\ (or if the Chairman of the Options 
Committee or his designee is unavailable, two Floor Officials) may 
determine to disengage the NBBO Feature for orders in certain automatic 
step-up options after notice to AUTOM users. In circumstances where the 
NBBO Feature is disengaged, such orders will continue to be executed 
manually, in accordance with Exchange rules. Finally, an additional 
proposed amendment to Exchange Rule 1080(e) would provide that the NBBO 
Feature is always disengaged when AUTO-X is disengaged.
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    \7\ The designee would be a member of the Options Committee. 
Telephone conversation between Richard Rudolph, Counsel, Phlx, and 
Terri Evans, Special Counsel, Division, Commission, on November 24, 
2000.
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B. Exclusion of Unreliable Quotes from NBBO

    Where the Chairman of the Options Committee or his designee (or if 
the Chairman of the Options Committee or his designee is unavailable, 
two Floor Officials), determines that quotes in certain automatic step-
up options on the Exchange or other markets are deemed not to be 
reliable, such unreliable quotes would be excluded from the calculation 
of NBBO, and customers would receive an automatic execution at NBBO 
based on the remaining markets whose quotes are not deemed to be 
unreliable.
    A quote could be deemed not to be reliable because of Exchange 
communications or systems problems; fast markets; delays in the 
dissemination of quotes because of queues on the Options Price 
Reporting Authority (``OPRA'') (in which case the Exchange would know 
that there is a delay in the dissemination of quotes from the other 
exchanges, which would likely render such quotes stale); or if the 
Exchange is advised by another exchange that it is experiencing 
communication or system problems that would cause its disseminated 
quotes to be unreliable.
    The text of the proposed rule change is as follows. New text is 
italicized.
    Rule 1080. (a)-(b) No change.
    (c) AUTO-X--AUTO-X is a feature of AUTOM that automatically 
executes public customer market and marketable limit orders up to the 
number of contracts permitted by the Exchange for certain strike prices 
and expiration months in equity options and index options, unless the 
Options Committee

[[Page 78238]]

determines otherwise. AUTO-X automatically executes eligible orders 
using the Exchange disseminated quotation and then automatically routes 
execution reports to the originating member organization. AUTOM orders 
not eligible for AUTO-X are executed manually in accordance with 
Exchange rules. Manual execution may also occur when AUTO-X is not 
engaged. An order may also be executed partially by AUTO-X and 
partially manually.
    The Options Committee may for any period restrict the use of AUTO-X 
on the Exchange in any option or series. Currently, orders up to 75 
contracts, subject to the approval of the Options Committee, are 
eligible for AUTO-X. With respect to OTC Prime Index (``OTX'') options, 
orders of up to 100 contracts are eligible for AUTO-X.
    The Options Committee may, in its discretion, increase the size of 
orders in one or more classes of multiply-traded equity options 
eligible for AUTO-X to the extent necessary to match the size of orders 
in the same options eligible for entry into the automated execution 
system of any other options exchange, provided that the effectiveness 
of any such increase shall be conditioned upon its having been filed 
with the Securities and Exchange Commission pursuant to Section 
19(b)(3)(A) of the Securities Exchange Act of 1934.

    (i) AUTO-X on the NBBO (NBBO Feature).--AUTO-X on the NBBO (the 
``NBBO Feature'') is a feature of AUTOM that automatically executes 
at the National Best Bid or Offer (``NBBO''). NBBO Feature will 
execute AUTO-X eligible orders at the NBBO for certain options 
designated by the Options Committee as eligible for the NBBO Feature 
(``automatic step-up options''), provided that the NBBO does not 
differ from the specialist's best bid or offer by more than the 
``step up parameter.''
    (A) The ``step-up parameter'' for automatic step-up options 
shall be the minimum trading increment for options in that series 
established pursuant to Exchange Rule 1034, or any greater amount 
established by the Options Committee in respect of specified 
automatic step-up options or series of options.
    (B) The Chairman of the Options Committee or his designee (or if 
the Chairman of the Options Committee or his designee is 
unavailable, two Floor Officials) may determine to disengage the 
NBBO Feature for orders in certain automatic step-up options after 
notice to AUTO users in situations in which the Exchange is 
experiencing communications or systems problems; fast markets; or 
delays in the dissemination of quotes because of queues on the 
Options Price Reporting Authority (``OPRA'') which would likely 
render such quotes stale, Where the NBBO Feature is disengaged, such 
orders shall be executed manually in accordance with Exchange rules.
    (C) In respect of automatic step-up options (1) where the 
specialist's best bid or offer is inferior to the current best bid 
or offer in another market by more than the step-up parameter; or 
(2) where the NBBO for one of the series of automatic step-up 
options is crossed (i.e., 2\1/8\ bid, 2 asked) or locked (i.e., 2 
bid 2 asked); or (3) in respect of equity options other than 
automatic step-up options where the specialist's best bid or offer 
is inferior to the current best bid or offer in another market by 
any amount, such orders shall be executed manually in accordance 
with Exchange rules. There may be circumstances in which the 
specialist's best bid or offer is inconsistent with the Exchange's 
best bid or offer. In such a circumstance, such an order shall be 
executed manually.
    (D) Where the Chairman of the Options Committee or his designee 
(or if the Chairman of the Options Committee or his designee is 
unavailable, two Floor Officials), determines that quotes in options 
on the Exchange or other markets are deemed not to be reliable due 
to Exchange communications or systems problems; fast markets; delays 
in the dissemination of quotes because of queues on the Options 
Price Reporting Authority (``OPRA'') which would likely render such 
quotes stale; or if the Exchange is advised by another exchange that 
it is experiencing communication or system problems that would cause 
its disseminated quotes to be unreliable, customer market orders 
will receive an automatic execution at NBBO based on the best bid or 
offer in markets whose quotes are not deemed to be unreliable, AUTOM 
customers will be duly notified via electronic message from AUTOM 
that such quotes are excluded from the calculation of NBBO.
    (E) Where the Chairman of the Options Committee or his designee 
(or if the Chairman of the Options Committee or his designee is 
unavailable, two Floor Officials), determines that quotes in options 
on the Exchange or other markets previously deemed not to be 
reliable pursuant to Section (D) of this paragraph are again 
reliable, such quotations will be included in the calculation of 
NBBO for such options. Factors to be considered in determining 
whether such quotes previously deemed not to be reliable are to be 
included in the calculation of NBBO include information via 
telephonic verification to the Exchange that such quotes are 
reliable; visual surveillance by Exchange staff or the specialist; 
and electronic messages from other markets. AUTOM customers will be 
duly notified via electronic message from AUTOM that such quotes are 
begin included in the calculation of NBBO.

    (d) No change.
    (e) Extraordinary Circumstances--In the event extraordinary 
circumstances with respect to a particular class of options exist, two 
Floor Officials may determine to disengage AUTO-X with respect to that 
option, in accordance with Exchange procedures. In the event 
extraordinary conditions exist floor-wide, two Exchange Floor 
Officials, the Chairperson of the options Committee or his designee may 
determine to disengage the AUTO-X feature floor-wide. The NBBO Feature 
is always disengaged when AUTO-X is disengaged.
    (i) The Exchange's Emergency Committee, pursuant to Rule 98, may 
take other action respecting AUTOM in extraordinary circumstances.
    (f)-(i) No change.
    Commentary: No change.

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

    In its filing with the Commission, the Exchange 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 place specified in Item 
IV below. The Exchange 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
    The purpose of the proposed rule change is to provide automatic 
executions for public customer orders at the NBBO. Currently, customer 
orders can be delivered electronically to the Exchange via AUTOM.\8\ An 
option order that is automatically executed via AUTOM's automatic 
execution feature, AUTO-X, is priced at the prevailing market quote on 
the Phlx at the time the order is received by AUTOM. If another 
marketplace is displaying a better quote away from the Phlx at the time 
of the delivery of such an order, then that order would be handled 
manually by the specialist so that it would not be automatically 
executed at an inferior price. Under the current system, the specialist 
handling the order determines whether the order should be executed at 
the away price.\9\ The Exchange believes

[[Page 78239]]

that adding a feature that provides automatic executions at the NBBO 
should minimize or eliminate any delays that are inherent in orders 
that are handled manually by the specialist, thus reducing the risk of 
an adverse movement in the market while such customer orders are being 
filled.
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    \8\ AUTOM is the Exchange's electronic order delivery and 
reporting system, which provides for the automatic entry and routing 
of equity option and index option orders to the Exchange trading 
floor. Orders delivered through AUTOM may be executed manually, or 
certain orders are eligible for AUTOM's automatic execution feature, 
AUTO-X. Equity option and index option specialists are required by 
the Exchange to participate in AUTOM and its features and 
enhancements. Option orders entered by Exchange members into AUTOM 
are routed to the appropriate specialist unit on the Exchange 
trading floor.
    \9\ Under normal market conditions, the specialist will execute 
the manually handled order at the best available price, i.e., the 
NBBO, unless the specialist determines that the superior price at 
the away market is not reliable due to fast market conditions; 
communications or other Exchange systems problems; delays in the 
dissemination of quotes because of queues on OPRA (in which case the 
specialist would know that there is a delay in the dissemination of 
quotes from the other exchanges, which likely would render such 
quotes stale); or if the specialist is advised by another exchange 
that it is experiencing communication or system problems that would 
cause its disseminated quotes to be unreliable.
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    To increase the number of orders handled automatically, the 
Exchange is also proposing to partially execute AUTO-X eligible orders 
that have a size greater than the guaranteed size for automatic 
execution. Thus, if an order exceeds the size of the AUTO-X guarantee 
for a given option, the portion of such an order that is within the 
AUTO-X guaranteed size would be executed automatically, and the 
remainder would be executed manually.
    The NBBO feature would execute AUTO-X eligible orders at the NBBO 
provided that the NBBO does not differ from the specialist's BBO by 
more than the step-up parameter. The proposed rule also provides that 
the step-up parameter for automatic step-up options would be equal to 
one tick, i.e., the minimum trading increment for options in that 
series established pursuant to Exchange Rule 1034, or any greater 
amount established by the Options Committee. In the event that the NBBO 
is better than the specialist's BBO by more than one tick, the existing 
procedure will continue to apply whereby the order would be handled 
manually by the specialist in order to avoid execution at a price 
inferior to the NBBO.
    The proposed rule states that there may be some circumstances in 
which the specialist's BBO is inconsistent with the Exchange's BBO. 
This would occur when the Exchange's BBO is composed of a quote of a 
Registered Option Trader (``ROT'') in a trading crowd or a customer 
limit order that improves the specialist's BBO. Due to the limitations 
of the Exchange's existing systems, the transactions would be executed 
manually to ensure that the specialist could execute an order at the 
Exchange's BBO and match it to the ROT quote or a customer limit order 
that posted it.
    Under this proposal, the Exchange's Options Committee, upon the 
request of a specialist, would designate which options traded on the 
Exchange qualify as automatic step-up options. This is to ensure the 
orderly introduction of this change to the Exchange's AUTO-X feature. 
In determining which options qualify as step-up options, the Options 
Committee may consider such factors as the open interest in the 
requested option, the average daily volume of the option, customer 
requests, and any such other factors as the Options Committee deems 
appropriate. The Options Committee would also have the ability to 
delete options from the list of automatic step-up options upon the 
request of the specialist using the same criteria. The Exchange would 
publish a list of all automatic step-up options in memoranda circulated 
to the Exchange members and member organizations and on its web site, 
and would inform all AUTOM users of any changes in the list at least 
one business day prior to the time such changes become effective.\10\
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    \10\ Currently, the Exchange publishes a list of all AUTO-X 
guarantees. It is anticipated that the publication of a list of 
options that qualify for the NBBO Feature will be published and 
disseminated in a similar fashion.
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    The proposed rule change authorizes the Chairman of the Options 
Committee or his designee (or if the Chairman of the Options Committee 
or his designee is unavailable, two Floor Officials) to determine that 
quotes in specified options or series of options or in respect of 
specified markets are not reliable. This authority would be expected to 
be exercised only in circumstances such as communications or systems 
problems; fast markets; delays in the dissemination of quotes because 
of queues on the OPRA (in which case the Exchange would know that there 
is a delay in the dissemination of quotes from the other exchanges, 
which would likely render such quotes stale); or if the Exchange is 
advised by another exchange that it is experiencing communication or 
system problems that would cause its disseminated quotes to be 
unreliable.
    In creating the NBBO Feature, the Exchange has sought to ensure 
that customer orders would not be disqualified from receiving an 
automatic execution due to another market's dissemination of unreliable 
quotes. When quotes in specified options or series of options or in 
respect of specified markets are deemed not to be reliable, such quotes 
would not be included in the calculation of the NBBO, and market orders 
would receive an automatic execution at the NBBO based on the best bid 
or offer in markets whose quotes are not deemed to be unreliable.
    Where the Chairman of the Options Committee or his designee (or if 
the Chairman of the Options Committee or his designee is unavailable, 
two Floor Officials), determines that quotes in options on the Exchange 
or other markets previously deemed not to be reliable are again 
reliable, such quotations will be included in the calculation of the 
NBBO for such options. Factors to be considered in determining whether 
such quotes previously deemed not to be reliable are to be included in 
the calculation of the NBBO include information via telephonic 
verification to the Exchange that such quotes are reliable; visual 
surveillance by Exchange staff or the specialist; and electronic 
messages from other markets. AUTOM customers will be duly notified via 
electronic message from AUTOM that such quotes are again included in 
the calculation of NBBO.
    The rule also provides that the NBBO Feature is always disengaged 
when AUTO-X is disengaged.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6 of the Act \11\ in general, and with Section 6(b)(5) of 
the Act \12\ specifically, in that it is designed to perfect the 
mechanisms of a free and open market and the national market system, 
protect investors and the public interest and promote just and 
equitable principles of trade, by enhancing the Exchange's ability to 
provide automatic execution of public customers' orders at the best 
available prices.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx does not believe that the proposed rule change will impose 
any inappropriate burden on competition.
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    \11\ 15 U.S.C. 78f.
    \12\ 15 U.S.C. 78f(b)(5).
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C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange has neither solicited nor received written comments.

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 within 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

[[Page 78240]]

(ii) as to which the Phlx 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, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
DC 20549-0609. Copies of the 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 
filing will also be available for inspection and copying at the 
principal office of the Phlx. All submissions should refer to File No. 
SR-Phlx-00-93 and should be submitted by January 4, 2001.

V. Commission's Findings and Order Granting Partial Accelerated 
Approval of the Proposed Rule Change

    The Commission finds that the proposed rule change relating to the 
automatic step-up feature \13\ is consistent with the requirements of 
the Act and the rules and regulations thereunder applicable to a 
national securities exchange. Specifically, the Commission finds that 
the proposal is consistent with the section 6(b)(5) \14\ requirements 
that the rules of an exchange be designed to promote just and equitable 
principles of trade and to protect investors and the public 
interest.\15\
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    \13\ The Commission is not approving Phlx Rule 1080(c)(i)(D), 
(E) at this time.
    \14\ 15 U.S.C. 78f(b)(5).
    \15\ In approving this rule change, 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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    By providing an automatic step-up feature, the rule should help to 
insure that investors receipt prompt, automatic execution of AUTO-X 
eligible orders at the best available prices (subject to the step-up 
parameter), even if those prices are being quoted on a market other 
than the Phlx. As a result, this proposal should minimize the delay 
inherent in manually handling orders in this circumstance, and thereby 
reduce the risk to investors that, as a result of an adverse move in 
the market while their orders are being manually handled, they may 
receive an inferior execution.
    The Commission finds good cause for approving this portion of the 
proposed rule change, prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. This will permit 
customers to receive the benefits of automatic price improvement under 
the proposed rule change more quickly. Further, the Exchange's proposed 
rule change regarding the automatic step-up feature is substantially 
similar to the Chicago Board Options Exchange Rule 6.8, Interpretations 
and Policies .02, which was approved in 1998.\16\ The Commission is not 
aware of any problems with respect to CBOE's automatic step-up feature.
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    \16\ See Securities Exchange Act Release No. 40096 (June 16, 
1998), 63 FR 34209 (June 23, 1998).
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VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\17\ that the portion of the proposed rule change (SR-Phlx-00-93), 
as amended, allowing AUTO-X eligible orders to be automatically 
executed at the NBBO, provided that the NBBO is not better than the 
specialist's BBO by a predetermined step-up parameter, is hereby 
approved on an accelerated basis.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Margaret McFarland,
Deputy Secretary.
[FR Doc. 00-31804 Filed 12-13-00; 8:45 am]
BILLING CODE 8010-01-M