[Federal Register Volume 66, Number 129 (Thursday, July 5, 2001)]
[Notices]
[Pages 35470-35472]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-16734]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44482; File No. 4-429]


Joint Industry Plan; Order Approving Amendment to the Options 
Intermarket Linkage Plan to Conform the Options Intermarket Linkage 
Plan to the Requirements of Securities Exchange Act Rule 11Ac1-7

June 27, 2001.

I. Introduction

    On March 13, 2001, the American Stock Exchange LLC (``Amex''), 
Chicago Board Options Exchange, Inc. (``CBOE''), International 
Securities Exchange LLC (``ISE''), Pacific Exchange, Inc. (``PCX''), 
and Philadelphia Stock Exchange, Inc. (``Phlx'') (collectively, the 
``Participants'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission'') in accordance with Section 11A(a)930 of the 
Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and 
Rule 11Aa3-2 thereunder,\2\ a proposed amendment to the options 
intermarket linkage plan (``Linkage Plan''),\3\ The amendment proposes 
to conform the Linkage Plan to the requirements of recently adopted 
Exchange Act Rule 11Ac1-7, the Trade-Through Disclosure Rule.\4\ The 
proposed amendment to the Linkage Plan was published in the Federal 
Register on April 4, 2001.\5\ Three comment letters were received in 
response to the notice.\6\ This order approves the proposed amendment 
to the Linkage Plan.
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    \1\ 15 U.S.C. 78k-1(a)(3).
    \2\ 17 CFR 240.11Aa3-2.
    \3\ On July 28, 2000, the Commission approved a national market 
system plan for the purpose of creating and operating an intermarket 
options market linkage (``Linkage Plan'') proposed by the Amex, 
CBOE, and ISE. See Securities Exchange Act Release No. 43086 (July 
28, 2000), 65 FR 48023 (August 4, 2000). Subsequently, the Phlx and 
PCX agreed to participate in the Linkage Plan. See Securities 
Exchange Act Release Nos. 43573 (November 16, 2000), 65 FR 70850 
(November 28, 2000) and 43574 (November 16, 2000), 65 FR 70851 
(November 28, 2000).
    \4\ 17 CFR 240.11Ac1-7. See Securities Exchange Act Release No. 
43591 (November 17, 2000), 65 FR 75439 (December 1, 2000) 
(``Adopting Release'').
    \5\ See Securities Exchange Act Release No. 44106 (March 27, 
2001), 66 FR 17977 (April 4, 2001) (``Notice'').
    \6\ See Letter to Jonathan G. Katz, Secretary, Commission, from 
Joseph B. Stefanelli, Executive Vice president, Derivative 
Securities, Amex, dated May 7, 2001 (``Amex letter); Letter to 
Jonathan G. Katz, Secretary, Commission, from Charles Rogers, 
Executive Vice President, Phlx, dated May 1, 2001 (``Phlx Letter''); 
and Letter to Jonathan G. Katz, Secretary, Commission, from Edward 
J. Joyce, President and Chief Operating Officer, CBOE, dated April 
26, 2001 (``CBOE Letter'').
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II. Description of the Proposed Amendment

    On November 17, 2000, the Commission adopted Exchange Act Rule 
11Ac1-7 to require a broker-dealer to disclose to its customer when the 
customer's order for listed options is executed at a price interior to 
a better quote displayed by another market (``intermarket trade-
through''), and to disclose the better published quote available at 
that time. Under the rules, however, a broker-dealer is not required to 
disclose to its customer an intermarket trade-through if the broker-
dealer effects the transaction on an exchange that participates in an 
approved linkage plan that includes provisions reasonably designed to 
limit intermarket trade-throughs.
    In the Adopting Release, the Commission noted that to conform to 
the requirements of the Trade Through Disclosure Rule, a linkage plan 
must, at a minimum, contain provisions to: (1) Limit participants from 
trading through, not only the quotes of other linkage plan 
participants, but also, the quotes of exchanges that are not 
participants in an approved linkage plan; (2) require plan participants 
to actively surveil their markets for trades executed at prices 
inferior to those publicly quoted on other exchanges; and (3) make 
clear that the failure of a market with a better quote to complain 
within a specified period of time that its quote was traded-through may 
affect potential liability, but does not signify that a trade-through 
has not occurred.\7\ The proposed amendment to the Linkage Plan was 
intended to add such provisions to the Linkage Plan.
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    \7\ See Adopting Release, supra note 4, at n.2 and accompanying 
text.
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    First, the proposed Amendment would change the definitions of 
``National Best Bid or Offer'' (``NBBO'') and ``Trade-Throughs'' so 
that the terms would apply to unlinked, as well as linked, exchanges. 
Second, the proposed amendment would require Participants to establish 
procedures for conducting surveillance for trade-throughs, both respect 
to trading through linked and unlinked markets. Third, it would require 
that Participants adopt uniform rules that make it a violation of a 
participant's rules for a member to engage in a pattern or practice of 
trading through bids and offers in other linked markets, unless one of 
the enumerated exceptions to the Linkage Plan's Trade-Through 
provisions applies and, in the case of a Block Trade, where the 
initiating member has satisfied aggrieved parties at the block price. 
Lastly, the proposed amendment would add a provision to the Linkage 
Plan that states that a failure to a lodge a Trade-Through complaint 
will not signify that a Trade-Through has not occurred, but instead, 
affects only liability.

III. Summary of Comments

    The Commission received comment letters from three participants in 
response to the notice published in the Federal Register.\8\ In these 
letters, the Participants expressed concerns regarding the reference in 
the Notice to footnote 62 of the Adopting Release. The Notice states 
``[n]otwithstanding the more limited language in the proposed amendment 
to the Linkage Plan, each exchange's rules must address trade-throughs 
of better quotes displayed by both linked and unlinked markets.''\9\
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    \8\ See Amex Letter; CBOE Letter; and Phlx Letter, supra note 6.
    \9\ See Notice, supra note 5, at n.5.
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    The commenters stated that they believe that the proposed amendment 
to the Linkage Plan fully complies with the requirements of the Trade-
Through Disclosure Rule, and that it is not necessary for the exchanges 
to adopt rules to address trade-throughs in addition to complying with 
the requirements of the Linkage Plan, as amended.\10\ The commenters 
argued that the proposed amendment clearly provides that members should 
not effect trade-throughs, and that participants to the Linkage Plan 
should conduct surveillance to detect any violations of this 
mandate.\11\ One commenter further noted that Section 4(b) of the 
Linkage Plan specifically requires that all

[[Page 35471]]

participants enforce the provisions of the Linkage Plan.\12\
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    \10\ See Amex Letter; CBOE Letter; and Phlx Letter, supra note 
6.
    \11\ Id.
    \12\ See Amex Letter, supra note 6.
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    Another commenter questioned how else the partipants could address 
trade-throughs beyond the requirements contained in the proposed 
amendment.\13\ The commenter disagreed that the participants must adopt 
rules to mandate disciplinary action against members for trading 
through unliked markets in order to comply with the Trade-Through 
Disclosure Rule, expressing frustration that this view was not 
expressed by the Commission before the proposed amendment was 
submitted.\14\
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    \13\ See CBOE Letter, supra note 6.
    \14\ See CBOE Letter, see also Amex Letter, supra note 6.
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    One commenter expressed concern regarding a requirement that the 
exchanges impose sanctions on their members for trading through 
unlinked markets.\15\ This commenter stated that while it agreed that 
members who trade through quotes from unlinked markets without 
justification or due diligence should be subject to investigation and 
possible sanction, it would be unfair for the exchanges to adopt rules 
under which members would be sanctioned if they traded through an 
unlinked market when investigation revealed that such market was 
inaccessible to members, or information concerning the validity of that 
market unreliable.\16\ This commenter also stated that upon submitting 
the proposed amendment to the Commission it did not understand that it 
also would be required to adopt specific exchange rules providing for 
sanctions on members that trade through unlinked markets.
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    \15\ See Phlx Letter, supra note 6.
    \16\ Id.
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    Finally, one commenter argued that the Commission's position that 
the proposed Linkage Plan does not satisfy the rule may severely impact 
broker-dealers due to the additional cost and potential liability 
associated with detecting and disclosing possible trade-throughs 
resulting from a failure to have in place a Commission-approved 
linkage.\17\ This commenter suggested that the compliance date of the 
rule should be coordinated with the implementation date of the proposed 
Linkage Plan.
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    \17\ See Amex Letter, supra note 6.
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IV. Discussion

    The Commission finds that the proposed amendment to the Linkage 
Plan satisfies the three minimal requirements set out in the Adopting 
Release to conform the Linkage Plan to the requirements of the Trade-
Through Disclosure Rule. Specifically, the Commission finds that by 
amending the definitions of ``NBBO'' and ``Trade-Throughs'' so that the 
terms apply to unlinked, as well as linked, exchanges, the proposed 
amendment would add to the Linkage Plan a provision to limit 
participants from trading through, not only the quotes of other linkage 
plan participants, but also, the quotes of exchanges that are not 
participants in an approved linkage plan. The Commission also finds 
that the proposed amendment would add to the Linkage Plan a requirement 
that each participant establish procedures for conducting surveillance 
for trade-throughs of both linked and unlinked markets. In addition, 
the Commission finds that the proposed amendment to the Linkage Plan 
clarifies that the failure of a market with a better quote to complain 
within a specified period of time that its quote was traded through may 
affect potential liability, but does not signify that a trade-through 
has not occurred.
    Further, the Commission has carefully considered the comment 
letters submitted by the CBOE, Phlx, and Amex. The Commission 
reiterates its statement made in the Adopting Release that, in addition 
to the minimal provisions that must be included in an intermarket 
linkage plan to allow broker-dealers effecting transactions on 
exchanges participating in the plan to be excepted from the disclosure 
requirements of the Trade-Through Disclosure Rule, each exchange 
participating in a linkage plan would have to adopt certain rules. The 
Adopting Release stated that an exchange participating in the Linkage 
Plan:

    Would have to adopt rules to allow the exchange to sanction 
specialists or market makers that trade through better prices of other 
exchanges, maintain policies and procedures that would limit the 
occurrence of intermarket trade-throughs, and maintain records that 
would identify intermarket trade-thoughs and any review or remedial 
action taken by the exchange in response to such intermarket trade-
throughs.\18\
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    \18\ See Adopting Release, supra note 4, at n.62.

    The Commission believes that the requirement set forth in the 
Adopting Release, detailed above, that the Linkage Plan participants 
adopt rules regarding trade-throughs of better prices of other 
exchanges, not only linked markets, provided adequate notice to the 
participants in the Linkage Plan that such rules were expected to be 
filed for Commission approval. The Commission again restates here that 
the Commission fully expects the Linkage Plan participants to satisfy 
this requirement. Moreover, the Commission notes that the concerns 
raised by commenters are, at this time, purely academic because all of 
the options exchanges currently are participants in the Linkage Plan.
    Finally, the Commission strongly believes that each exchange must 
have rules to allow it to sanction any member who has the ability to 
execute a transaction in its market at a price inferior to a price 
displayed by another exchange. In connection with the requirement set 
forth in the Adopting Release that each exchange adopt rules to allow 
it to sanction ``specialists or market makers that trade through better 
prices of other exchanges,'' the Commission believes that this language 
cannot be read as limiting the reach of the exchanges' rules to only 
specialists or market makers in each market. Rather, this provision 
must be read in conjunction with the other requirements set forth in 
the Adopting Release and consistent with a plain reading of the Linkage 
Plan. Specifically, the Commission believes that the requirement in the 
Adopting Release that, in addition to provisions that the Linkage Plan 
must contain to conform to the requirements of the Trade-Through 
Disclosure Rule, each exchange participating in the Linkage Plan has to 
``maintain policies and procedures that would limit the occurrence of 
intermarket trade-throughs,'' \19\ can only be read to require that 
such policies and procedures limit the occurrence of intermarket trade-
throughs for all trades, other than those trades expressly excluded 
from the Trade-Through Disclosure Rule, regardless of the member 
affecting such trade. Moreover, Section 8(c) of the Linkage Plan states 
that ``the Participants agree that absent reasonable justification and 
during normal market conditions, members in their markets should not 
effect trade-throughs (emphasis added).''
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    \19\ See Adopting Release, supra note 4, at n.62.
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    Finally, after careful review, the Commission finds that the 
proposed amendment to the Linkage Plan to consistent with the 
requirement of the Act and the rules and regulations thereunder, 
Specifically, the Commission believes that the proposed amendment is 
consistent with Section 11A of the Act,\20\ and Rule 11Aa3-2 
thereunder,\21\ in the it is appropriate in the public interest, for 
the protection of investors and the maintenance of fair and orderly 
markets, to remove

[[Page 35472]]

impediments to, and perfect the mechanisms of, a national market 
system. Moreover, the Commission believes that the Linkage Plan, as 
amended, satisfies the minimal requirements of the Trade-Through 
Disclosure rule to except broker-dealers who effect transactions on one 
of the linked markets from making the required disclosures under the 
Trade-Through Disclosure Rule, so long as each of the linked markets 
has adopted the required rules, discussed above.
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    \20\ 15 U.S.C. 78k-1.
    \21\ 17 CFR 240.11Aa3-2.
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V. Conclusion

    It is Therefore Ordered, pursuant to Section 11A of the Act \22\ 
and Rule 11Aa3-2 thereunder,\23\ that the proposed Linkage Plan 
amendment is approved.
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    \22\ 15 U.S.C. 78k-1.
    \23\ 17 CFR 240.1Aa3-2.
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    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(29).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-16734 Filed 7-03-01; 8:45 am]
BILLING CODE 8010-01-M