[Federal Register Volume 66, Number 219 (Tuesday, November 13, 2001)]
[Notices]
[Pages 56879-56888]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-28272]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45013; File No. SR-Phlx-2001-97]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Numbers 1 and 2 by the Philadelphia Stock 
Exchange, Inc. Relating to Competing Specialists

November 2, 2001.

    Pursuant to section 19(b)(1) of the Securities Exchange Act of 
1934\1\ (``Act''), and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on October 22, 2001, the Philadelphia Stock

[[Page 56880]]

Exchange, Inc. (``Phlx'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by Phlx. The Exchange filed with the Commission Amendments 1 and 2 on 
October 30, 2001 and October 31, 2001 respectively. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
and amendments from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \1\ 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

    Phlx proposes to establish a competing specialist program. 
Specifically, the Exchange proposes to adopt new Phlx Rule 460, which 
contains a specific procedure for application, withdrawal and 
participation in the Competing Specialist Program, new Phlx Rule 517, 
which integrates Competing Specialists into the existing equity 
allocation rules, and new section (f) of Phlx Rule 506 which imposes a 
3 business day notice requirement for specialists withdrawing from 
their equity securities. Phlx also proposes to adopt new Phlx Rule 229A 
providing for PACE order executions in a competing specialist 
environment and new Phlx Rule 229B providing for an Order Entry Window, 
a new feature of the Exchange's equity trading system. Finally, the 
Exchange proposes to amend Phlx Rule 155 regarding the obligations of a 
Floor Broker to clarify the nature of such obligations in a competing 
specialist environment. The following is the text of the proposed rule 
change (all new language in italics):

Rule 229A  Operation of PACE System When Competing Specialists Are 
Trading

    (a) Applicability. This Rule 229A applies only where a Competing 
Specialist (as defined below) has been approved by the Equity 
Allocation, Evaluation and Securities Committee pursuant to Rule 460 
and has commenced its competing specialist operations. This rule 
applies to orders which are entered into the PACE system pursuant to 
Rule 229, Philadelphia Stock Exchange Automated Communication and 
Execution System.
    (b) Defined Terms. (1) ``Directed Order'' shall mean an order that 
a member organization directs to a particular specialist pursuant to an 
agreement with that specialist in which the member organization agrees 
to place orders in the security with that specialist.
    (2) ``Non-Directed Order'' shall mean an order which is not 
directed to a particular specialist.
    (3) ``Directed Specialist'' shall mean the specialist to whom a 
Directed Order is directed. In any given case the Directed Specialist 
may be the Primary Specialist (as defined below) or a Competing 
Specialist. 
    (4) ``Non-Directed Specialist'' shall mean any specialist other 
than the specialist to whom a Directed Order is directed. 
    (5) ``Primary Specialist'' shall mean the primary specialist 
identified as such by the Equity Allocation, Evaluation and Securities 
Committee. The Primary Specialist may be either the Directed Specialist 
or the Non-Directed Specialist in the case of any particular Directed 
Order. The Primary Specialist shall be deemed to be the Directed 
Specialist with respect to any Non-Directed Order.
    (6) ``Competing Specialist'' shall mean any competing specialist 
identified as such by the Equity Allocation, Evaluation and Securities 
Committee pursuant to Rule 460. A Competing Specialist may be either 
the Directed Specialist or the Non-Directed Specialist in the case of 
any particular Directed Order. 
    (7) ``PACE'' shall mean the Exchange's automatic order routing, 
delivery, execution and reporting system for equity securities which is 
governed by Rule 229, Philadelphia Stock Exchange Automated 
Communication and Execution System.
    (8) ``API'' shall mean the PACE automatic price improvement feature 
which specialists may elect to activate pursuant to Rule 229, 
Supplementary Material .07(c)(i). 
    (9) ``Extend API'' shall mean the PACE quote feature which a 
Directed Specialist may elect to activate and which will commit the 
Directed Specialist to extend the maximum size of his API guarantee up 
to the volume specified in the Directed Specialist's manual principal 
quote when the quote is at or part of the NBBO and at the same time 
greater than his automatic execution level. 
    (10) ``API Execution Price'' shall mean the execution price of an 
order which is better than the NBBO price as a result of the 
application of API. 
    (11) ``API Situation'' shall mean a situation where (a) Extend API 
applies, or (b) the Directed Specialist has elected to activate API and 
where the size of the NBBO spread and the size of the order are such 
that an API Execution Price is available pursuant to the terms of Rule 
229, Supplementary Material Rule .07(c). 
    (12) ``Calculated Automatic Execution Level'' shall mean the lower 
of (a) the automatic execution level established by the Specialist 
under Rule 229, Supplementary Material .05, or (b) the size of the NBBO 
market if the Specialist has activated Volume Check (as defined below); 
provided, however, that in no event shall the Calculated Automatic 
Execution Level be less than the minimum automatic execution level 
established by the Exchange under Rule 229. 
    (13) ``Step-Up API'' shall mean the PACE system's quote feature 
whereby a Non-Directed Specialist commits to trade against any Directed 
Specialist's Directed Orders at the Directed Specialist's API Execution 
Price.
    (14) ``Specialist'' `` All references in this rule to a specialist, 
including references to a Directed Specialist, a Non-Directed 
Specialist, a Primary Specialist, or a Competing Specialist, shall be 
deemed to be references to a specialist unit and not to an individual 
specialist. 
    (15) ``Volume Check'' shall mean the PACE system feature which may 
be activated by a specialist on a security by security basis and which, 
when activated, will prevent the automatic execution of incoming orders 
(within the Directed Specialist's automatic execution level) if the 
size of the NBBO market is less than the size of the incoming order. 
    (c) PACE Guarantees. Each specialist shall determine his minimum 
PACE acceptance (delivery) and automatic execution guarantees with 
respect to a security as provided in Rule 229. An order may be 
automatically executed up to the aggregate of the Directed Specialist's 
automatic execution guarantee combined with the quoted size of each 
Non-Directed Specialist. The price of any order automatically executed 
against either the Directed Specialist or any Non-Directed Specialist 
shall be (1) the NBBO, or (2) if the Directed Specialist has activated 
API, the API Execution Price established by the Directed Specialist. 
Notwithstanding Rule 229 Supplementary Material .02 which would 
otherwise permit each specialist to determine whether to provide 
automatic execution parameters to non-agency orders, both agency and 
non-agency orders under Rule 229A will be executed against Non-Directed 
Specialists as provided herein, without distinction. 
    (d) PACE Delivered Orders Executed Manually. All orders which are 
to be executed manually pursuant to the terms of Rule 229 shall be 
executed manually by the Directed Specialist. 

[[Page 56881]]

    (e) PACE Order Execution Rules for Market and Marketable Limit 
Orders. In circumstances where orders are not to be executed manually 
pursuant to subsection (d) above, where the bid (offer) is comprised of 
an order on the book or agency interest represented in a Directed or 
Non-Directed Specialist's quote, then consistent with Rules 119, 120 
and 218, an incoming eligible sell (buy) market or marketable limit 
order is executable based on price and time priority first against such 
book or agency interest and then as follows: 
    (1) No Non-Directed Specialist Quoting at NBBO. If at the time the 
order is received, there are no Non-Directed Specialists quoting at the 
NBBO, the order is executed against the Directed Specialist as provided 
in Rule 229.
    (2) Non-Directed Specialist Quoting at NBBO and Directed Specialist 
Not Quoting at NBBO. If at the time the order is received, any Non-
Directed Specialist is quoting at the NBBO and the Directed Specialist 
is not quoting at the NBBO, orders are to be executed as follows:
    (A) In cases that are not an API Situation,
    (i) If the Directed Specialist has not activated API or if the 
spread is too small to permit API to occur pursuant to Rule 229, then 
the order is to be automatically executed against the Non-Directed 
Specialist up to the Non-Directed Specialist quote size. Any reminder 
shall (a) if such remainder is equal to or less than the Directed 
Specialist's Calculated Automatic Execution Level, be automatically 
executed against the Directed Specialist, up to the Directed 
Specialist's Calculated Automatic Execution Level, or (b) if such 
remainder is greater than the Directed Specialist's Calculated 
Automatic Execution Level, be executed manually by the Directed 
Specialist; or
    (ii) If the Directed Specialist has activated API and if the spread 
is sufficiently wide to permit API pursuant to Rule 229 Supplementary 
Material Rule .07(c), but the size of the order is greater than the 
Directed Specialist's Calculated Automatic Execution Level, then the 
order would be executed manually be the Directed Specialist.
    (B) In an API Situation, the order shall be executed as follows.
    (i) If the Non-Directed Specialist has activated Step-Up API, the 
order shall be executed against the Non-Directed Specialist up to the 
Non-Directed Specialist's quote size. Any remainder shall, if such 
remainder is equal to or less than the Directed Specialist's Calculated 
Automatic Execution Level, be automatically executed against the 
Directed Specialist.
    (ii) If the Non-Directed Specialist has not activated Step-Up-API, 
the order shall be executed against the Directed Specialist as provided 
in Rule 229.
    (3) Directed Specialist and any Non-Directed Specialist Both 
Quoting at NBBO. If at the time the order is received both the Directed 
and any Non-Directed Specialists are quoting at the NBBO, then, 
regardless of which specialist first quoted at the NBBO prior to the 
time the order was received:
    (A) In cases that are not an API Situation, the order is to be 
executed as follows.
    (i) If the Directed Specialist has not activated API or if the 
spread is too small to permit API to occur pursuant to Rule 229, then 
the order is to be executed automatically against the Directed 
Specialist if the order is less than or equal to the Directed 
Specialist's automatic execution level, otherwise (a) against the 
Directed Specialist up to an amount (the ``Directed Specialist's 
Component'') equal to (I) his quoted size, plus (II) the remainder of 
the order size less the Non-Directed Specialist's quoted size, and (b) 
against the Non-Directed Specialist up to the Non-Directed Specialist's 
quoted size.
    (ii) If the Directed Specialist has activated API and if the spread 
is sufficiently wide to permit API pursuant to Rule 229 Supplementary 
Material Rule .07(c), but the size of the order is greater than the 
Directed Specialist's Calculated Automatic Execution Level and
    (I) If the Directed Specialist's quote size is less than or equal 
to the Directed Specialist's automatic execution level established 
pursuant to Rule 229, Supplementary Material .05, then the order would 
be executed manually by the Directed Specialist, or
    (II) If the Directed Specialist's quote size is greater than the 
Directed Specialist's automatic execution level established pursuant to 
Rule 229, Supplementary Material .05, then the order would be executed 
automatically up to the Directed Specialist's quote size, with the 
remainder handled manually by the Directed Specialist.
    (B) In an API Situation, the order shall be executed as follows:
    (i) If the Non-Directed Specialist has not activated Step-Up API, 
the order shall be executed as provided in Rule 229.
    (ii) If the Non-Directed Specialist has activated Step-Up API, the 
order is to be executed as provided in section (e)(3)(A) above.
    (4) Multiple Non-Directed Specialists. In any case under (1) 
through (3) above where an order is executable in full or in part 
against multiple Non-Directed Specialists because they are each quoting 
at the NBBO, the portion of the order to be executed against such Non-
Directed Specialists will be automatically executed against them based 
upon time priority.

Rule 460  Procedures for Competing Specialists

    (a) Application
    Any specialist unit approved pursuant to Rule 501 can apply to the 
Exchange to function as a competing specialist unit (as opposed to a 
primary specialist) pursuant to the following procedures.
    (i) Application to become a competing specialist must be directed 
to the Equity Allocation, Evaluation and Securities Committee (the ``ES 
Committee'') in writing on the appropriate form submitted to the 
appropriate Exchange department and must list, in order of preference, 
the securities in which the applicant seeks to be a competing 
specialist.
    (ii) Once a competing specialist application is received by the 
Exchange, a written notification will be issued to the primary 
specialist. Each primary specialist is required to sign and date such 
notification acknowledging receipt, and return the notification to the 
Securities Department representative. Any objection by the primary 
specialist in one or more of such specialist's securities must be in 
writing on a form designated by the Exchange and filed with the 
Exchange within 48 hours of notice of the competing specialist's 
application. Only the primary specialist can object to a competing 
specialist application in his/her securities. The objection will be 
considered by the EAES Committee in reviewing the application.
    All applicant specialist units, existing or newly created, must 
satisfy the EAES Committee that they have sufficient staff to enable 
them to fulfill the functions of a specialist as set forth in Rule 203, 
in all of the securities in which the applicant will be registered 
either as a primary or a competing specialist. The EAES Committee will 
determine whether to approve the application based upon the criteria 
set forth in Rule 511(b) as well as any objection by the primary 
specialist. The decision may be appealed consistent with Exchange By-
laws and procedures. 

(b) Obligations

    Each competing specialist unit must be registered with the Exchange 
as such and must meet the current minimum requirements for specialists 
as set forth

[[Page 56882]]

in Exchange Rules, including the minimum capital and equity 
requirements, and must conform to all other performance requirements, 
standards, policies and rules set forth in the Rules of the Exchange.

(c) Withdrawal

    If a competing specialist seeks to withdraw from acting as such in 
a security, it should so notify the Committee at least three business 
days prior to the desired effective date of such withdrawal. Withdrawal 
by a competing specialist bars that Competing Specialist from applying 
to compete in that same security for 90 days following the effective 
date of withdrawal. When the primary specialist requests to withdraw 
from a security, it shall be posted for reallocation by the EAES 
Committee. In the interim, if the EAES Committee is satisfied that a 
competing specialist can continue to maintain a fair and orderly market 
in such security, the competing specialist shall serve as the primary 
specialist until the security has been reallocated. Where there is more 
than one competing specialist in the security, a primary specialist 
shall be selected from among the competing specialists by the EAES 
Committee until reallocation.

(d) Competing Markets in a Security

    (i) Notwithstanding the existence of competing specialist 
situations, there is only one Exchange market in a security. Each 
specialist (primary or competing) shall quote their own market. 
Competing specialists must cooperate with the primary specialist 
regarding openings, halts and reopenings to ensure that they are 
unitary. One market, the Phlx Best Bid/Offer (``PBBO''), will be 
disseminated.
    (ii) Competing and primary specialists in a particular security 
must keep each other informed and communicate to inquiring Floor 
Brokers the full size of any executable ``all or none'' orders or any 
other order in their possession that cannot be represented in the 
published quote. Competing specialists are expected to represent such 
orders on a ``best efforts'' basis to ensure the execution of the 
entire order at a single price or prices, or not at all.

Rule 229B  Order Entry Window

    Floor Brokers and Specialists may elect to enter orders through an 
order entry window (the ``Order Entry Window'' or ``OEW''), which will 
route orders to the appropriate specialist, in accordance with Rule 
229A, with all OEW orders treated as Non-Directed Orders, as that term 
is defined in Rule 229A. Specialists may enter orders only in those 
stocks that they have been approved to trade as a specialist by the 
Equity Allocation, Evaluation and Securities Committee. Orders sent 
through the OEW will be displayed to the specialist for a period of 
time to be determined by the Exchange. During that time, the specialist 
can choose to interact with the OEW order. At the end of the time 
period, absent previous specialist action, the OEW order will be 
automatically executed or cancelled.

Rule 506 (new language is italic)

    (a)-(e) [no change]
    (f) If a specialist seeks to withdraw from acting as such in a 
security, it should so notify the Committee at least three business 
days prior to the desired effective date of such withdrawal.

Rule 517  Competing and Remote Competing Specialist

    Rules governing the approval of trading as a competing specialist 
and as a remote competing specialist are set forth in 460, Procedures 
for Competing Specialists and Rule 461, PACE Remote Specialist, 
respectively, and are incorporated by reference herein. Rules 500 
through 599 shall apply both to the specialist selected by the 
Committee following solicitation of applications under Rule 506(a) to 
serve as primary specialist and to any competing specialist approved 
under Rule 460, except that the primary specialist shall determine 
whether a security shall be PACE registered. Applications for 
allocation of competing specialist privileges pursuant to Rule 460 
shall contain the information required in Rule 506(b), and competing 
specialist privileges may be terminated on the same basis that primary 
specialist privileges may be removed and reallocated.

Rule 155  General Responsibility of Floor Brokers (new language italic)

    A Floor Broker handling an order is to use due diligence to execute 
the order at the best price or prices available to him in accordance 
with the Rules of the Exchange. A Floor Broker may (a) enter an order 
into the Order Entry Window as provided in Rule 229B, or (b) take the 
order to the specialist in that security on the trading floor or, where 
there are competing specialists, to the primary specialist in that 
security.

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

    In its filing with the Commission, 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 self-regulatory organization 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 adopt a Competing 
Specialist Program on the Exchange. The purpose of each proposed rule 
is discussed below.
Rule 460  Procedures for Competing Specialists
    The purpose of proposed Rule 460 is to establish a framework 
pursuant to which multiple specialists could trade on the equity 
trading floor of the Exchange.\3\ Currently, there is one specialist 
unit (referred to herein as the ``Primary Specialist'') for each equity 
security traded on the floor. This Primary Specialist is approved by 
the Exchange's Equity Allocation, Evaluation and Securities Committee 
(the ``EAES Committee'')\4\ pursuant to applications solicited by the 
Exchange under Rule 506(a) and criteria set forth in Rule 511(b). Those 
rules, generally, provide for the allocation of equity securities 
(commonly called ``books'') to particular specialist units, which 
consist of specialists and other staff.\5\
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    \3\ The Exchange is also separately proposing new Rule 461, 
which would provide for the trading by Competing Specialists from a 
remote location. See SR-Phlx-2001-98. Additionally, this proposed 
rule change dealing with Competing Specialists will have no impact 
on Exchange Rules 201A and 202A dealing with Alternate Specialists. 
Exchange specialists approved as Alternate Specialists may continue 
to trade in that capacity regardless of the existence of Competing 
Specialists.
    \4\ See By-Law Article 10-6 and Rule 500.
    \5\ See Rule 501.
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    Proposed Rule 460 would permit approved specialist units to apply 
to trade in a given security as Competing Specialists. The Primary 
Specialist would continue to trade as well and would have certain 
privileges and responsibilities that a Competing Specialist would not 
have.\6\ The

[[Page 56883]]

Exchange's proposal does not limit the number of Competing Specialists 
in each security (in addition to the Primary Specialist), but each 
shall be approved by the EAES Committee. Each Competing Specialist 
would have the same affirmative and negative obligations under Phlx 
Rule 203 as are imposed on the Primary Specialist.
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    \6\ For example, the Primary Specialist determines whether or 
not a security will trade on or off the PACE system. If the Primary 
Specialist determines that the security will trade on PACE, then all 
Competing Specialists must trade that security on PACE. If the 
Primary Specialist elects to take the security off the PACE system, 
the security is subject to reallocation to another specialist unit 
willing to trade the security on the PACE system. See Rule 520-523. 
Additionally, under proposed new Rule 229A (see below), the Primary 
Specialist will be deemed to be the Directed Specialist with respect 
to any Non-Directed Orders. Pursuant to Rule 155, also described 
further below, floor brokers must represent orders to the Primary 
Specialist, except as provided for in proposed Rule 229B. Under this 
proposal, there must be a Primary Specialist in order for there to 
be Competing Specialists.
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    The proposal is intended to attract additional order flow to the 
Exchange. In addition, the Competing Specialist program should 
encourage specialist units to actively market their services, as well 
as benefits and guarantees provided by Phlx rules, to a new customer 
base.
    Proposed Rule 460 consists of four sections dealing with 
application for approval as a Competing Specialist, the obligations of 
a Competing Specialist once approved, the withdrawal of a Competing 
Specialist from Competing Specialist status in a security, and a 
description of competing markets in a security. Proposed Rule 460(a) 
provides that Competing Specialist applications are to be submitted in 
writing on the appropriate form to the EAES Committee and must list in 
order of preference the securities in which the applicant intends to 
function as a Competing Specialist. The EAES Committee will make a 
determination whether to approve such application based on the factors 
set forth in Rule 511(b) for the selection of a Primary Specialist in a 
security, in addition to any objection that may have been registered 
with the EAES Committee by the Primary Specialist in that security.\7\ 
The EAES Committee will not approve any application to act as a 
Competing Specialist in any security not traded on the Exchange's PACE 
System.\8\
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    \7\ Although the Exchange seeks approval to trade all equity 
securities in its competing specialist program, the Exchange intends 
initially to limit the competing specialist program to common stock. 
The Exchange may determine to include other equity securities, such 
as Trust Shares, Index Fund Shares and Trust Issued Receipts, in the 
competing specialist program at a later date.
    \8\ The Exchange notes that pursuant to Rule 522 any security 
not traded on the PACE system may be reallocated to a specialist 
that is willing to trade the security on PACE. Thus, if a security 
is unavailable to be traded by a Competing Specialist because it is 
not on PACE, any specialist unit which otherwise may have applied to 
trade the security as a Competing Specialist may apply to trade the 
security as the Primary Specialist pursuant to Rule 522. Thereafter, 
the former Primary Specialist may apply to be a competing 
specialist.
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    Proposed Rule 460(b) establishes that each Competing Specialist 
must be registered with the Exchange as such and must meet all current 
minimum requirements for specialists. Thus, each Competing Specialist 
is to meet the same minimum standards applicable to the Primary 
Specialist. For instance, a Competing Specialist must meet the 
financial responsibility requirements of Rule 703.\9\
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    \9\ The Exchange's Equity Floor Procedure Advices would also 
apply to Competing Specialists.
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    Proposed Rule 460(c) outlines the procedures for Competing 
Specialists who wish to withdraw from the Competing Specialist program 
in a particular security. The Competing Specialist is required to give 
three business days notice to the Exchange prior to the withdrawal.\10\ 
Rule 460(c) would bar any competing specialist from applying for that 
same security for a period of ninety days following the effective date 
of withdrawal.
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    \10\ Proposed new Rule 506(f) would also impose a three-day 
notice of withdrawal requirement on all specialists, including 
Primary Specialists.
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    If a Primary Specialist requests to be relieved of a security, the 
security is to be posted for reallocation by the EAES Committee and, in 
the interim, one of the Competing Specialists may be required to serve 
as the Primary Specialist until reallocation.
    Proposed Rule 460(d) establishes that each Primary Specialist and 
Competing Specialist shall quote its own market but that, nevertheless, 
there is only one Exchange market in a security. That one market, the 
Phlx best bid/offer, is disseminated; it may consist of aggregated 
sizes of various specialists. Further, the rule requires Competing 
Specialists to cooperate with the Primary Specialist regarding 
openings, halts and reopenings to determine they are unitary. It also 
requires Competing Specialists and Primary Specialists to keep each 
other informed and communicate to inquiring Floor Brokers the full size 
of any orders in their possession that cannot be represented in the 
published quote. These requirements are intended to address the co-
existence of multiple specialists.
Rule 229A  Operation of PACE System When Competing Specialists Are 
Trading
    Today, Rule 229 governs execution of orders on the PACE system. 
Because the Exchange currently operates under a sole specialist system, 
Rule 229 does not address how orders would be executed if more than one 
specialist were making a market in a particular security; incoming PACE 
orders are generally executed against either the specialist, at the 
National Best Bid/Offer (``NBBO''),\11\ or a PACE order on the book, as 
described further below.
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    \11\ Rule 229 refers to the NBBO as the ``PACE Quote.''
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    New Rule 229A would provide an algorithmic handling of orders 
through the PACE system in cases where Competing Specialists are 
trading. The Rule 229 algorithm determines the specialist against which 
an incoming PACE order is executed, and details the amount of shares. 
Rule 229A builds on the guarantees and operation of the PACE System, as 
provided in Rule 229. Thus, how PACE operates is an important 
underpinning of this proposal.
The PACE System
    By way of background, PACE is the Exchange's order routing, 
delivery, execution and reporting system, governed by Rule 229. Rule 
229 is a voluntary system, such that specialists are not required to 
participate. Specialists who choose to participate in PACE are required 
to provide its guarantees to agency orders, including, among other 
things, accepting orders up to 2,099 shares for delivery and 
automatically executing eligible orders up to 599 shares. Above these 
minimum levels, specialists may set their delivery or execution levels 
at higher numbers.
    Automatic execution is one of the features and guarantees of PACE. 
Only certain orders are eligible for automatic execution; other orders 
are handled manually even when delivered electronically. Certain 
conditions cause PACE orders to be handled manually, including when the 
execution price would be outside the high/low range of the day for that 
security (out-of-range protection) and when the execution would be at a 
down-tick. Certain orders are subject to a 30 second order exposure 
window prior to automatic execution, pursuant to Supplementary Material 
.05.
    Another PACE guarantee under Rule 229 pertains to non-marketable 
limit orders. Specifically, Supplementary Material .10(a)(ii) provides 
that round-lot limit orders up to 500 shares and the round-lot portion 
of PRL limit orders up to 599 shares which are entered at a price 
different than the PACE Quote (non-marketable limit orders) will be 
executed in sequence at the limit price when an accumulative volume of 
1,000 shares of the security named in the order prints at the limit 
price or better

[[Page 56884]]

on the New York market \12\ after the time of entry of any such order 
into PACE. For each accumulation of 1,000 shares executed at the limit 
price on the New York market, the specialist shall execute a single 
limit order up to a maximum of 500 shares for each round-lot limit 
order up to 500 shares or the round-lot portion of a PRL limit order up 
to 599 shares. This guarantee is commonly referred to as primary market 
print protection.
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    \12\ Within the PACE Rule, New York market refers to the primary 
market, which is usually the New York Stock Exchange or the American 
Stock Exchange.
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    With respect to non-agency orders, specialists may choose to accept 
non-agency orders \13\ under Rule 229.02, under the conditions 
specified in that rule. Specialists may also choose to accept orders 
through PACE without participating in PACE execution guarantees, where 
the entering member organization has generally elected not to receive 
such guarantees.
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    \13\ Agency orders are defined as orders entered on behalf of a 
public customer, and does not include any order entered for the 
account of a broker-dealer, the account of an associated person of a 
broker-dealer, or any account in which a broker-dealer or an 
associated person of a broker-dealer has any direct or indirect 
interest. See Securities Exchange Act Release No. 26968 (June 23, 
1989), 54 FR 28141 (July 5, 1989)(SR-Phlx-89-13).
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    PACE also offers an automatic price improvement feature (``API''). 
API is a feature of the PACE system that automatically affords price 
improvement to eligible orders, pursuant to Rule 229.07(c). 
Specifically, API executes at a price better than the NBBO, in certain 
situations, by $.01 or a percentage of the spread between the bid and 
offer, as determined by the specialist. Even when a specialist does not 
choose to activate API, the specialist is required by Rule 
229.07(c)(ii) to manually provide double-up/double-down price 
protection to PACE orders.
    In summary, the PACE System and Rule 229 together provide certain 
execution guarantees to eligible orders, including automatic execution 
at the NBBO.
Rule 229A  Summary
    In cases where only the Primary Specialist is trading a security, 
PACE orders will continue to be executed as provided in Rule 229, and 
Rule 229A would not apply. In cases where Competing Specialists are 
trading a security, Rule 229 would continue to apply to the extent that 
it is not inconsistent with Rule 229A. For example, the provisions of 
Rule 229 dealing with API (as well as many of the guarantees and 
obligations of Rule 229) would continue to apply in both Competing 
Specialist and sole specialist situations.
    To begin, new Rule 229A would apply to PACE orders where there is 
at least one Competing Specialist in a security. Paragraph (b) of Rule 
229A provides a number of defined terms used throughout the rule. Most 
notably, ``Directed Order'' is defined to mean an order that a member 
organization directs to a particular specialist pursuant to an 
agreement with that specialist in which the member organization agrees 
to place orders in the security with that specialist. Any orders not 
placed with a particular specialist are called ``Non-Directed Orders.'' 
The specialist to whom a Directed Order is directed is defined as the 
``Directed Specialist'' and any other specialist (regardless of whether 
the Primary Specialist or a Competing Specialist) is defined as a Non-
Directed Specialist. Thus, the identity of the Directed Specialist and 
the Non-Directed Specialist is determined on an order-by-order basis. 
The Primary Specialist \14\ is deemed to be the Directed Specialist 
with respect to any Non-Directed Orders.
---------------------------------------------------------------------------

    \14\ The Primary Specialist is the specialist identified as such 
by the EAES Committee.
---------------------------------------------------------------------------

    Rule 229A defines a number of new procedures in the routing and 
execution of PACE orders that are affected by the bid (offer) posted by 
each specialist, whether each specialist is quoting at the NBBO, the 
automatic execution size of each specialist, the size of each 
specialist's bid (offer), the size of the NBBO, the spread of the NBBO 
as it relates to (whether API applies) application by the Directed 
Specialist, the activation of a step-up price improvement feature by 
Non-Directed Specialists and the priority of Non-Directed Specialist's 
bids (offers). The operation of these factors is discussed more fully 
below.
    In summary, Rule 229A expressly preserves the priority of the limit 
order book consistent with Rules 119, 120 and 218. When there is no 
such order involved, Rule 229A will allow the Directed Specialist to 
trade against its own directed order flow and execute orders \15\ in 
accordance with Rule 229 where no other specialist is at the NBBO, or 
where just the Directed Specialist is at the NBBO. However, Rule 229A 
also permits the Non-Directed Specialist to trade against Directed 
Orders. Specifically, when a Non-Directed Specialist is at the NBBO, he 
will attract away from the Directed Specialist part or all of Directed 
Order, depending on the size of the order and the applicability of the 
Directed Specialist's API level. Generally, if the Directed Specialist 
and other Non-Directed Specialists are at the NBBO, the Directed 
Specialist may retain part or all of an order depending on the size of 
the order and the applicability of the Directed Specialist's API or, in 
the case of Non-Directed Specialists, whether the PACE system's step-up 
automatic price improvement feature (``Step-Up API'') has been 
activated by the Non-Directed Specialist. Where specialists are 
bidding/offering at the same price, time priority will prevail, except 
that a Directed Specialist will be given priority over any Non-Directed 
Specialist (despite time priority of any Non-Directed Specialist) when 
they are bidding (offering) at the NBBO. Other factors which play a 
part in the direction and execution of orders are the size of the NBBO 
and the activation of extended API by the Directed Specialist, all of 
which are discussed more fully below. Depending on the circumstances, 
when an overage of order volume exists, it will be sent to the Directed 
Specialist.
---------------------------------------------------------------------------

    \15\ See letter from Carla Behnfeldt, Director, Legal Department 
New Product Development Group, Phlx to John Riedel, Attorney 
Adviser, Division of Market Regulation (``Division''), Commission, 
dated October 30, 2001 (``Amendment No. 1''). Most references to 
orders hereinafter refer to an incoming PACE sell order.
---------------------------------------------------------------------------

    More specifically, the execution methodology of Rule 229A is 
divided into three scenarios, discussed in greater detail below.
No Non-Directed Specialist at NBBO
    The first scenario, covered by paragraph (e)(1), is where, if at 
the time the incoming PACE order is received, there are no Non-Directed 
Specialists quoting at the NBBO, in which case the incoming order is 
executed against the Directed Specialist as provided in Rule 229,\16\ 
whether or not the Directed Specialist is quoting at the NBBO. The 
order would be automatically executed up to the Directed Specialist's 
automatic execution size or quote size, whichever is greater. For 
instance,\17\ where the market (NBBO) for a particular stock is $50  x  
$50.10 (10,000  x  10,000 shares), and the Phlx market (PBBO) is $50 
x  $50.15 (500 1,000 shares), with the Non-Directed Specialist bidding 
$49.95 for 500 shares, an incoming order for 1,000

[[Page 56885]]

shares would automatically execute against the Directed Specialist, 
whether he was bidding $49.95 or $50.00.\18\ This is because the Non-
Directed Specialist was not quoting at the NBBO.
---------------------------------------------------------------------------

    \16\ The cross-reference to Rule 229 is intended, here and 
throughout Rule 229A, to capture the various guarantees and 
situations where automatic executions occur under the PACE Rule 
today.
    \17\ In all of the examples provided in this proposed rule 
change for purposes of illustration, each specialist's maximum 
automatic execution level and API level is assumed to be 1,099 
shares, and all quotes reflect the specialist's principal (not 
agency) interest, the order book is away from the market, and the 
PACE system's volume check feature (as described below) has been 
activated by the specialist.
    \18\ If the Directed Specialist was bidding for 1,200 shares, an 
incoming order for 1,200 shares would automatically execute against 
him, because his 1,099 automatic execution level would be extended 
to his quoted size of 1,200 shares.
---------------------------------------------------------------------------

    Where multiple Non-Directed Specialists are quoting at prices other 
than the NBBO, those quotes, even if better than the quote of the 
Directed Specialist, are not relevant because the execution price 
against the Directed Specialist is generally the NBBO or better. This 
is consistent with how the PACE System currently operates, as automatic 
executions occur at the NBBO, regardless of the (sole) specialist's 
actual quote.
Non-Directed Specialist at NBBO; Directed Specialist Not at NBBO
    Secondly, Rule 229A(e)(2) applies where the Directed Specialist is 
not quoting at the NBBO and at least one Non-Directed Specialist is 
quoting at the NBBO. In this sub-paragraph, how the order is executed 
depends on whether there is an API Situation. An API Situation is 
defined in Rule 229A as a situation: (a) where Extend API applies,\19\ 
or (b) where the Directed Specialist has elected to activate API and 
where the size of the NBBO spread and the size of the order are such 
that an API Execution Price is available pursuant to the terms of Rule 
229, Supplementary Material Rule .07(c). In essence, an API Situation 
is where an API execution price (a price better than the NBBO) can be 
given by the system, because the specialist has activated the API 
feature and the situation would allow it.
---------------------------------------------------------------------------

    \19\ Extend API is defined as the PACE quote feature which a 
Directed Specialist may elect to activate and which will commit the 
Directed Specialist to extend the maximum size of his API guarantee 
up to the volume specified in the Directed Specialist's manual 
principal quote when the quote is at or part of the NBBO and at the 
same time greater than his automatic execution level. If the 
Directed Specialist activates Extend API, an order could 
automatically execute against the Directed Specialist for a size 
greater than his automatic execution (maximum) level, up to his 
quoted size.
---------------------------------------------------------------------------

    In an API Situation (where the Directed Specialist is not quoting 
at the NBBO but a Non-Directed Specialist is), Rule 229A(e)(2)(B) 
provides that the incoming PACE order is executed against the Directed 
Specialist at the API price, unless the Non-Directed Specialist quoting 
at the NBBO has activated Step-Up API. Step-Up API is the PACE system's 
quote feature whereby a Non-Directed Specialist commits to trade 
against any Directed Specialist's Directed Orders at the Directed 
Specialist's API Execution Price.\20\ For example, where the market 
(NBBO) for a particular stock is $50  x  $50.10 (10,000  x  10,000 
shares), and the Phlx market (PBBO) is $50  x  $50.15 (500  x  100 
shares), with the Directed Specialist bidding $49.95 for 500 shares 
(with API on) and the Non-Directed Specialist bidding $50 for 500 
shares (with Step-Up API not activated), an incoming order for 1,000 
shares would automatically execute against the Directed Specialist at 
his API price ($50.03). Even though he was quoting at a better price, 
the Non-Directed Specialist was unwilling to step up to the Directed 
Specialist's API price, such that he did not participate. Thus, if the 
Non-Directed Specialist has not activated Step-Up API, then Rule 
229A(e)(2)(B)(ii) provides that the order shall be executed against the 
Directed Specialist.
---------------------------------------------------------------------------

    \20\ Step-Up API does not apply to a specialist's own directed 
orders, because API would; Step-Up API only applies to Non-Directed 
Specialists, because it is a way of stepping up to someone else's 
API price that would otherwise apply to that order.
---------------------------------------------------------------------------

    If the Non-Directed Specialist has activated Step-Up API, Rule 
229A(e)(2)(B)(i) provides that the order shall be executed against the 
Non-Directed Specialist at the Directed Specialist's API price up to 
the Non-Directed Specialist's quoted size. Any remainder that is less 
than the Directed Specialist's Calculated Automatic Execution Level 
(``CAEL'') \21\ will be automatically executed against the Directed 
Specialist at his API price. For example, where the NBBO is $50  x  
$50.10 (10,000  x  10,000 shares), and the Phlx market is $50  x  
$50.15 (500  x  1,000 shares), with the Directed Specialist bidding 
$49.95 for 500 shares (with API on) and the Non-Directed Specialist 
bidding $50 for 500 shares (with Step-Up API activated), an incoming 
order for 1,000 shares would be automatically executed as follows: 500 
shares against the Non-Directed Specialist at the Directed Specialist's 
API price ($50.03) and 500 shares against the Directed Specialist at 
$50.03. In this example, each specialist receives their quoted size.
---------------------------------------------------------------------------

    \21\ The CAEL is the lower of (a) the automatic execution level 
established by the Specialist under Rule 229, Supplementary Material 
.05 (599 shares or more), or (b) the size of the NBBO market if the 
Specialist has activated Volume Check (as defined below); provided, 
however, that in no event shall the Calculated Automatic Execution 
Level be less than the minimum automatic execution level established 
by the Exchange under Rule 229 (599 shares). Volume Check is the 
PACE system feature which may be activated by a Specialist on a 
security by security basis and which, when activated, will prevent 
the automatic execution of incoming orders if the size of the NBBO 
market does not equal or exceed the Directed Specialist's automatic 
execution level.
---------------------------------------------------------------------------

    Rule 229A(e)(2)(A) applies where there is no API Situation and the 
Directed Specialist is not quoting at the NBBO, while at least one Non-
Directed Specialist is. The two sub-paragraphs thereunder, in 
determining against whom the order is executed, focus on why there is 
no API Situation. Sub-paragraph (i) applies where the Directed 
Specialist has not activated API or the spread is too small to permit 
API to occur.\22\ In both cases, the incoming PACE order is 
automatically executable against the Non-Directed Specialist up to the 
Non-Directed Specialist's quoted size, because the Non-Directed 
Specialist is quoting at the NBBO. For example, where the NBBO is $50 
x  $50.01 (10,000  x  10,000 shares), and the Phlx market is $50  x  
$50.15 (500  x  100 shares), with the Directed Specialist bidding 
$49.95 for 500 shares (with API on) and the Non-Directed Specialist 
bidding $50 for 500 shares (with Step-Up API activated), an incoming 
order for 1,000 shares would be automatically executed 500 shares 
against the Directed Specialist and 500 shares against the Non-Directed 
Specialist. Because the spread is too small, neither API (even if 
activated) are applicable here.
---------------------------------------------------------------------------

    \22\ API only operates where the spread is: (1) $.02 or greater 
where the specialist chooses to give API in the form of a percentage 
of the spread; or (2) either $.03 or $.05, depending on the 
specialist's choice, where the specialist chooses to give API of 
$.01.
---------------------------------------------------------------------------

    In another example, where the NBBO is $50  x  $50.01 (10,000  x  
10,000 shares) and the Phlx market is $50  x  $50.15 (2.000  x  100 
shares), with the Directed Specialist bidding $49.95 for 500 shares and 
the Non-Directed Specialist bidding $50 for 2,000 shares, an incoming 
order for 2,000 would be automatically executed against the Non-
Directed Specialist for 2,000 shares. The entire order went to the Non-
Directed Specialist, because he was quoting at the NBBO for the entire 
size of that order.
    Rule 229A(e)(2)(A)(i) further provides that any remainder of an 
incoming PACE order is automatically executed against the Directed 
Specialist up to the Directed Specialist's CAEL. Referring back to the 
prior example, where the NBBO is $50  x  $50.01 (10,000  x  10,000 
shares) and the Phlx market is $50  x  $50.15 (2,000  x  100 shares), 
with the Directed Specialist bidding $50 for 2,000 shares, an incoming 
order for 2,200 shares would be automatically executed against the Non-
Directed Specialist for 2,000 shares (who was quoted at the NBBO) and 
200 shares against the Directed Specialist. If the

[[Page 56886]]

remainder of the order is greater than the Directed Specialist's CAEL, 
then the order is handled manually by the Directed Specialist. For 
instance, where the NBBO is $50  x  $50.01 (10,000  x  10,000 shares) 
and the Phlx market is $50  x  $50.15 (500  x  100 shares), with the 
Directed Specialist bidding $49.95 for 500 shares and the Non-Directed 
Specialist bidding $50 for 500 shares, an incoming order for 2,000 
shares is automatically executed 500 shares against the Non-Directed 
specialist and 1,500 shares are handled manually by the Directed 
Specialist.
    Rule 229A(e)(2)(a)(ii) applies where there is no API situation for 
a different reason. If there is not an API Situation because, although 
the Directed Specialist has activated API and the spread is 
sufficiently wide to permit API, the size of the incoming order is too 
large (it exceeds the Directed Specialist's CAEL), the order would be 
executed manually by the Directed Specialist. For example, where the 
NBBO is $50  x  $50.10 (10,000  x  10,000 shares), and the Phlx market 
is $50  x  $50.15 (2,000  x  100 shares), with the Directed Specialist 
bidding $49.95 for 500 shares (with API on) and the Non-Directed 
Specialist bidding $50 for 2,000, an incoming order for 2,000 shares 
would be manually handled by the Directed Specialist, because the 
volume of the incoming order (2,000 shares) exceed the Directed 
Specialist's CAEL--both his automatic execution level (1,099 shares) 
and his quote size (500 shares).
Directed Specialist and a Non-Directed Specialist at NBBO
    The third situation is where the Directed Specialist and a Non-
Directed Specialist are quoting at the NBBO; Rule 229A(e)(3) applies. 
The execution of the incoming PACE order depends on whether there is an 
API Situation, regardless of which specialist quoted at the NBBO first. 
Rule 229A(e)(3)(A) applies where there is no API Situation. Pursuant to 
Rule 229A(e)(3)(A)(i), if the Directed Specialist has not activated API 
or if the spread is too small for API to occur, the order is to be 
executed automatically against the Directed Specialist if it is within 
his automatic execution level, otherwise against the Directed 
Specialist up to his quoted size, then against any Non-Directed 
Specialist quoting at the NBBO up to his quoted size, with the 
remainder manually against the Directed Specialist. Thus, the Directed 
Specialist has priority up to his quoted size, regardless of whether 
any Non-Directed Specialist may have quoted at the NBBO first.
    For example, where the NBBO is $50  x  $50.01 (10,000  x  10,000 
shares), and the Phlx market is $50  x  $50.15 (1,000  x  100 shares), 
with the Directed Specialist bidding $50 for 500 shares and the Non-
Directed Specialist bidding $50 for 500 shares, an incoming order for 
1,000 shares would automatically execute against the Directed 
Specialist. An incoming order for 1,500 shares would automatically 
execute against the Directed Specialist for 1,000 shares and against 
the Non-Directed Specialist for 500 shares.
    The size of the order may result in manual handling of the Directed 
Specialist's portion. For instance, referring back to the prior 
example, an incoming order for 1,700 shares would automatically execute 
against the Non-Directed Specialist for 500 shares, and 1,200 shares 
would be handled manually by the Directed Specialist. The 1,200 shares 
exceeds the Directed Specialist's automatic execution level, as well as 
his quote size.
    In a similar example, where the NBBO is $50  x  $50.01 (500  x  
10,000 shares), the Phlx market is $50  x  $50.15 (400  x  100 shares), 
the Directed and Non-Directed Specialist are each bidding $50 for 200 
shares, an incoming order for 1,000 shares would automatically execute 
200 shares against the Non-Directed Specialist and 800 shares would be 
handled manually by the Directed Specialist. Only 200 shares would 
automatically execute in this example because 800 shares (although 
within the Directed Specialist's automatic execution level) exceeds the 
NBBO size (which is 500 shares). Thus, 800 shares exceeds the Directed 
Specialist's CAEL.\23\
---------------------------------------------------------------------------

    \23\ If volume check were not activated, the order would have 
automatically executed.
---------------------------------------------------------------------------

    Where the NBBO is $50  x  $50.01 (10,000  x  10,000 shares) \24\ 
and the Phlx market is $50  x  $50.15 (1,700 shares  x  100 shares) 
with the Directed Specialist is bidding $50 for 1,200 shares and the 
Non-Directed Specialist is bidding $50 for 500 shares, an incoming 
order for 2,000 shares would automatically execute 500 shares against 
the Non-Directed Specialist, 1,200 shares automatically against the 
Directed Specialist and 300 shares would be manually handled by the 
Directed Specialist; this is because the Directed Specialist's quoted 
size of 1,200 shares is greater than his automatic execution level of 
1,099 shares.
---------------------------------------------------------------------------

    \24\ Telephone call between Carla Behnfeldt, Director, Legal 
Department New Product Development Group, Phlx and John Riedel, 
Attorney Adviser, Division, Commission, dated October 31, 2001 
(``Amendment No. 2'').
---------------------------------------------------------------------------

    Where the Directed Specialist is bidding for 500 shares and the 
Non-Directed Specialist is bidding for 1,200 shares, an incoming order 
for 2,000 shares would automatically execute 1,200 shares against the 
Non-Directed Specialist and 800 shares against the Directed Specialist; 
this is because 800 shares is less than the Directed Specialist CAEL.
    There is a second scenario where there is no API situation, which 
is covered by Rule 229A(e)(3)(A)(ii). If the Directed Specialist has 
activated API and the spread is sufficiently wide for API to occur, but 
the order size is too big (it exceeds the Directed Specialist's CAEL 
and the Directed Specialist's quote size exceeds his automatic 
execution level), then the order would be automatically executed up to 
the Directed Specialist's quote size, with the remainder handled 
manually by the Directed Specialist. For example, where the NBBO is $50 
 x  $50.10 (10,000  x  10,000 shares), and the Phlx market is $50  x  
$50.15 (1,700  x  100 shares), with the Directed Specialist bidding $50 
for 1,200 shares and the Non-Directed Specialist bidding $50 for 500 
shares, an incoming order for 2,000 shares would automatically execute 
500 shares against the Non-Directed Specialist and 1,200 shares against 
the Directed Specialist, with the remaining 300 shares handled manually 
by the Directed Specialist. The 1,200 shares was automatically executed 
against the Directed Specialist because that was his quote size (even 
though greater than his automatic execution size).
    If the order size exceeds the Directed Specialist's CAEL, but his 
quote size does not exceed his automatic execution level, then the 
order would be handled manually by the Directed Specialist. For 
example, where the NBBO is $50  x  $50.10 (10,000  x  10,000 shares) 
and the Phlx market is $50  x  $50.15 (1,700  x  100 shares), with the 
Directed Specialist bidding $50 for 600 shares and the Non-Directed 
Specialist is bidding $50 for 500 shares, an incoming order for 2,000 
shares would automatically execute 500 shares against the Non-Directed 
Specialist and 1,500 shares would be handled manually by the Directed 
Specialist. In this example, the Directed Specialist's portion is 
handled manually because his quote size is less than his automatic 
execution level.
    Even if there is an API Situation, this result may occur--that the 
Directed Specialist gets priority and an automatic execution up to his 
quoted size or the ability to execute the entire order manually--where 
the Non-Directed Specialist has not activated Step-Up API. This is 
provided for in Rule

[[Page 56887]]

229A(e)(3)(B)(ii), which cross-references Rule 229A(e)(3)(A).
    If there is an API situation where a Non-Directed Specialist is 
quoting at the NBBO and the Directed Specialist is not, then how an 
incoming order is executed depends on whether the Non-Directed 
Specialist has activated Step-Up API. If the Non-Directed Specialist 
has not activated Step-Up API, the order is executable against the 
Directed Specialist at the Directed Specialist's API price, and 
pursuant to Rule 229A(e)(3)(A)(i) and (ii).
    For example, where the NBBO is $50  x  $50.10 (10,000  x  10,000 
shares), and the Phlx market is $50  x  $50.15 (1,700  x  100 shares), 
with the Directed Specialist bidding $50 for 1,200 shares (with API on) 
and the Non-Directed Specialist bidding $50 for 500 shares (with Step-
Up API not activated), an incoming order for 1,000 shares would 
automatically execute against the Directed Specialist at $50.03.
    An incoming order for 2,000 shares would execute as follows against 
the Directed Specialist: 1,200 shares automatically at the Directed 
Specialist's API price ($50.03) and 800 shares to be handled manually. 
In this example, the Non-Directed Specialist does not participate in 
the incoming order because he was unwilling to step up to the Directed 
Specialist's API price of $50.03. This example also illustrates that 
1,200 shares automatically execute against the Directed Specialist, 
even though his automatic execution level is only 1,099 shares because 
his quote size of 1,200 shares extended his automatic execution size to 
1,200 shares.
    If the Non-Directed Specialist has activated Step-Up API, the order 
is executable against the Directed Specialist at the Directed 
Specialist's API price up to the Directed Specialist's quoted size, and 
then against the Non-Directed Specialist, up to his quoted size, with 
the remainder to the Directed Specialist. If the Directed Specialist's 
quote size is greater than his automatic execution level, then the 
remainder is automatically executed up to the quote size and the rest 
is handled manually. If the Directed Specialist's quote size is less 
than his automatic level, then the remainder is either all 
automatically executed or all handled manually, depending on the size.
    For example, where the NBBO is $50  x  $50.10 (10,000  x  10,000 
shares), and the Phlx market is $50  x  $50.15 (1700  x  100 shares), 
with the Directed Specialist bidding $50 for 1,200 shares (with API on) 
and the Non-Directed Specialist bidding $50 for 500 shares (with Step-
Up API activated), an incoming order for 1,000 shares would 
automatically executed against the Directed Specialist, because 1,000 
shares is within the quoted size.
    An incoming order for 2,000 shares would execute as follows: 500 
shares automatically against the Non-Directed Specialist at the 
Directed Specialist's API price of $50.03, 1,200 shares automatically 
against the Directed Specialist at the API price, and 300 shares would 
be handled manually by the Directed Specialist; this is because the 
order was automatically executed up to his quote size with the 
remainder handled manually.
    The next example demonstrates how the size of the quote impacts the 
outcome. First, where the market (NBBO) for a particular stock is $50 
x  $50.10 (10,000  x  10,000 shares), and the Phlx market (PBBO) is $50 
 x  $50.15 (2700  x  100 shares), with the Directed Specialist bidding 
$50.00 for 1,200 shares (with API on) and the Non-Directed Specialist 
bidding $50 for 1,500 shares (with Step-Up API activated), an incoming 
order for 2,000 shares would execute as follows: 1,200 shares 
automatically against the Directed Specialist at his API price of 
$50.03 and 800 automatically against the Non-Directed Specialist at the 
Directed Specialist's API price. This example shows that the Directed 
Specialist has priority and gets filled first up to his quoted size.
Multiple Non-Directed Specialists
    Rule 229A(e)(4) provides that where multiple Non-Directed 
Specialists are quoting at the NBBO, each will be treated with time 
priority. For example, where the NBBO is $50  x  $50.10 (10,000  x  
10,000 shares), and the Phlx market is $50  x  $50.15 (2,200  x  100 
shares), with the Directed Specialist bidding $50 for 1,200 shares 
(with API on) at 10:05 AM, Non-Directed Specialist 1 bidding $50 for 
500 shares (with Step-Up API activated) at 10:00 AM, and Non-Directed 
Specialist 2 bidding $50 for 500 shares at 10:01 AM, an incoming order 
for 2,000 shares would automatically execute against the Directed 
Specialist for 1,200 shares at his API price of $50.03, 500 shares 
against Non-Directed Specialist 1 at $50.03 and 300 shares against Non-
Directed Specialist 2 at $50.03.
Rule 155  General Responsibility of Floor Brokers
    Rule 155 currently provides that a Floor Broker is to use due 
diligence to execute orders at the best prices available to him in 
accordance with the Rules of the Exchange. This rule is proposed to be 
revised to establish how a Floor Broker may discharge his or her due 
diligence obligation where there is more than one specialist. As 
revised, the Floor Broker's obligation would be discharged if he or she 
(a) enters the order into the Order Entry Window under Rule 229B (see 
below), or (b) takes the order to the specialist in that security on 
the trading floor or, where there are competing specialists, to the 
Primary Specialist in that security. This rule is intended to establish 
that Floor Brokers must represent orders to the Primary Specialist, 
unless relying on the Order Entry Window of Rule 229B.
Rule 229B  Order Entry Window
    New Rule 229B would provide for a new feature of the Exchange's 
equity trading system, the Order Entry Window (``OEW''). The OEW would 
allow members the ability to access or probe the internal Phlx market. 
Specialists may enter orders only in those stocks that they have been 
approved to trade as a specialist by the EAES Committee. Orders entered 
into the OEW will be routed to the appropriate Phlx specialists 
(Competing and Primary), in accordance with Rule 229A as a Non-Directed 
Order.\25\ For example, where there is no Competing Specialist quoting 
at the NBBO, the OEW would route an incoming order to the Directed 
Specialist--in this example, the Primary Specialist. Unlike PACE 
orders, however, orders routed to a specialist by the OEW will not be 
immediately executed according to the Rule 229A algorithm but will be 
displayed for a period of time, to be determined by the Exchange. 
During that time, the specialist can choose to interact with the OEW 
order. For instance, the specialist may choose to execute the order. At 
the end of the time period, absent previous specialist action, the OEW 
order will be automatically executed, if executable, or cancelled. The 
OEW is intended to serve as an order routing mechanism for Floor 
Brokers as well as specialists seeking to access other specialists' 
markets.
---------------------------------------------------------------------------

    \25\ Thus, the Primary Specialist will be deemed to be the 
Directed Specialist with all OEW orders.
---------------------------------------------------------------------------

Rule 517
    Proposed Rule 517 incorporates Rules 460 and 461 by reference into 
the 500--599 series of Exchange rules. The purpose of Rule 517 is to 
integrate the provisions of the Competing Specialist and Remote 
Specialist rules into the existing framework for allocation of 
securities and specialist performance evaluation.

[[Page 56888]]

2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with section 6(b) of the Act \26\ in general, and furthers the 
objectives of section 6(b)(5) \27\ in particular, in that it is 
designed to promote just and equitable principles of trade; to foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities; to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system; and, in general, to protect investors and the public interest; 
and is not designed to permit unfair discrimination between customers, 
issuers, brokers or dealers. Specifically, the proposed rule change 
will permit member firms to direct order flow to the specialist of 
their choice and promotes competition to provide the best market.
---------------------------------------------------------------------------

    \26\ 15 U.S.C. 78f(b).
    \27\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

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

    The Phlx does not believe that the proposed rule change will impose 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

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

    The Phlx has neither solicited nor received written comments with 
respect to the proposed rule change.

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 (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 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 Section. 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-2001-98 and 
should be submitted by December 4, 2001.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-28272 Filed 11-9-01; 8:45 am]
BILLING CODE 8010-01-P