[Federal Register Volume 67, Number 34 (Wednesday, February 20, 2002)]
[Notices]
[Pages 7728-7731]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-4055]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45436; File No. SR-Phlx-2001-24]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendments Nos. 1, 2, 3, and 4 Thereto by the Philadelphia 
Stock Exchange, Inc. Relating to the Manual Handling of Certain AUTOM 
Orders by Specialists

February 12, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934

[[Page 7729]]

(``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on March 2, 2001, 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 Phlx. 
On April 13, 2001, the Phlx submitted Amendment No. 1 to the proposed 
rule change.\3\ On July 3, 2001, the Phlx submitted Amendment No. 2 to 
the proposed rule change.\4\ On August 8, 2001, the Phlx submitted 
Amendment No. 3 to the proposed rule change.\5\ On December 11, 2001, 
the Phlx submitted Amendment No. 4 to the proposed rule change.\6\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Richard S. Rudolph, Counsel, Phlx, to Nancy 
J. Sanow, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated April 12, 2001 (``Amendment No. 
1''). Amendment No. 1 designates the proposed rule change as filed 
pursuant section 19(b)(2) of the Act, and the Exchange requests that 
the proposed rule change is given accelerated effectiveness. 15 
U.S.C. 78s(b)(2).
    \4\ See Letter from Richard S. Rudolph, Counsel, Phlx, to Nancy 
J. Sanow, Assistant Director, Division, Commission, dated July 2, 
2001 (``Amendment No. 2''). Amendment No. 2 corrects technical 
errors to the proposed rule text.
    \5\ See Letter from Richard S. Rudolph, Counsel, Phlx, to Nancy 
J. Sanow, Assistant Director, Division, Commission, dated August 7, 
2001 (``Amendment No. 3''). Amendment No. 3 updates the proposed 
rule text that refers to a pilot program that permits the Exchange 
to automatically execute option contracts within a 15 second period. 
In addition, Amendment No. 3 corrects technical errors to the 
proposed rule text.
    \6\ See Letter from Richard S. Rudolph, Counsel, Phlx, to Nancy 
J. Sanow, Assistant Director, Division, Commission, dated December 
10, 2001 (``Amendment No. 4''). Amendment No. 4 replaces the 
original filing in its entirety and modifies earlier revisions by: 
(1) Discussing the calculation of a zero bid by the Exchange's 
Autoquote System; (2) discussing the Exchange's audit trail and 
other documentation in cases which AUTO-X is disengaged; (3) 
discussing the authority of the Exchange's Options Committee to 
restrict the use of AUTO-X on the Exchange; and (4) updating the 
proposed rule text that refers to the pilot program that permits the 
Exchange to automatically execute option contracts within a 15 
second period.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Phlx proposes to adopt Phlx Rule 1080(c)(iv) to codify that an 
options order otherwise eligible for the Exchange's Automated Execution 
System (``AUT-X'') will instead be manually handled by the specialist 
in certain circumstances. Specifically, an options order entered 
through the Exchange's Automated Options Market (``AUTOM'') System,\7\ 
that is otherwise eligible for AUTO-X, may instead be handled manually 
by the specialist. Below is the text of the proposed rule change. 
Additions are italicized.
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    \7\ AUTOM is the Phlx's automated order routing, delivery, 
execution, and reporting system for options.
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Rule 1080. Philadelphia Stock Exchange Automated Options Market (AUTOM) 
and Automatic Execution System (AUTO-X)
    (a)-(b) No change.
    (c) AUTO-X--AUTO-X is a feature of AUTOM that automatically 
executes eligible 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 determines otherwise. AUTO-X automatically 
executes eligible orders using the Exchange disseminated quotation 
(except if executed pursuant to the NBBO Feature in sub-paragraph (i) 
below) 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, such as pursuant 
to sub-paragraph (iv) below. 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 100 
contracts, subject to the approval of the Options Committee, 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)-(C) No change.
    (D)-(E) Reserved.
    (ii) No change.
    (iii) Reserved.
    (iv) Except as otherwise provided in this Rule, in the following 
circumstances, an order otherwise eligible for AUTO-X will instead be 
manually handled by the specialist:
    (A) the Exchange's disseminated market is crossed (i.e., 2-1/8 bid, 
2 offer) or locked (i.e., 2 bid, 2 offer), or crosses or locks the 
disseminated market of another options exchange;
    (B) one of the following order types: stop, stop limit, market on 
closing, market on opening, or an all-or-none order where the full size 
of the order cannot be executed;
    (C) the AUTOM System is not open for trading when the order is 
received (which is known as a pre-market order);
    (D) the disseminated market is produced during an opening or other 
rotation;
    (E) when the specialist posts a bid or offer that is better than 
the specialist's own bid or offer;
    (F) if the NBBO Feature, described in paragraph (c)(i) above, is 
not engaged, and the Exchange's bid or offer is not the NBBO;
    (G) when the price of a limit order is not in the appropriate 
minimum trading increment pursuant to Rule 1034;
    (H) when the bid price is zero respecting sell orders; and
    (I) when the number of contracts automatically executed within a 15 
second period in an option (subject to a pilot program until May 30, 
2002) exceeds the AUTO-X guarantee, a 30 second period ensues during 
which subsequent orders are handled manually.
    (d)-(j) No Change.
    Commentary: No change.

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

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

[[Page 7730]]

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 codify the situations 
in which an otherwise eligible AUTO-X order is handled manually by the 
specialist. The Phlx believes that the proposal also clarifies that the 
manual handling of such orders reflects the normal operation of AUTOM 
and AUTO-X.\8\ Currently, Phlx Rule 1080, ``Philadelphia Stock Exchange 
Automated Options Market (AUTOM) and Automated Execution System (AUTO-
X),'' governs the operation of AUTOM. AUTO-X is addressed primarily in 
paragraph (c) of the rule. Phlx Rule 1080(c) provides that only certain 
order types are eligible for AUTO-X. Specifically, Rule 1080(c) 
currently provides that 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 determines otherwise.
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    \8\ On September 11, 2000, the SEC issued an order, which 
required the Phlx (as well as the other options exchanges) to 
implement certain undertakings. One such undertaking was to adopt 
new, or amend existing exchange rules concerning automatic quotation 
and execution systems which specify the circumstances, if and, by 
which automated execution systems would be disengaged or operated in 
any manner other than the normal manner set forth in the exchange's 
rules; and, require the documentation of the reasons for each 
decision to disengage an automatic execution system or operate it in 
any manner other than the normal manner. See In the Matter Certain 
Activities of Options Exchanges, Securities Exchange Act Release No. 
43268 (September 11, 2000). The proposed rule change codifies that 
such orders being handled manually by specialists in the stated 
circumstances is the normal operation of AUTOM and AUTO-X.
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    According to the Phlx, AUTO-X automatically executes eligible 
orders using the Exchange disseminated quotation and then automatically 
routes execution reports to the originating member organization.\9\ In 
all other circumstances, AUTOM orders that are not eligible for AUTO-X 
would be executed manually in accordance with Exchange rules.
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    \9\ The Exchange is also proposing to cross-reference Phlx Rule 
1080(c)(i), ``AUTO-X on the NBBO (NBBO Feature),'' in cases in which 
AUTO-X will not execute at the Exchange's disseminated quotation.
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    According to the Exchange, Phlx Rule 1080 currently enumerates some 
of the situations where an order may not be automatically executed. For 
example, manual execution may occur when AUTO-X is not engaged.\10\ In 
addition, Rule 1080(c) also currently states that an order may be 
executed partially by AUTO-X and partially handled manually by the 
specialist.
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    \10\ See Phlx Rule 1080(e), and Option Floor Procedure Advices 
A-13 and F-10.
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    The Phlx is proposing to codify nine additional situations in which 
an order would not automatically execute. First, if the Exchange's 
disseminated market is crossed (i.e., 2\1/8\ bid, 2 offer) or locked 
(i.e., 2 bid, 2 offer), there is no valid market, such that no 
automatic execution would occur.\11\ If the Exchange's disseminated 
market crosses or locks the disseminated market of another options 
exchange, an incoming AUTOM order would not automatically execute in 
order to prevent a trade-through from occurring.
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    \11\ See also CBOE Rule 6.8(c).
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    Second, the following order types do not automatically execute: 
stop, stop limit, market on closing, and market on opening, because 
these orders consist of contingencies, such as pricing (stop at a 
certain price) or timing (execute only on the opening) that the AUTOM 
System cannot address.\12\ Similarly, an all-or-none order where the 
full size of the order cannot be executed is not eligible for AUTO-X 
because such an order has no standing and is thus inconsistent with 
automated handling.\13\
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    \12\ See e.g., Option Floor Procedure Advice A-5 (``Execution of 
Stop and Stop Limit Orders'').
    \13\ See Option Floor Procedure Advice A-9 (``All-or-None Option 
Orders'').
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    Third, AUTOM orders received when the AUTOM System is not open for 
trading (known as pre-market orders) are not eligible for automatic 
execution because they are entitled to the opening price.\14\ The Phlx 
also notes that openings are handled manually, with AUTO-X engaged 
promptly following an option's opening,\15\ once there is an 
established price against which an automatic execution can occur.\16\
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    \14\ See Option Floor Procedure Advice A-12 (``Opening Rotations 
and SORT Procedures'').
    \15\ See Option Floor Procedure Advice A-13 (``Auto Execution 
Engagement/Disengagement Responsibility'').
    \16\ The Exchange believes that CBOE Rule 6.8(f) similarly 
provides that RAES does not operate until after the opening. See 
CBOE Rule 6.8(f).
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    Fourth, when the disseminated market is produced during an opening 
or other rotation, an incoming order is not automatically executed, 
similar to pre-market orders, because there must be an established 
price against which an automatic execution can occur.
    Fifth, an incoming AUTOM order will not automatically execute when 
the specialist posts a bid or offer that is better than the 
specialist's own bid or offer. The bid or offer could represent a 
customer order or a price-improving bid or offer by a Registered 
Options Trader (``ROT''). Currently, these can be displayed manually by 
the specialist using a certain indicator, which causes AUTO-X (and its 
trade allocation feature, the Wheel) \17\ to not engage. Thus, any 
incoming order would be manually handled by the specialist in lieu of 
automatic execution.\18\
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    \17\ See Option Floor Procedure Advice F-24 (``AUTO-X Contra-
Party Participation (The Wheel)'').
    \18\ See also CBOE Rule 6.8(b).
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    Sixth, certain options are subject to the NBBO Feature, described 
in Phlx Rule 1080(c)(i), which automatically executes eligible orders 
at the National Best Bid or Offer (``NBBO'') provided that the NBBO 
does not differ from the specialist's best bid or offer by more than 
the ``step-up parameter,'' which is determined by the Options 
Committee. According to the Phlx, participation on an option-by-option 
basis in the NBBO Feature is voluntary, such that if the specialist 
elects not to engage the NBBO Feature, or disengages it pursuant to the 
Exchange rule, and the Exchange's disseminated bid or offer is inferior 
to the NBBO, an incoming AUTOM order would not automatically execute. 
Thus, in order to prevent AUTO-X from creating a trade-through, such an 
order would be handled manually.\19\
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    \19\ See also CBOE Rule 6.8, Interpretations and Policies .02 
for a similar provision.
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    Seventh, when the price of an order is not expressed in the 
appropriate minimum trading increment pursuant to Phlx Rule 1034, the 
order would not be automatically executed because the price is presumed 
to be invalid. Nevertheless, in lieu of rejecting such an order, the 
order would be handled manually by the specialist, which may result in 
an execution at a better price and in the correct increment. For 
example, where the market is 2.00-2.25, an incoming buy order for 2.21 
would not automatically execute; while manually handled by the 
specialist, it may be executed at 2.20, a better price.
    Eighth, where the bid price for a particular option series is zero, 
an incoming AUTOM sell order would not automatically execute, because 
the ``zero'' price is not a valid execution price. According to the 
Phlx, a ``zero'' bid price is typically calculated by Auto-Quote, the 
Exchange's automatic pricing system, when an option that is well out-
of-the-money approaches expiration, and thus has neither intrinsic 
value nor time value. In such circumstance, as stated above, an 
incoming order to sell would not be AUTO-X eligible, since an automatic 
execution is not possible at a ``zero'' bid.

[[Page 7731]]

    Lastly, the Phlx represents that certain options are subject to a 
pilot program under which when the number of contracts automatically 
executed within a 15 second period exceeds the AUTO-X guarantee, a 30 
second period ensues during which subsequent orders are handled 
manually.\20\ The Phlx proposes to codify this program, which is 
discussed more fully in its adopting release, in Rule 1080(c).
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    \20\ See Securities Exchange Act Release No. 45090 (November 21, 
2001), 66 FR 59834 (November 30, 2001) (SR-PHLX-2001-100).
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    In any of these situations, the Phlx would disseminate a message to 
its quotation vendors that indicates to users on a series-by-series 
basis, whether or not such series is AUTO-X eligible. Internally, the 
Phlx represents that it maintains an electronic audit trail, called an 
AUTO-X Disengagement Log, that electronically monitors and records 
every situation in which AUTO-X is disengaged. According to the Phlx, 
the AUTO-X Disengagement Log indicates whether the disengagement was 
done automatically by AUTOM for any of the nine aforementioned reasons, 
or pursuant to a request by the specialist. In the latter situation, 
the Phlx represents that approval of two Floor Officials is required to 
disengage AUTO-X. The Market Surveillance Department of the Phlx 
maintains a record of each such situation.
    Additionally, Phlx Rule 1080 provides that the Options Committee 
may for any period restrict the use of AUTO-X on the Exchange in any 
option or series.\21\ According to the Phlx, such restriction may, in 
some instances, affect the eligibility of certain options to be 
executed via AUTO-X. For example, the Options Committee has previously 
restricted certain options from AUTO-X eligibility due to the unusual 
volatility in certain series, or due to the unusually high premiums for 
deep in-the-money options that generally do not generate interest from 
public customers.\22\ The Phlx represents that any restriction on the 
use of AUTO-X on the Exchange in any option or series approved by the 
Options Committee will be clearly communicated to its membership and 
AUTOM users through an electronic message via AUTOM, and through an 
Exchange information circular. The Phlx also represents that such 
restriction would not take effect until after such communication has 
been made.
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    \21\ The Options Committee has supervision of all connections or 
means of communications with the equity and index options trading 
floor and may require the discontinuance of any such connection or 
means of communication when, in the opinion of the Committee, it is 
contrary to the welfare or interest of the Exchange. See Phlx By-Law 
Article X, Section 10-19. The Phlx believes that such connections 
and means of communication include AUTOM and AUTO-X.
    \22\ See Securities Exchange Act Release No. 36467 (November 8, 
1995), 60 FR 57615 (November 16, 1995) (order approving SR-Phlx-95-
33). The Commission approved the Exchange's limitation of AUTO-X 
eligibility for National Over-the-Counter Index (``XOC'') options to 
XOC series where the bid is $10 or less. The Options Committee 
approved this restriction due to the significantly reduced public 
customer demand for high priced XOC options, and to the unusually 
high volatility in over-the-counter markets at the time, which made 
it increasingly difficult for specialists and market makers to 
monitor quotations to reflect changes in the markets for underlying 
securities.
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2. Statutory Basis
    The Phlx believes that its proposal is consistent with section 6(b) 
of the Act in general,\23\ and furthers the objectives of section 
6(b)(5) of the Act in particular,\24\ in that it is designed to promote 
just and equitable principles of trade, remove impediments to and 
perfect the mechanism of a free and open market and protect investors 
and the public interest by causing certain AUTOM orders to be handled 
manually.
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    \23\ 15 U.S.C. 78f(b).
    \24\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Phlx believes that the proposed rule change does not 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 any written comments on 
the proposed rule change.

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

    Within 35 days of the 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 Exchange consents, the Commission will:
    (A) By order approve such proposed rule change or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, 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-2001-24 and should 
be submitted by March 13, 2002.


    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-4055 Filed 2-19-02; 8:45 am]
BILLING CODE 8010-01-P