[Federal Register Volume 67, Number 61 (Friday, March 29, 2002)]
[Notices]
[Pages 15271-15273]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-7612]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45629; File No. SR-Phlx-2001-89]


Self-Regulatory Organizations; Order Granting Approval to a 
Proposed Rule Change and Amendment No. 1 Thereto by the Philadelphia 
Stock Exchange, Inc. Relating to an Increase in the Maximum Guaranteed 
Size for AUTO-X Eligible Orders in Options on the Nasdaq-100 Index 
Tracking Stock (``QQQ'') from 100 Contracts to 250 Contracts

March 22, 2002.

I. Introduction

    On September 27, 2001, the Philadelphia Stock Exchange, Inc. 
(``Phlx'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to increase its automatic 
execution guarantee for options overlying the QQQ from 100 contracts to 
250 contracts. On October 9, 2001, the Phlx filed Amendment No. 1 to 
the proposed rule change.\3\ On November 15, 2001, the proposed rule 
change and Amendment No. 1 were published for public comment in the 
Federal Register.\4\ The Commission received no comments on the 
proposed rule change, as amended. This order approves the proposed rule 
change, as amended.
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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 
Sanow, Assistant Director, Division of Market Regulation, 
Commission, dated October 5, 2001 (``Amendment No. 1''). In 
Amendment No. 1, the Phlx changed the status of the proposal from a 
filing made pursuant to Section 19(b)(3)(A) of the Act to a filing 
made pursuant to Section 19(b)(2) of the Act.
    \4\ See Securities Exchange Act Release No. 45046 (November 7, 
2001), 66 FR 57500.
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II. Description of the Proposed Rule Change

    The Exchange proposes to increase the maximum order size 
eligibility for its automatic execution system (``AUTO-X'') in QQQ 
options from 100 contracts to 250 contracts. Under the rules of the 
Phlx, through AUTOM,\5\

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orders are routed from member firms directly to the appropriate 
specialist on the trading floor. Of the public customer market and 
marketable limit orders routed through AUTOM, certain orders are 
eligible for AUTOM's automatic execution feature, AUTO-X. These orders 
are automatically executed at the disseminated quotation price on the 
Exchange and reported back to the originating firm.\6\
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    \5\ AUTOM is the Exchange's electronic order delivery and 
reporting system, which provides for the automatic entry and routing 
of equity option and index option orders to the Exchange trading 
floor. Orders delivered through AUTOM may be executed manually or 
routed to AUTOM's automatic execution feature, AUTO-X, if they are 
eligible for execution on AUTO-X. Equity option and index option 
specialists are required by the Exchange to participate in AUTOM and 
its features and enhancements. Option orders entered by Exchange 
members into AUTOM are routed to the appropriate specialist unit on 
the Exchange trading floor.
    \6\ See Phlx Rule 1080(c).
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    The Exchange represents that AUTO-X affords prompt and efficient 
automatic executions at the disseminated quotation price on the 
Exchange. Therefore, the Exchange believes that increasing automatic 
execution levels for eligible orders in QQQ options from 100 contracts 
to 250 contracts should provide the benefits of automatic execution to 
a larger number of customer orders. Further, the Exchange notes that 
this increase in the automatic execution levels in QQQ options should 
enable the Exchange to remain competitive for order flow with other 
exchanges that trade QQQ options.
    The Exchange notes that there are many safeguards incorporated into 
Exchange rules to ensure the appropriate handling of AUTO-X orders. For 
example, Phlx Rule 1080(f)(iii) states that the specialist is 
responsible for the remainder of an AUTOM order where a partial 
execution has occurred. Phlx Rule 1015 governs execution guarantees and 
requires the trading crowd to ensure that public orders are filled at 
the best market to a minimum of the disseminated size. In addition, 
Phlx Options Floor Procedure Advice F-7 provides that the size of any 
disseminated bid or offer by the Exchange shall be equal to the AUTO-X 
guarantee for the quoted option and shall be firm, except that the 
disseminated size of bids and offers of limit orders on the book shall 
be 10 contracts and shall be firm, regardless of the actual size of the 
orders. Violations of any of these provisions could be referred to the 
Business Conduct Committee for disciplinary action.
    The Wheel is a mechanism that allocates AUTO-X trades among 
specialists and Registered Options Traders (``ROTs'').\7\ An ROT has 
discretion to participate on the Wheel to trade any option class to 
which he is assigned. The Exchange states that an increase in the 
maximum AUTO-X order size in QQQ options would not prevent an ROT from 
declining to participate on the Wheel. The Exchange states that, 
because the Wheel rotates in two-lot to ten-lot increments depending 
upon the size of the order,\8\ no single ROT will be allocated the 
entire 250 contracts.
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    \7\ Unlike ROTs, specialists are required to participate on the 
Wheel. See Phlx Rule 1080(g).
    \8\ See Exchange Options Floor Procedure Advice F-24(e).
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    The Exchange also has procedures that permit a specialist to 
disengage AUTO-X in extraordinary circumstances.\9\ The Exchange 
represents that AUTOM users will be notified of such circumstances.
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    \9\ See Phlx Rule1080(e) and Exchange Options Floor Procedure 
Advice A-13.
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    With respect to financial responsibility issues, the Exchange notes 
that it has a minimum net capital requirement respecting ROTs.\10\ 
Furthermore, an ROT's clearing firm performs risk management functions 
to ensure that the ROT has sufficient financial resources to cover 
positions throughout the day. In this regard, the function includes 
real-time monitoring of positions. The Exchange believes that clearing 
firm procedures address the issue of whether an ROT has the financial 
capability to support the AUTO-X trading of orders in QQQ options as 
large as 250 contracts.
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    \10\ See Phlx Rule 703.
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    The Exchange believes that automatic execution of orders in QQQ 
options for up to 250 contracts should provide customers with quicker 
executions for a larger number of orders by providing automatic rather 
than manual executions, thereby reducing the number of orders subject 
to manual processing. The Exchange also believes that increasing the 
AUTO-X maximum order size in QQQ options should not impose a 
significant burden on operation or capacity of the AUTOM system and 
will give the Exchange better means of competing with other options 
exchanges for order flow.

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange and, in particular, the requirements of Section 6 
of the Act.\11\ Among other provisions, Section 6(b)(5) of the Act 
requires that the rules of an exchange be designed to foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating securities transactions; remove impediments to and perfect 
the mechanism of a free and open market and a national market system; 
and protect investors and the public interest.\12\
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    \11\ The Commission has considered the proposed rule's impact on 
efficiency, competition and capital formation. 15 U.S.C. 78c(f).
    \12\ 15 U.S.C. 78f(b)(5).
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    While increasing the maximum order size limit in QQQ options from 
100 contracts to 250 contracts for automatic execution eligibility by 
itself does not raise concerns under the Act, the Commission believes 
that this increase raises collateral issues that the Phlx will need to 
monitor and address. Increasing the maximum order size for QQQ options 
will make a larger number of QQQ option orders eligible for AUTO-X. 
These orders may benefit from greater speed of execution, but at the 
same time create greater risks for market maker participants. The 
specialists and ROTs signed onto AUTO-X will be exposed to the 
financial risks associated with larger-sized orders in QQQ options 
being routed through the system for automatic execution at the 
displayed price. When the market for the underlying security changes 
rapidly, it may take a few moments for the related option's price to 
reflect that change. In the interim, customers may submit orders that 
try to capture the price differential between the underlying security 
and the option. The larger the orders accepted through AUTO-X, the 
greater the risk the specialists and ROTs must be willing to accept. 
The Commission does not believe that, because the Phlx's Options 
Committee determines to approve orders as large as 250 contracts in QQQ 
options as eligible for AUTO-X, the Options Committee or any other Phlx 
committee or officials should disengage AUTO-X more frequently by, for 
example, declaring an ``extraordinary circumstance.'' \13\ Disengaging 
AUTO-X can negatively affect investors by making it slower and less 
efficient to execute their orders. It is the Commission's view that the 
Phlx, when increasing the maximum size of orders that can be sent 
through AUTO-X, should not disadvantage all customers--the vast 
majority of whom enter orders for less than 250 contracts

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in QQQ options--by making their automatic execution systems less 
reliable.
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    \13\ The Phlx has filed a proposed rule change (File No. SR-
Phlx-2001-27) with the Commission that would specify the procedures 
governing the disengagement of AUTO-X for ``extraordinary 
circumstances,'' define what constitutes ``extraordinary 
circumstances,'' and require the documentation of any action taken 
to disengage AUTO-X. The proposed rule change was filed pursuant to 
the Order Instituting Public Administrative Proceedings Pursuant to 
Section 19(h)(1) of the Securities Exchange Act of 1934, Making 
Findings and Imposing Remedial Sanctions, Securities Exchange Act 
Release No. 43268 (September 11, 2000) (File No. 3-10282) and is 
pending with the Commission.
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IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, with Section 6(b)(5) of the Act.\14\
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    \14\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-Phlx-2001-89), as amended, 
is approved.
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    \15\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-7612 Filed 3-28-02; 8:45 am]
BILLING CODE 8010-01-U