[Federal Register Volume 67, Number 77 (Monday, April 22, 2002)]
[Notices]
[Pages 19610-19612]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-9780]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45758; File No. SR-Phlx-2001-40]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change and Amendment Nos. 1, 2, 3, and 4 Thereto and Notice of Filing 
and Order Granting Accelerated Approval of Amendment No. 5 Thereto by 
the Philadelphia Stock Exchange, Inc. Establishing a Six-Month Pilot 
Program Relating to Broker-Dealer Access to AUTOM

April 15, 2002.

I. Introduction

    On May 2, 2001, the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``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 amend Exchange Rule 1080, 
Philadelphia Stock Exchange Automated Options Market (``AUTOM'') and 
Automated Execution System (``AUTO-X''), to permit access to AUTOM, the 
Exchange's options order routing, delivery, execution and reporting 
system, to off-floor broker-dealers on a six-month pilot basis. On July 
26, 2001, the Exchange filed Amendment No. 1 \3\ to the proposed rule 
change with the Commission. On November 29, 2001, the Exchange filed 
Amendment No. 2 \4\ to the proposed rule change with the Commission. On 
February 1, 2002, the Exchange filed Amendment No. 3 \5\ to the 
proposed rule change with the Commission. On February 20, 2002, the 
Exchange filed Amendment No. 4 \6\ to the proposed rule change with the 
Commission. The substance of these Amendments was described in the 
notice of this proposed rule change, which was published for comment in 
the Federal Register on March 7, 2002.\7\ No comments were received on 
the proposed rule change. On April 15, 2002, the Exchange filed 
Amendment No. 5 \8\ to the proposed rule change with the Commission. 
This order approves the proposed rule change, as amended, for a pilot 
period of six months through October 15, 2002, and issues notice of 
filing and approves Amendment No. 5 to the proposed rule change on an 
accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4
    \3\ See letter to Nancy J. Sanow, Senior Special Counsel, 
Division of Market Regulation (``Division''), SEC, from Richard s. 
Rudolph, Counsel, Phlx, dated July 25, 2001 (``Amendment No. 1'').
    \4\ See letter to Nancy J. Sanow, Senior Special Counsel, 
Division, SEC, from Richard S. Rudolph, Counsel, Phlx, dated 
November 28, 2001 (``Amendment No. 2'').
    \5\ See letter to Nancy J. Sanow, Senior Special Counsel, 
Division, SEC, from Richard S. Rudolph, Counsel, Phlx, dated January 
31, 2002 (``Amendment No. 3'').
    \6\ See letter to Nancy J. Sanow, Senior Special Counsel, 
Division, SEC, from Richard S. Rudolph, Counsel, Phlx, dated 
February 19, 2002 (``Amendment No. 4'').
    \7\ See Securities Exchange Act Release NO. 45485 (February 27, 
2002), 67 FR 10465.
    \8\ See letter to Nancy J. Sanow, Senior Special Counsel, 
Division, SEC, from Richard S. Rudolph, Counsel, Phlx, dated April 
12, 2002 (``Amendment No. 5''). In Amendment No. 5, the Exchange 
proposes to add clarifying language to the proposed rule text 
providing that off-floor broker-dealer AUTO-X eligible limit orders 
may be eligible for the Exchange's NBBO Step-Up Feature on an issue-
by-issue basis, subject to the approval of the Exchange's Options 
Committee.
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II. Description of the Proposal

    Exchange Rule 1080 governs the operation of AUTOM, the Exchange's 
automated order routing, delivery, execution and reporting system for 
options. This proposed rule change would permit off-floor broker-
dealers,\9\ on a six-month pilot basis and subject to certain 
restrictions, to have electronic access to the specialist's limit order 
book \10\ through AUTOM. The proposed rule change would also allow off-
floor broker-dealer orders to be automatically executed on AUTO-X, the 
automatic execution feature of AUTOM, under certain conditions.
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    \9\ In Amendment No. 3, the Exchange clarified that the proposed 
rule change applies only to off-floor broker-dealer limit orders. 
The Exchange noted that on-floor broker-dealer limit orders (such as 
those entered via electronic interface with AUTOM by registered 
options traders (``ROTs'') and specialists) would be governed by a 
separate proposed rule change that the Exchange has filed with the 
Commission and which is currently pending. See File No. SR-Phlx-
2002-04. Thus, orders from specialists and ROTs would not be 
eligible for AUTOM or AUTO-X under this proposed rule change.
    \10\ The electronic ``limit order book'' is the Exchange's 
automated specialist limit order book, which accepts book eligible 
orders that are automatically routed by AUTOM to the book and 
displays orders real-time in order of price-time priority. Orders 
not delivered through AUTOM may also be entered onto the limit order 
book. See Exchange Rule 1080, Commentary .02.
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    The proposal generally permits certain off-floor broker-dealer 
limit orders for up to 200 contracts, depending on the option, to be 
eligible for AUTOM order delivery on an issue-by-issue basis, subject 
to the approval of the Options Committee. The Exchange's Options 
Committee may increase the eligible order delivery size to an amount 
above 200 contracts on an issue-by-issue basis. Specifically, the 
proposed rule change provides that the following types of off-floor 
broker-dealer limit orders are eligible for AUTOM order delivery: day, 
GTC, simple cancel, simple cancel to reduce size (cancel leaves), 
cancel to change price, and cancel with replacement order.\11\
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    \11\ The Exchange stated that market makers from other markets 
could elect either to submit orders via AUTOM or via the proposed 
Plan for the Purpose of Creating and Operating an Intermarket Option 
Linkage (``Linkage'').
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    Proposed Commentary .05 establishes certain conditions and 
restrictions on the new use of AUTOM. First, the proposed rule states 
that off-floor broker-dealer orders must be represented on the Exchange 
floor by a floor member; such a floor member may be a floor broker or 
the specialist. Second, the proposal provides that off-floor broker-
dealer orders delivered via AUTOM shall be for a minimum size of one 
(1) contract.
    Third, proposed Commentary .05 states that the restrictions and 
prohibitions concerning electronically generated orders set forth in 
Exchange Rule 1080(i) \12\ and off-floor market makers set forth in 
Exchange Rule 1080(j) \13\ apply to orders entered for the account(s) 
of off-floor broker-dealers.
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    \12\ Exchange Rule 1080(i) prohibits members from entering, 
permitting, or facilitating the entry of orders into AUTOM if those 
orders are created and communicated electronically without manual 
input (i.e., order entry by public customers or associated persons 
of members must involve manual input such as entering the terms of 
an order into an order-entry screen or manually selecting a 
displayed order against which an off-setting order should be sent). 
See Securities Exchange Act Release No. 43376 (September 28, 2000), 
65 FR 59488 (October 5, 2000) (approving Exchange Rule 1080(i)) (SR-
Phlx-00-79).
    \13\ Exchange Rule 1080(j) prohibits members from entering, or 
facilitating the entry into AUTOM, as principal or agent, limit 
orders in the same options series from off the floor of the 
Exchange, for the account or accounts of the same or related 
beneficial owners, in such a manner that the off-floor member or the 
beneficial owner(s) effectively is operating as a market maker by 
holding itself out as willing to buy and sell such options contract 
on a regular or continuous basis. See Securities Exchange Act 
Release No. 43939 (February 7, 2001) (approving Exchange Rule 
1080(j)) (SR-Phlx-01-05).
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    Fourth, proposed Commentary .05 provides that off-floor broker-
dealer limit orders entered via AUTOM establishing a bid or offer may 
establish priority, and the specialist and crowd may match such a bid 
or offer and be at parity. Off-floor broker-dealer orders, however, are 
subject to the priority yielding provisions set forth in Exchange Rule 
1014.\14\ Fifth, the

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proposal provides that off-floor broker-dealer limit orders that are 
eligible for execution via AUTO-X entered via AUTOM for the account(s) 
of the same beneficial owner may not be entered in options on the same 
underlying security more frequently than every 15 seconds.\15\
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    \14\ Exchange Rule 1014(g) provides that orders on controlled 
accounts must yield priority to customer orders, but are not 
required to yield priority to other controlled accounts. Thus, under 
proposed Commentary .05(ii), if an off-floor broker-dealer limit 
order entered via AUTOM establishes priority, and a customer order 
is entered into the limit order book at the same price, the off-
floor broker-dealer limit order would be required to yield priority 
to the customer order. Phlx Rule 1014(g)(i) provides that a 
``controlled account'' includes any account controlled by or under 
common control with a broker-dealer. See Securities Exchange Act 
Release No. 45114 (November 28, 2001) 66 FR 63277 (December 5, 
2001).
    \15\ See Exchange Rule 1080(c)(ii). The Exchange has clarified 
that, where a non-member off-floor broker-dealer enters an order 
through a member, the prohibition against entry of orders more 
frequently than 15 seconds (``unbundling prohibition'') applies only 
to the member. Telephone conversation between Richard S. Rudolph, 
Counsel, Phlx, Kelly Riley, Senior Special Counsel, Division, 
Commission, Gordon Fuller, Counsel to the Assistant Director, 
Division, Commission, and Christopher Solgan, Law Clerk, Division, 
Commission, on April 10, 2002. The Commission notes that the 
Exchange may not take punitive action against a non-member off-floor 
broker-dealer in the event that a member violates the unbundling 
prohibition.
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    The proposed rule change requires specialists to accept off-floor 
broker-dealer day or GTC orders, and to allow them to be automatically 
executed via AUTO-X. Additionally, the proposal would allow the AUTO-X 
guarantee for off-floor broker-dealer limit orders to be for a 
different number of contracts, on an issue-by-issue basis, than the 
AUTO-X guarantee for public customer orders, subject to the approval of 
the Options Committee.
    Finally, the Exchange proposes to permit off-floor broker-dealer 
orders that are eligible for AUTO-X to be eligible for the Exchange's 
National Best Bid or Offer (``NBBO'') Step-Up Feature. The Exchange's 
Options Committee would approve options for the NBBO Step-Up Feature 
for off-floor broker-dealer orders on an issue-by-issue basis.\16\
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    \16\ See Amendment No. 5, supra note 8.
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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.\17\ In particular, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\18\ 
which requires, among other things, that the rules of an exchange be 
designed to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market, and 
to protect investors and the public interest.
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    \17\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \18\ 15 U.S.C. 78f(b)(5).
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    The Commission finds that the proposed rule change should allow the 
Exchange to improve the efficiency with which orders for the account(s) 
of off-floor broker-dealers are currently executed. Currently, off-
floor broker-dealer orders only have access to the limit order book 
manually and are not eligible to receive automatic execution in AUTO-X. 
By providing off-floor broker-dealers with access to AUTOM and AUTO-X, 
the Exchange should enhance executions and provide a better audit trail 
for these orders. Specifically, off-floor broker-dealer orders that are 
AUTO-X eligible should receive faster executions. Further, orders 
residing in the limit order book would now be exposed to more contra-
side interest from off-floor broker-dealers in a more timely and 
efficient fashion, which should enhance the execution of booked orders. 
In addition, by providing prompt execution for off-floor broker-dealer 
orders, the proposal may help attract off-floor broker-dealer options 
orders to the Exchange, and thus help to improve the depth and 
liquidity of the Exchange's options market.
    The Commission believes that it is reasonable for the Exchange to 
permit off-floor broker-dealer orders to interact with the electronic 
limit order book and be eligible for execution on AUTO-X, provided the 
relevant Phlx systems have sufficient capacity and retail customers are 
not adversely affected. In this regard, the Exchange has represented 
that its systems are capable of processing the potential increased 
order flow through AUTOM and AUTO-X.\19\ The Commission expects that 
during the six-month pilot period, the Exchange will monitor, AUTOM, 
its electronic limit order book and AUTO-X in light of the addition of 
off-floor broker-dealer orders and will implement any necessary system 
enhancements to accommodate any increase in volume resulting from this 
proposal.
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    \19\ Telephone conversation between Richard S. Rudolph, Counsel, 
Phlx, Kelly Riley, Senior Special Counsel, Division, Commission, 
Gordon Fuller, Counsel to the Assistant Director, Division, 
Commission, and Christopher Solgan, Law Clerk, Division, Commission, 
on April 10, 2002.
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    The Commission notes that the Exchange has specifically clarified 
that off-floor broker-dealer orders are subject to the priority-
yielding provisions of Exchange Rule 1014(g)(1).\20\ The Commission 
believes that this requirement of the proposal should ensure that 
retail customers are not adversely affected, and should promote 
investor protection by retaining customers orders' priority on the 
book.
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    \20\ The Exchange submitted a letter to the Division 
representing that the proposal is consistent with Section 11(a) of 
the Act and Rule 11a2-2(T) under the Act. See letter to Catherine 
McGuire, Chief Counsel, Division, Commission, from Richard S. 
Rudolph, Counsel, Phlx, dated April 15, 2002. In response to the 
Exchange's request, Commission staff has provided interpretive 
guidance to the Exchange under Section 11(a) of the Act, 15 U.S.C. 
78k(a). See letter from Paula R. Jenson, Deputy Chief Counsel, 
Division, Commission, to Richard S. Rudolph, Counsel, Phlx, dated 
April 15, 2002.
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    In addition, the Commission believes that allowing off-floor 
broker-dealer orders to be eligible for automatic execution may enhance 
competition among the options exchanges. Currently, the Pacific 
Exchange, Inc. (``PCX'') permits broker-dealer orders to be executed on 
the PCX's automatic execution system, Auto-Ex.\21\ The Commission 
believes that the enhanced competition could lead to better quotes and 
executions for investors.
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    \21\ See Securities Exchange Act Release No. 45032 (November 6, 
2001), 66 FR 57145 (November 14, 2001).
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    Finally, the Commission finds good cause for accelerating approval 
of Amendment No. 5 to the proposed rule change prior to the thirtieth 
day after publication in the Federal Register. The Commission believes 
that accelerated approval will permit the Exchange to implement, and 
investors to benefit from, the proposed rule change without undue 
delay. Amendment No. 5 provides that off-floor broker-dealer AUTO-X 
eligible limit orders would be eligible for the Exchange's NBBO Step-Up 
Feature of AUTO-X, on an issue-by-issue basis subject to approval by 
the Exchange's Options Committee, provided that the order is for a 
``NBBO Step-Up Option'' as described in Exchange Rule 1080(c)(i), and 
provided that the NBBO does not differ from the Exchange's best bid or 
offer by more than the step-up parameter. The Commission believes that 
Amendment No. 5, which permits the use of the NBBO Step-Up Feature for 
off-floor broker-dealers, should provide better prices for those orders 
that are eligible. For this reason, the Commission finds good cause 
exists, consistent with Sections 6(b)(5) \22\ and 19(b)(2) of the 
Act,\23\ to approve Amendment No. 5 to the proposed rule change on an 
accelerated basis.
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    \22\ 15 U.S.C. 78f(b)(5).
    \23\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 5, including whether Amendment No. 5 
is consistent with the Act. Persons making written submissions should 
file

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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 Amendment that are filed with the Commission, and all 
written communications relating to the Amendment 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 Exchange. All submissions should refer 
to file number SR-Phlx-2001-40 and should be submitted by May 13, 2002.

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-Phlx-2001-40), as amended, 
is approved, on a six-month pilot basis, until October 15, 2002.
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    \24\ 15 U.S.C. 78s(b)(2).

    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. 02-9780 Filed 4-19-02; 8:45 am]
BILLING CODE 8010-01-U