[Federal Register Volume 67, Number 100 (Thursday, May 23, 2002)]
[Notices]
[Pages 36289-36291]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12898]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45927; File No. SR-Phlx-2001-24]


Self-Regulatory Organizations; Order Granting Approval of a 
Proposed Rule Change and Amendment No. 4 and Notice of Filing and Order 
Granting Accelerated Approval of Amendment No. 5 to the Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc. Relating to the Manual 
Handling of Certain AUTOM Orders by Specialists

May 15, 2002.
    On March 2, 2001, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') a proposed rule change, pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 
19b-4 thereunder,\2\ relating to the manual handling of certain 
Exchange Automated Options Market (``AUTOM'') orders by Exchange 
specialists.\3\ The Phlx filed Amendment Nos. 1,\4\ 2,\5\ 3,\6\ and 
4\7\ to the proposed rule change, respectively. The proposed rule 
change, as amended, was published for public comment in the Federal 
Register on February 20, 2002.\8\ The Commission received no comments 
on the proposal. On May 15, 2002, the Phlx filed Amendment No. 5 to the 
proposed rule change.\9\ 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\ The Exchange filed this proposed rule change pursuant to the 
requirements of Section IV.B.h.(i)(bb) of the Commission's September 
11, 2000 Order Instituting Public Administrative Proceedings 
Pursuant to Section 19(h)(1) of the Act, which required the Phlx (as 
well as the other floor-based options exchanges) to adopt new, or 
amend existing rules concerning automatic quotation and execution 
systems which specify the circumstances, if any, 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, 
requires 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 Securities Exchange Act Release 
No. 43268 (September 11, 2000), Administrative Proceeding File No. 
3-10282.
    \4\ 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).
    \5\ 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.
    \6\ 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.
    \7\ 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) Clarifying the calculation of a zero bid by the Exchange's 
Autoquote System; (2) clarifying the Exchange's audit trail and 
other documentation in cases which AUTO-X is disengaged; (3) 
clarifying 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.
    \8\ See Securities Exchange Act Release No. 45436 (February 12, 
2002), 67 FR 7728.
    \9\ See Letter from Richard S. Rudolph, Counsel, Phlx, to Nancy 
J. Sanow, Assistant Director, Division, Commission, dated May 14, 
2002 (``Amendment No. 5''). Amendment No. 5: (1) Deletes references 
in the purpose section of the proposed rule change regarding the 
AUTO-X Disengagement Log, which does not apply to the nine codified 
circumstances under which an incoming order would be manually 
handled by an Exchange specialist; (2) amends proposed rule text to 
provide that any restriction by the Options Committee on the use of 
Auto-X will be clearly communicated to its membership and users of 
the Exchange's Automated Options Market (``AUTOM'') via an 
electronic message and an information circular; and (3) amends the 
proposed rule text to provide that, to the extent one of the nine 
codified circumstances under proposed Phlx Rule 1080(c)(iv) occur, 
the Exchange's AUTO-X system has the ability to identify inbound 
orders that are not eligible for automatic execution.
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I. Description of the Proposal

    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 (``AUTO-X'') will instead be manually handled by the specialist 
in certain circumstances. The Exchange also proposes 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.
    Currently, Phlx Rule 1080 governs the operation of AUTOM and AUTO-
X. AUTO-X is addressed primarily in Phlx Rule 1080(c), which provides 
that only certain order types are eligible for AUTO-X. Phlx Rule 
1080(c) also 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.
    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. In all 
other circumstances, AUTOM orders that are not eligible for AUTO-X 
would be executed manually in accordance with Exchange rules. Phlx Rule 
1080 currently enumerates some of the situations where an order may not 
be automatically executed.
    The Phlx proposes to codify nine additional situations in which an 
otherwise AUTO-X eligible order would not automatically execute. The 
first case is when the Exchange's disseminated market crosses or locks 
the disseminated market of another options exchange. Second, stop, stop 
limit, market on closing, market on opening, and all-or-none orders do 
not automatically execute because these orders consist of 
contingencies, such as price, time, or size that the AUTOM system 
cannot address. Third, pre-market orders received when the AUTOM system 
is not open for trading are not eligible for automatic execution. 
Fourth, when the disseminated market is produced during an opening or 
other rotation, incoming orders will not automatically execute.\10\ 
Fifth, when the specialist posts a bid or offer that is better than the 
specialist's own bid or offer, incoming orders will not automatically 
execute.\11\ Sixth, because certain options are subject to the NBBO 
Feature, as described in Phlx Rule 1080(c)(i), when the NBBO Feature is

[[Page 36290]]

not engaged and the Exchange's bid or offer is not the NBBO, incoming 
AUTOM orders will not automatically execute.\12\ Seventh, when the 
price of a limit order is not in the appropriate minimum trading 
increment pursuant to Phlx Rule 1034, the order will not automatically 
execute. Eighth, an incoming AUTOM sell order would not automatically 
execute if the bid price for a particular option series is zero.\13\ 
Lastly, the Phlx represents that certain options are subject to a pilot 
program which provides that 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.\14\
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    \10\ The Phlx notes that AUTO-X is engaged promptly after an 
option's opening, once there is an established price against which 
an automatic execution can occur.
    \11\ According to the Phlx, the bid or offer could represent a 
customer order or a price-improving bid or offer by a Registered 
Options Trader (``ROT'').
    \12\ The Phlx represents that certain options are subject to the 
NBBO Feature, 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. 
See Phlx Rule 1080(c)(i). According to the Phlx, participation on an 
option-by-option basis in the NBBO Feature is voluntary. 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, to prevent AUTO-X from creating a 
trade-through, such an order would be handled manually.
    \13\ 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.
    \14\ See Securities Exchange Act Release No. 45862 (May 1, 
2002), 67 FR 30990 (May 8, 2002) (SR-Phlx-2002-22).
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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. In addition to 
the nine aforementioned situations in which an order may not 
automatically execute, 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.\15\ The Phlx proposes that any restriction on 
the use of AUTO-X on the Exchange in any option or series approved by 
the Options Committee would be clearly communicated to its membership 
and AUTOM users through an electronic message via AUTOM, and through an 
Exchange information circular. The Phlx also proposes that such 
restriction would not take effect until after such communication has 
been made.
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    \15\ See Phlx Rule 1080(c). The Commission has also approved 
Phlx's proposal to provide in Phlx Rule 1080(c) that the 
effectiveness of restrictions to the use of AUTO-X shall be 
conditioned upon its having been approved by the Commission pursuant 
to Section 19(b) of the Act and the rules and regulations 
thereunder. See Securities Exchange Act Release No. 45928 (May 15, 
2002) (SR-Phlx-2001-27).
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    Because in the nine proposed circumstances that an Exchange 
specialist would manually execute an incoming AUTOM order, the AUTO-X 
system will not be disengaged,\16\ in Amendment No. 5,\17\ the Phlx 
proposes to delete references to the AUTO-X disengagement log, which 
records every situation in which AUTO-X is disengaged. Instead, the 
Exchange's systems would be able to determine that the otherwise AUTO-X 
eligible order cannot automatically execute because of the existence of 
one of the nine aforementioned circumstances. As a result, an Exchange 
specialist would manually execute the order. Further, Amendment No. 5 
clarifies in the proposed rule text that the Options Committee will 
clearly communicate to its membership and AUTOM users through an 
electronic message via AUTOM and an Exchange information circular, any 
restrictions to the use of AUTO-X in any option or series approved by 
the Options Committee. Amendment No. 5 also clarifies in the proposed 
rule text that, to the extent one of the nine codified circumstances 
under proposed Phlx Rule 1080(c)(iv) occurs, the Exchange's systems are 
able to identify inbound orders that were not eligible for automatic 
execution.
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    \16\ Telephone conversation among Richard S. Rudolph, Counsel, 
Phlx, and Deborah Lassman Flynn, Assistant Director, and Lisa Jones, 
Attorney, Division, Commission (May 8, 2002).
    \17\ See note 8, supra.
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II. Discussion

    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.\18\ In particular, the Commission finds that the proposal is 
consistent with Section 6(b)(5) of the Act,\19\ which requires, among 
other things, that the rules of the Exchange be designed to prevent 
fraudulent and manipulative acts and practices and promote just and 
equitable principles of trade.
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    \18\ In approving this proposed rule change, the Commission has 
considered its impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \19\ 15. U.S.C. 78f(b)(5).
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    The Commission finds that the proposal is consistent with the Act 
because, by codifying the situations in which an otherwise eligible 
AUTO-X order is handled manually by the specialist, it enhances the 
transparency of the operation of the Phlx market, to the benefit of all 
market participants, including investors.
    Specifically, the Phlx codifies nine particular instances in which 
Exchange specialists would handle incoming AUTOM orders manually. The 
Exchange disseminates a message to its quotation vendors that indicates 
to a user on a series-by-series basis, whether or not such series is 
AUTO-X eligible. The Phlx rules also provide for the Options Committee 
to restrict for any period the use of AUTO-X on the Exchange in any 
option or series. The Commission notes that any restriction on the use 
of AUTO-X 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. Such restriction would not take effect until after such 
communication has been made. The Commission believes that this 
provision should provide Phlx members and AUTOM users with adequate 
notice of any changes to the availability of AUTO-X in any option or 
series. The Commission also notes that Exchange systems dictate, and 
Exchange specialists do not have discretion over, which otherwise AUTO-
X eligible orders are manually handled. The Commission finds good cause 
for approving Amendment No. 5 of the proposed rule change prior to the 
thirtieth day after notice of the publication in the Federal Register. 
In addition to deleting inapplicable language regarding the AUTO-X 
disengagement log, an internal electronic audit trail system that 
records every situation in which AUTO-X is disengaged, Amendment No. 5 
clarifies the proposed rule text in response to concerns of Commission 
staff. The Commission believes Amendment No. 5 is consistent with 
Section 6(b)(5) of the Act,\20\ and therefore the approval of Amendment 
No. 5 on an accelerated basis is appropriate.
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    \20\ 15. U.S.C. 78f(b)(5).
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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 the proposed 
amendment 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

[[Page 36291]]

with respect to the proposed 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 at the Commission's 
Public Reference Room. Copies of such filing also will 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 June 13, 2002.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\21\ that the proposed rule change (SR-Phlx-2001-24), as amended, 
is approved.
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    \21\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to the delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-12898 Filed 5-22-02; 8:45 am]
BILLING CODE 8010-01-P