[Federal Register Volume 67, Number 108 (Wednesday, June 5, 2002)]
[Notices]
[Pages 38687-38689]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-14011]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46001; File No. 4-429]


Joint Industry Plan; Order Granting Approval of Joint Amendments 
Nos. 2 and 3 to the Options Intermarket Linkage Plan Relating to 
Satisfaction of Trade-Throughs, the Procedures for Handling Multiple 
Principal Orders, Restrictions on Withdrawal, and an Implementation 
Timetable

May 30, 2002.
    On November 20, 2001, November 21, 2001, December 10, 2001, 
December 10, 2001, and December 26, 2001, the Philadelphia Stock 
Exchange, Inc. (``Phlx''), International Stock Exchange LLC (``ISE''), 
Chicago Board Options Exchange, Inc. (``CBOE''), Pacific Exchange, Inc. 
(``PCX''), and American Stock Exchange LLC (``AMEX'') (collectively, 
the ``Participants''), respectively, filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission''), pursuant to section 
11A(a)(3) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 
11Aa3-2 thereunder,\2\ an amendment (``Joint Amendment No. 2'') to the 
Options Intermarket Linkage Plan.\3\ In addition, on April 5, 2002, 
April 9, 2002, April 15, 2002, April 15, 2002 and April 16, 2002, CBOE, 
ISE, Phlx, PCX, and Amex, respectively, filed with the Commission an 
additional amendment (``Joint Amendment No. 3'') to the Linkage Plan.
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    \1\ 15 U.S.C. 78k-1(a)(3).
    \2\ 17 CFR 240.11Aa3-2.
    \3\ On July 28, 2000, the Commission approved a national market 
system plan (``Linkage Plan'') for the purpose of creating and 
operating an intermarket options market linkage (``Linkage'') 
proposed by Amex, CBOE, and ISE. See Securities Exchange Act Release 
No. 43086 (July 28, 2000), 65 FR 48023 (August 4, 2000). 
Subsequently, Phlx and PCX joined the Linkage Plan. See Securities 
Exchange Act Release Nos. 43573 (November 16, 2000), 65 FR 70850 
(November 28, 2000) and 43574 (November 16, 2000), 65 FR 70851 
(November 28, 2000). On June 27, 2001, the Commission approved an 
amendment to the Linkage Plan. See Securities Exchange Act Release 
No. 44482 (June 27, 2001), 66 FR 35470 (July 5, 2001).
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    The proposed amendments to the Linkage Plan were published for 
comment in the Federal Register on April 30, 2002.\4\ No comments were 
received on the proposal. This order approves the proposed amendments 
to the Linkage Plan.
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    \4\ See Securities Exchange Act Release No. 45795 (April 22, 
2002), 67 FR 21302 (April 30, 2002).
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I. Description of the Proposed Amendments

A. Proposed Joint Amendment No. 2

    In Proposed Joint Amendment No. 2, the Participants propose changes 
to two provisions of the Linkage Plan to modify: (1) The manner in 
which a Participant displaying the best published quote may be 
compensated when its quote represents a customer order and another 
Participant executes an order for a listed option at a price inferior 
to the best-published quote displayed on that exchange (``intermarket 
trade-through''); and (2) the procedures for monitoring restrictions on 
how often orders for the account of market makers (``Principal 
Orders'') may be sent through the Linkage.
1. Satisfaction of Trade-Throughs
    One of the main goals of the Linkage Plan is to limit the incidence 
of intermarket trade-throughs. As part of achieving this goal, the 
Linkage Plan provides that if a customer order is the best-published 
quote and a trade is executed at a worse price, the exchange 
representing that customer order may request compensation from the 
exchange that executed the trade-through.
    Currently, the Linkage Plan requires that, to be compensated by 
another Participant, a Participant generally must lodge a complaint 
with that Participant within three minutes of the time that the 
transaction report was disseminated. The Linkage Plan requires that the 
complaint specify the number of customer contracts at the disseminated 
quotation that were traded-through. The Participant that traded through 
is then required to respond to the complaint, either by claiming an 
exception to liability \5\ or by taking corrective action. If no 
exception to liability applies, the Participant initiating the trade-
through may either: (1) Send a Satisfaction Order \6\ to the 
Participant that sent the complaint; or (2) adjust the price of the 
trade to a price at which a trade-through would not have occurred.
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    \5\ The exceptions to liability are set forth in Sec. 8(c)(iii) 
of the Linkage Plan.
    \6\ A Satisfaction Order is currently defined in the Linkage 
Plan as an order for the principal account of a member who initiated 
a trade-through, sent through the linkage to satisfy the liability 
arising from that trade-through. section 2(16)(c) of the Linkage 
Plan. In Joint Proposed Amendment No. 2, the Participants propose to 
define a Satisfaction Order as an order sent through the linkage to 
notify a Participant of a trade-through and to seek satisfaction of 
liability arising from that trade-through. See Proposed amendments 
to Sec. 2(16)(c) of the Linkage Plan.
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    The proposed amendment would simplify this procedure by combining 
the complaint and satisfaction process. Specifically, if a Participant 
identifies a trade-through by another exchange, that Participant would 
send a Satisfaction Order to the exchange that traded-through for the 
number of customer

[[Page 38688]]

contracts at the disseminated quotation. The exchange receiving the 
Satisfaction Order can: (1) Fill the order; (2) claim an exemption from 
liability; or (3) take other action currently permitted under the 
Linkage Plan (such as correcting the price of the transaction to a 
price that would not be a trade-through). Due to the uncertainty as to 
whether a Participant will receive an execution of the Satisfaction 
Order, the proposed amendment would permit the Participant that sent 
the Satisfaction Order to reject any execution it receives if the 
customer order(s) underlying the Satisfaction Order had been executed 
or canceled while the Satisfaction Order was pending.\7\
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    \7\ See Proposed amendments to the definitions of ``Satisfaction 
Order'' and ``Reference Price,'' and Sec. 8(c) of the Linkage Plan.
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2. Sending Principal Orders Through the Linkage
    Currently, the Linkage Plan provides that a market maker may send a 
Principal Order for automatic execution to another exchange for up to 
10 contracts. If a market maker of a Participant sends such a Principal 
Order for automatic execution to another Participant, there are limits 
and prohibitions on any market maker from that Participant sending 
additional Principal Orders to the same exchange in the same options 
class. Specifically, subject to certain exceptions, a Participant 
cannot send another Principal Order for automatic execution for 15 
seconds, and for the following 45 seconds it can only send Principal 
Orders larger than the automatic execution size.
    The Participants propose to place the responsibility for monitoring 
compliance with these limitations on the receiving, not the sending, 
Participant. Specifically, proposed amended Section 7(a)(ii)(C) of the 
Linkage Plan states that if a Participant received a second Principal 
Order for automatic execution from a Participant within 15 seconds, it 
could reject such order. Similarly, for the next 45 seconds, the 
receiving Participant could deny automatic execution to any Principal 
Orders it receives from the same Participant. The same exceptions to 
these provisions contained in the current Linkage Plan would continue 
to apply.\8\
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    \8\ If there is a change of price in the receiving Participant's 
disseminated offer (bid) and such price continues to be at the NBBO, 
the receiving Participant may not reject a second order received 
from the same Participant within 15 seconds of the initial order; if 
there is a change of price in the receiving Participant's 
disseminated offer (bid), the receiving Participant may not reject a 
second order received from the same Participant after 15 seconds and 
within one minute of the initial order. See section 7(a)(ii)(C) of 
the Linkage Plan.
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B. Proposed Joint Amendment No. 3

    Proposed Joint Amendment No. 3 would substantively modify the 
Linkage Plan by: (1) Restricting Participants' withdrawal from the 
Linkage Plan; (2) incorporating a timetable for implementing the 
linkage; and (3) requiring each Participant to submit to the Commission 
a project plan for implementation and monthly status reports.\9\
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    \9\ Proposed Joint Amendment No. 3 also would conform two 
Linkage Plan provisions to Joint Amendment No. 2 by replacing 
references to trade-through complaints with references to 
Satisfaction Orders. See proposed Amendments to Sec. 8(c) of the 
Linkage Plan.
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1. Withdrawal from the Linkage Plan
    Currently, a Participant is required to provide only 30 days 
written notice to the other Participants and the facilities manager to 
withdraw from the Linkage Plan. The proposed amendment would delete 
this provision and require, instead, that a Participant wishing to 
withdraw from the Linkage Plan effect an amendment to the Linkage Plan, 
which would be subject to Commission approval. The Participant would be 
required to state how it plans to accomplish, by alternate means, the 
goals of the Linkage Plan regarding limiting trade-throughs of prices 
on other exchanges trading the same options classes. A Participant 
would be permitted to propose such an amendment unilaterally, and 
approval of the other Participants would not be required.\10\
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    \10\ See Proposed section 4(d) of the Linkage Plan.
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2. Implementation Timetable
    The proposed amendment would incorporate into the Linkage Plan a 
specific implementation timetable. The Participants propose to 
implement the linkage in two phases: the first phase would be limited 
to those aspects of the Linkage Plan providing for automatic execution, 
and the second phase would implement all other linkage functionality. 
The proposal would require the Participants to begin full intermarket 
testing of phase 1 no later than December 1, 2002, and testing of phase 
2 no later than March 1, 2003. The Participants would be required to 
implement phase 1 and phase 2 as soon as practical after successful 
testing, and no later than February 1, 2003 and April 30, 2003, 
respectively.\11\
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    \11\ See Proposed section 12(a) of the Linkage Plan.
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3. Project Plan and Monthly Status Reports
    Finally, proposed Joint Amendment No. 3 would require each 
Participant to provide the Commission with a detailed project plan and 
monthly status reports regarding implementation of such project 
plan.\12\
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    \12\ See Proposed section 12(b) of the Linkage Plan.
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II. Discussion

    After careful consideration, the Commission finds that the proposed 
Joint Amendments to the Linkage Plan are consistent with the 
requirements of the Act and the rules and regulations thereunder. 
Specifically, the Commission finds that the proposed Joint Amendments 
are consistent with section 11A of the Act,\13\ and Rule 11Aa3-2 
thereunder,\14\ in that it is appropriate in the public interest, for 
the protection of investors and the maintenance of fair and orderly 
markets, to remove impediments to, and perfect the mechanisms of, a 
national market system.
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    \13\ 15 U.S.C. 78k-1.
    \14\ 17 CFR 240.11Aa3-2.
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    The Commission believes that the proposed streamlined procedures 
for achieving satisfaction of trade-throughs set forth in proposed 
Joint Amendment No. 2 should enable each Participant to more easily 
seek compensation on behalf of customer orders represented in the quote 
in circumstances in which it believes that a trade-through of that 
quote has occurred. In addition, the proposal to place the 
responsibility for monitoring the handling of multiple principal orders 
on the receiving, rather than the sending, Participant should address 
the Participants' technical concerns regarding implementation of this 
provision, without modifying the substance or intent of the provision.
    The Commission further believes that the proposed restrictions on 
withdrawal from the Linkage Plan, proposed in Joint Amendment No. 3, 
will ensure that each of the Participants remains subject to the 
requirements of the Linkage Plan to avoid trading through better prices 
displayed on the other options markets, unless the Participant can 
demonstrate to the Commission's satisfaction that it can accomplish the 
same goal by an alternate means. Because each Participant would be 
required to obtain Commission approval before it could withdraw from 
the Linkage Plan, the Commission is assured of an opportunity to 
carefully consider the full implications of any such proposed 
withdrawal from the Linkage Plan.
    Moreover, the proposed implementation timetable provides

[[Page 38689]]

certainty regarding the dates by which an intermarket linkage in the 
options market will be available. Finally, the submission by the 
exchanges to the Commission of detailed project plans and monthly 
status reports will enhance the Commission's ability to continue 
monitoring the Participants' progress in achieving full implementation 
of the Linkage Plan within the established timetables.
    Accordingly, It is ordered, pursuant to section 11A of the Act,\15\ 
and Rule 11Aa3-2 thereunder,\16\ that the proposed Joint Amendments No. 
2 and 3 to the Options Intermarket Linkage Plan are approved.
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    \15\ 15 U.S.C. 78k-1.
    \16\ [16]: 17 CFR 240.11Aa3-2.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-14011 Filed 6-4-02; 8:45 am]
BILLING CODE 8010-01-P