[Federal Register Volume 67, Number 170 (Tuesday, September 3, 2002)]
[Notices]
[Pages 56335-56338]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-22342]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46407; File No. SR-Phlx-2002-17]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Nos. 1, 2, and 3 Thereto by the Philadelphia Stock 
Exchange, Inc. Relating to Participation Rights in Trades Involving 
Crossing, Facilitation, and Solicited Orders

August 23, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on March 18, 2002, the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by Phlx. On May 2, 2002, 
July 24, 2002, and August 20, 2002, Phlx submitted Amendment Nos. 1, 2, 
and 3 to the proposed rule change, respectively.\3\ 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 letters from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division of Market 
Regulation (``Division''), Commission, dated May 1, 2002 (Amendment 
No. 1); and to Ira Brandriss, Special Counsel, Division, Commission, 
dated July 23, 2002, and August 19, 2002 (Amendment Nos. 2 and 3). 
The proposal was originally filed to be immediately effective 
pursuant to Section 19(b)(3)(A) of the Act. In Amendment No. 1, Phlx 
changed its status to a proposal filed pursuant to Section 19(b)(2) 
of the Act and requested accelerated effectiveness. The changes made 
by Amendment Nos. 2 and 3 have been incorporated into this notice.
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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 Commentary .02 to Phlx Rule 1064, 
Crossing, Facilitation and Solicited Orders, governing the crossing of 
equity option orders by floor brokers, to give the member firm from 
which an order originates a participation right in trades that are 
proposed to be crossed in certain circumstances. The Exchange further 
proposes to adopt Commentary .03 to Phlx Rule 1064, setting forth a 
general requirement that a member or member organization facilitating a 
customer order pursuant to this rule shall disclose all securities that 
are components of the customer order which is subject to facilitation 
before requesting bids and offers for the execution of all components 
of the order.
    The text of the proposed rule change follows. Additions are 
italicized.
* * * * *

Crossing, Facilitation and Solicited Orders

Rule 1064. (a)-(d) No change.

Commentary:

    .01. No change.
    .02. Firm Participation Guarantees. (i) Notwithstanding the 
provisions of paragraphs (a) and (b) of this Rule, when a Floor Broker 
holds an equity option order of the eligible order size or greater 
(``original order''), the Floor Broker is entitled to cross a certain 
percentage of the original order with other orders that he is holding 
or in the case of a customer order, with a facilitation order of the 
originating firm (i.e., the firm from which the original customer order 
originated).
    (ii) The Options Committee may determine, on an option by option 
basis, the eligible size for an order that may be transacted pursuant 
to this Commentary, however, the eligible order size may not be less 
than 500 contracts. Orders for less than 500 contracts may be crossed 
pursuant to this rule but are not subject to subsection (iii) below 
pertaining to participation guarantees. In accordance with his 
responsibilities for due diligence, a Floor Broker representing an 
order of the eligible order size or greater which he wishes to cross 
shall request bids and offers for such option series and make all 
persons in the trading crowd aware of his request. In determining 
whether an order satisfies the eligible order size requirement, any 
multi-part or spread order must contain one leg alone which is for the 
eligible order size or greater. If the same member organization is the 
originating firm and also the specialist for the particular class of 
options to which the order relates, then the specialist is not entitled 
to any Enhanced Specialist Participation with respect to the particular 
cross transaction.
    (iii)The percentage of the order which a Floor Broker is entitled 
to cross, after all public customer orders that were (1) on the limit 
order book and then (2) represented in the trading crowd at the time 
the market was established have been satisfied, is determined as 
follows: (A) 20% of the remaining contracts in the order if the order 
is traded at the best bid or offer given by the crowd in response to 
the Floor Broker's initial request for a market; or (B) 40% of the 
remaining contracts in the order if the order is traded between the 
best bid or offer given by the crowd in response to the Floor Broker's 
initial request for a market.
    (iv) When crossing an order pursuant to this Commentary, a Floor 
Broker must disclose on its order ticket for any order which is subject 
to crossing, all of the terms of such order, including any contingency 
involving, and all related transactions in, either options or 
underlying or related securities. The Floor Broker must disclose all 
securities that are components of the customer order which is subject 
to crossing before requesting bids and offers for the execution of all 
components of the order.
    (v) Once the trading crowd has provided a quote, it will remain in 
effect until: (A) A reasonable amount of time has passed, or (B) there 
is a significant change in the price of the underlying security, or (C) 
the market given in response to the request has been improved. In the 
case of a dispute, the term ``significant change'' will be interpreted 
on a case-by-case basis by two Floor Officials based upon the extent of 
the recent trading in the option and in the underlying security, and 
any other relevant factors.
    (vi) If a trade pursuant to this Commentary occurs when the 
specialist is on parity with one or more controlled accounts, then the 
Enhanced Specialist Participation which is established pursuant to 
Exchange Rule 1014(g)(ii)-(iv) shall apply only to the number of 
contracts remaining after the following orders have been satisfied: 
those public customer orders which trade ahead of the cross 
transaction, and any portion of an order being crossed against the 
original order being represented by the Floor Broker. The Enhanced 
Specialist Participation may only be 20% of the original order after 
customer orders have been executed for orders crossed pursuant to this 
paragraph unless the Floor Broker has chosen to cross less than its 20% 
entitlement, in which case the Enhanced Specialist Participation will 
be a percentage that combined with the percentage the firm crossed is 
no more than 40% of the original order. If the trade occurs at a price 
other than the specialist's disseminated bid or offer, the specialist 
is entitled to no guaranteed participation.

[[Page 56336]]

    (vii) The members of the trading crowd who established the market 
will have priority over all other orders that were not represented in 
the trading crowd at the time that the market was established (but not 
over customer orders on the book) and will maintain priority over such 
orders except for orders that improve upon the market. A Floor Broker 
who is holding a customer order and either a facilitation or solicited 
order and who makes a request for a market will be deemed to be 
representing both the customer order and either the facilitation order 
or solicited order, so that the customer order and the facilitation 
order or solicited order will also have priority over all other orders 
that were not being represented in the trading crowd at the time the 
market was established.
    (viii) Nothing in this paragraph is intended to prohibit a Floor 
Broker or a specialist from trading more than their percentage 
entitlements if the other members of the trading crowd do not choose to 
trade the remaining portion of the order.
    (ix) A Floor Broker may not cross an order that he is holding with 
an order from a Registered Options Trader that is then in the trading 
crowd.
    (x) Spread, straddle, combination or hedge orders, as defined in 
Exchange Rule 1066, on opposite sides of the market may be crossed, 
provided that the Floor Broker holding such orders proceeds in the 
manner described in paragraphs (a) or (b) of this Rule as appropriate. 
Members may not prevent a spread, straddle, stock-option, or 
combination cross from being completed by giving a competing bid or 
offer for one component of such order. In determining whether an order 
satisfies the eligible order size requirement, any multi-part or spread 
order must contain one leg which, standing alone, is for the eligible 
order size or greater.
    .03 A member or member organization facilitating a customer order 
pursuant to this rule shall disclose all securities that are components 
of the customer order which is subject to facilitation before 
requesting bids and offers for the execution of all components of the 
order.
* * * * *

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 Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change, as 
amended, 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 Exchange has prepared summaries, set 
forth in Sections A, B, and C below, of the most significant aspects of 
such statements.

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 give the member firm 
from which an order originates (``originating firm'') a participation 
right in trades that are proposed to be crossed in certain 
circumstances, similar to existing rules on other options exchanges.\4\
    Exchange Rule 1064 sets forth the procedures by which a floor 
broker holding a customer order (``original order'') may cross it with 
either another customer order \5\ or orders from the same originating 
firm, or a contra side order provided by the originating firm from its 
own proprietary account (``facilitation order'').\6\
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    \4\ See, e.g., Chicago Board Options Exchange, Inc. Rule 
6.74(d), American Stock Exchange LLC Rule 950(d), Commentary .02, 
and Pacific Exchange, Inc. Rule 6.47(b).
    \5\ See Exchange Rule 1064(a).
    \6\ See Exchange Rule 1064(b).
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    Currently, under Exchange Rule 1064(a) and (b), a floor broker 
seeking to cross buy and sell orders for the same options series must 
first bring the transaction to the trading floor and request markets 
from the trading crowd for all components of the order. After providing 
the crowd with the opportunity to make such markets, the floor broker 
must announce that he holds an order subject to crossing or 
facilitation, and then must propose a price at which to cross the 
original order that improves upon the price provided by the crowd. 
However, before the floor broker can effect the cross, the market 
makers in the crowd are given the opportunity to take all or part of 
the transaction at the proposed price.
    Under these rules, if the crowd does not want to participate in the 
trade, the floor broker may proceed with the cross. If the crowd wants 
to participate in part of the order, however, the crowd has priority 
and the floor broker may cross only that amount remaining after the 
crowd has taken its portion. If the crowd wants to participate in the 
entire order, the floor broker will not be able to cross or facilitate 
any part of the order.
    The proposed rule change, adding new Commentary .02 to Exchange 
Rule 1064, would apply to transactions in equity options, and would 
initially apply to customer orders of a minimum size of 500 
contracts.\7\ The Options Committee may determine, on an option by 
option basis, the eligible size for an order that may be transacted 
pursuant to the proposal; however, the eligible order size may not be 
less than 500 contracts.\8\
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    \7\ See Amendment No. 2, clarifying that the proposal would 
include facilitation of all customer orders, not only public 
customer orders.
    \8\ For instance, the Options Committee may determine, in 
administering this proposed rule, to limit its application to orders 
of 1,000 contracts or more; similarly, the Options Committee may 
determine to establish different minimum sizes for different 
options. However, a proposed rule change would be required to permit 
the application of this rule to orders for a size of less than 500 
contracts.
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    The proposed rule change would entitle the floor broker, under 
certain conditions, to cross a specified percentage of the original 
order on behalf of the originating firm, before Registered Options 
Traders (``ROTs'') in the crowd can participate in the transaction. The 
percentage of the floor broker's guarantee would depend upon whether 
the price at which the order is ultimately traded is at the crowd's 
best bid or offer in response to the floor broker's initial request, or 
at an improved price.
    The proposed rule change provides that, where the floor broker 
proposes the cross at a price that improves the crowd's market, and the 
crowd then wants to take part in some or all of the order at the 
improved price, the floor broker would be entitled to cross 40% of the 
contracts before the crowd could participate in the transaction. For 
example, if the market provided by the crowd in response to a floor 
broker's request for a market in a particular option series is 1.00-
1.15, and a crossing transaction for 500 contracts pursuant to the 
proposed rule takes place at the improved price of 1.10 (after public 
customer orders have been satisfied), the floor broker would be 
entitled to cross 200 contracts (40% of 500) at 1.10.
    Under the proposal, and distinguished from current Phlx Rule 1064, 
the floor broker would be granted a right to cross even at a price that 
does not improve upon the best bid or offer provided by the crowd in 
response to his initial request for a market. The proposed rule change 
provides that where the trade takes place at the market provided by the 
crowd (which could include the Exchange's disseminated market 
determined by Auto-Quote,\9\ or specialized quote

[[Page 56337]]

feed \10\ in the event that no crowd participant responds to the floor 
broker's request for a market \11\), all public customer orders on the 
book and those represented in the trading crowd at the time the market 
was established must first be satisfied. Once these public customer 
orders are satisfied, the floor broker would be entitled to cross 20% 
of the contracts remaining in the original order. To continue with the 
above example, if the market provided by the crowd in response to a 
floor broker's request for a particular option series is 1.00-1.15, and 
a crossing transaction for 500 contracts pursuant to the proposed rule 
takes place at 1.00 (after public customer orders have been satisfied), 
the floor broker would be entitled to cross 100 contracts (20% of 500) 
at 1.00.
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    \9\ Auto-Quote is the Exchange's electronic options pricing 
system, which enables specialists to automatically monitor and 
instantly update quotations. See Exchange Rule 1080, Commentary 
.01(a).
    \10\ A specialist may separately employ its own pricing models, 
by establishing a specialized interface with AUTOM known as a 
specialized quote feed, thus by-passing the Exchange's Auto-Quote 
System. See Exchange Rule 1080, Commentary .01(c).
    \11\ The Exchange's disseminated market (whether by Auto-Quote 
or specialized quote feed) is deemed to represent the quotations of 
all Registered Options Traders (``ROTs'') in that option unless an 
ROT has expressly indicated otherwise in a clear and audible manner. 
See id.
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    The proposed rule would provide that, once the trading crowd has 
provided a market, that market will remain in effect until a reasonable 
amount of time has passed, a significant change has occurred in the 
price of the underlying security of the option, or the market is 
improved. In case of a dispute, ``significant change'' would be 
determined on a case-by-case basis by two Floor Officials, based upon 
the extent of recent trading in the option and the underlying security 
and any other relevant factor. The Phlx states that the purpose of this 
provision is to ensure that the trading crowd is given an adequate 
opportunity to participate in the crossing transaction if it is not 
consummated immediately upon the floor broker's receipt of the crowd 
market.
    In the case of a complex order such as a spread or straddle, the 
proposed rule would require that at least one leg of such an order, 
standing alone, would need to meet the eligible size requirement to 
qualify for the provisions of the proposed rule change. Thus, the 
aggregate size of all components of such an order would not be 
sufficient to qualify for the provisions of the proposed rule change 
unless one leg of the order is for the minimum size. The proposed rule 
change would provide that Members who wish to prevent a complex order 
from being crossed under the Commentary must bid or offer for all 
components of the complex order, and may not prevent a spread, 
straddle, stock-option, or combination cross from being completed by 
giving a competing bid or offer for one component of such order. In 
determining whether an order satisfies the eligible order size 
requirement, any multi-part or spread order would be required to 
contain one leg which, standing alone, is for the eligible order size 
or greater.
    The floor broker would be required to disclose on the order ticket 
for any order subject to crossing all terms of the order, including any 
contingency involving, and all related transactions in, either options 
or underlying or related securities. The floor broker would be required 
to disclose all securities that are components of the customer order 
which is subject to crossing before requesting bids and offers for the 
execution of all components of the order.\12\ The Phlx states that the 
purpose of this provision is to eliminate any actual or perceived 
advantage that an originating firm may have over the trading crowd, 
since the originating firm (and its floor broker) would know the actual 
bid or offer price of the customer order it represents prior to 
requesting markets from the crowd under the proposal.
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    \12\ Telephone conversation between Richard S. Rudolph, Director 
and Counsel, Phlx, and Ira Brandriss, Special Counsel, and Frank N. 
Genco, Attorney, Division, Commission, August 22, 2002.
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    If the same member organization of the Exchange is both the 
originating firm and the specialist for the option in which the 
transaction takes place, and the floor broker acting on behalf of the 
originating firm crosses or facilitates under the proposed rule, the 
specialist would not be entitled to the Enhanced Specialist 
Participation with respect to the particular cross transaction.
    However, if the specialist is not the same member organization as 
the originating firm, and the trade takes place at the specialist's 
disseminated bid or offer when the specialist is on parity with one or 
more controlled accounts, the specialist would be entitled to 
participate in a percentage of the contracts remaining after public 
customer orders have been executed and the originating firm's crossing 
rights have been exercised. The percentage that the specialist would 
receive is determined by reference to the Enhanced Specialist 
Participation established pursuant to Phlx Rule 1014(g)(ii)-(iv),\13\ 
subject to limitation.
    If the floor broker crosses the full 20% of the originating firm's 
entitlement, the number of contracts guaranteed to the specialist could 
not exceed 20% of the remainder of the order after the originating firm 
has taken its share. For example, if the crossing order is for 500 
contracts, and the floor broker crosses 100 (20% of 500) on the 
specialist's bid or offer, the specialist would be entitled to receive 
a maximum of 100 contracts (20% of 500).
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    \13\ See Amendment No. 3.
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    If the floor broker does not cross 20%, the specialist may be 
entitled to receive more contracts, but in no case would the specialist 
be guaranteed a percentage that, when combined with the percentage 
crossed by the floor broker, exceeds 40% of the original order (after 
relevant public customer orders have been satisfied). For example, if 
the crossing order is for 500 contracts, and the floor broker crosses 
50 contracts (10% of 500) on the specialist's bid or offer, the 
specialist would be entitled to receive a maximum of 150 contracts (30% 
of 500). In this example, the specialist's participation, when combined 
with the floor broker's participation, does not exceed 40% of the 
order, or 200 contracts (50+150 = 200). Nothing in this proposal, 
however, would prohibit specialists from trading more than their 
percentage entitlements if the other members of the trading crowd do 
not choose to trade with the remainder of the order. If the trade takes 
place at a price other than that of the specialist's disseminated bid 
or offer, the specialist would not be entitled to any guaranteed 
participation.
    A Floor Broker would not be able to cross an order that he is 
holding with an order from a ROT that is then in the trading crowd. The 
Phlx states that this provision is intended to prevent the situation in 
which such ROT would have his/her interest represented by two different 
crowd participants (him/herself and the Floor Broker) at the same 
time.\14\
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    \14\ See Amendment No. 3.
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    The proposed rule change also provides that the members of the 
crowd who establish the market in response to the floor broker's 
initial request would have priority over all other orders that were not 
represented in the crowd at the time that market was established (but 
not over customer orders on the book), except for orders that improve 
upon those quotes. Further, a floor broker holding a customer order and 
either a facilitation order or a solicited order and who makes a 
request for a market would be deemed to be representing both the 
customer order and either the facilitation order or solicited order, so 
that the customer order, and the facilitation or solicited order would 
also have priority over all other orders that

[[Page 56338]]

were not being represented in the trading crowd at the time the market 
was established.\15\
    Proposed Commentary .03 would require a member or member 
organization facilitating a customer order pursuant to Rule 1064 to 
disclose all securities that are components of the customer order which 
is subject to facilitation before requesting bids and offers for the 
execution of all components of the order. The Phlx states that the 
purpose of this business-related provision is to avoid the situation in 
which a facilitating floor broker representing a firm and customer 
order enters a crowd and establishes the firm's own contra-side bid (in 
the case of the customer selling) or offer (in the case of a customer 
buying) before disclosing the customer's bid or offer to the crowd. The 
Phlx states that otherwise the floor broker would establish priority 
before the crowd is made aware of the terms of the customer's order. If 
the customer order is disclosed first, however, the crowd may be more 
likely to bid or offer competitively as contra side to that customer's 
order, thus benefiting the customer.\16\ The Exchange's Options 
Committee determined that informing the trading crowd of the customer 
component of the order first is fairer overall, because the contra-side 
is often merely a facilitation or response to that order.
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    \15\ See Amendment No. 2.
    \16\ See Amendment No. 3. Commentary .03 would apply to the 
entire facilitation cross provision of Phlx Rule 1064, and is 
intended to require, among other things, that the Floor Broker make 
the crowd aware of which side of the crossing transaction (i.e., buy 
or sell) is the customer order. Telephone conversation between 
Richard S. Rudolph, Director and Counsel, Phlx, and Ira Brandriss, 
Special Counsel, and Frank N. Genco, Attorney, Division, Commission, 
August 21, 2002.
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2. Statutory Basis
    The Exchange believes that the proposed rule change, as amended, is 
consistent with Section 6(b) of the Act,\17\ in general, and furthers 
the objectives of Section 6(b)(5) of the Act,\18\ in particular, in 
that it is designed to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanism of a free and open 
market and a national market system, and, in general, to protect the 
investors and the public interest by providing incentives for crowd 
participants to quote competitively, and by making the Exchange more 
competitive by providing incentive to order flow providers to bring 
order flow to the Exchange. The Exchange believes that the proposed 
rule change will result in tighter spreads, and thus benefit customers 
whose orders are subject to the new crossing rule. The Exchange further 
believes that allowing order flow providers a participation guarantee 
should provide incentive for such order flow providers to bring their 
order flow to the Exchange, making the Exchange a more competitive 
marketplace.
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    \17\ 15 U.S.C. 78f(b).
    \18\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change, as 
amended, will impose any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were solicited or received with respect to the 
proposed rule change, as amended.

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

    Within 35 days of the date of 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, as amended; 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, as 
amended, 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 the filing will also be available for 
inspection and copying at the principal offices of the Exchange. All 
submissions should refer to File No. SR-Phlx-2002-17 and should be 
submitted by September 24, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-22342 Filed 8-30-02; 8:45 am]
BILLING CODE 8010-01-P