[Federal Register Volume 67, Number 217 (Friday, November 8, 2002)]
[Notices]
[Pages 68222-68224]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-28427]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46761; File No. SR-Phlx-2002-49]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc. Relating to PACE 
Guarantee Exemption

November 1, 2002.

I. Introduction

    On September 12, 2002, the Philadelphia Stock Exchange, Inc. 
(``Phlx'' or ``Exchange'') submitted to 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 exempt specialists from the 
requirement to execute certain orders that are traded-through by 
another

[[Page 68223]]

market if those orders are for the exchange-traded funds (``ETFs'') 
tracking the Nasdaq-100 Index (``QQQs''), the Dow Jones Industrial 
Average (``DIAMONDs''), and the Standard & Poor's 500 Index 
(``SPDRs'').\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The Exchange does not currently trade DIAMONDs or SPDRs but 
may determine to do so in the future. The Exchange does trade QQQs.
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    The proposed rule change was published for comment in the Federal 
Register on October 2, 2002.\4\ No comments were received on the 
proposal. This order approves the proposal.
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    \4\ See Securities Exchange Act Release No. 46545 (September 24, 
2002), 67 FR 61944. The proposed rule change is currently in effect 
as a pilot. See Securities Exchange Act Release Nos. 46481 
(September 10, 2002), 67 FR 58669 (September 17, 2002)(notice of 
immediate effectiveness of pilot for the period September 4, 2002 to 
October 4, 2002); 46615 (October 8, 2002), 67 FR 63723 (October 15, 
2002)(notice of immediate effectiveness of extension of pilot to 
November 3, 2002.)
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II. Description of the Proposal

A. Background

    The Phlx is a participant in the Intermarket Trading System 
(``ITS''). The ITS is an order routing network designed to facilitate 
intermarket trading in exchange-listed equity securities among 
participating self-regulatory organizations (``SROs'') based on current 
quotation information emanating from their markets. The terms of the 
linkage are governed by the ITS Plan, a national market system plan 
approved by the Commission pursuant to Section 11A of the Act and Rule 
11Aa3-2 thereunder.\5\
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    \5\ See Securities Exchange Act Release No. 19456 (January 27, 
1983), 48 FR 4938 (February 3, 1983). The SROs participating in ITS 
include the American Stock Exchange LLC (``Amex''), the Boston Stock 
Exchange, Inc. (``BSE''), the Chicago Board Options Exchange, Inc. 
(``CBOE''), the Chicago Stock Exchange, Inc. (``CSE''), the 
Cincinnati Stock Exchange, Inc. (``Cincinnati''), the National 
Association of Securities Dealers, Inc. (``NASD''), the New York 
Stock Exchange, Inc. (``NYSE''), the Pacific Stock Exchange, Inc. 
(``PCX''), and the Phlx (collectively ``Participant Exchanges'').
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    Section 8(d)(i) of the ITS Plan provides that absent reasonable 
justification or excuse, a member of a Participant Exchange should not 
effect trade-throughs.\6\ If, however, a trade-through does occur and a 
complaint is received through ITS from the party whose bid or offer was 
traded through, the party who initiated the trade-through may be 
required to satisfy the bid or offer traded through or take other 
remedial action.\7\ Each Participant Exchange, including the Phlx,\8\ 
has adopted and obtained Commission approval of a ``trade-through 
rule,'' which is substantively the same as that provided in the ITS 
Plan.
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    \6\ A trade-through results when a member purchases (or sells) a 
security at a price that is higher (lower) than the price offered in 
one or more of the other ITS participant's markets. See ITS Plan, 
Section 8(d)(i).
    \7\ See ITS Plan, Exhibit B.
    \8\ See Phlx Rule 2001A.
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    In a recent Order, the Commission recognized that the ITS trade-
through provisions were designed to encourage market participants to 
display their trading interest, and to help achieve best execution for 
customer orders in exchange-listed securities.\9\ The Commission also 
acknowledged, however, that these rules were designed at a time when 
``the order routing and execution facilities of markets were much 
slower, intermarket competition was less keen, and the minimum quote 
increment for exchange-listed securities was \1/8\ of a dollar ($ 
0.125).''\10\ The Commission noted that with the introduction of 
decimal pricing and technology changes that greatly reduced execution 
times, the trade-through provisions of the ITS Plan have limited the 
ability of a Participant to provide an automated execution when a 
better price is displayed by another Participant that does not offer 
automated executions.\11\ In support of this conclusion, the Commission 
explained that certain electronic systems are able to deliver 
executions in a fraction of a second, while ITS participants have, at a 
minimum, thirty seconds to respond to a commitment to trade. Because of 
this, ``an ITS Participant seeking to execute a transaction at a price 
inferior to the price quoted by another ITS Participant must generally 
either (i) attempt to access the other Participant's quote, which could 
delay the customer's transaction by thirty seconds or more, or (ii) 
become potentially liable to the other Participant for the amount by 
which its quote was traded through.''\12\
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    \9\ See Securities Exchange Act Release No. 46428 (August 28, 
2002), 67 FR 56607 (September 4, 2002) at 56607 (``ITS Exemption 
Order'').
    \10\ Id.
    \11\ Id.
    \12\ Id. at 56607-8.
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    In its Order, the Commission stated that the ITS trade-through 
provisions were particularly restrictive in the case of the QQQs, 
DIAMONDs and SPDRs, as these ETFs are highly liquid securities, and 
their value is derived from the values of the underlying shares. The 
Commission noted that immediate execution of these securities might be 
more important than the opportunity to obtain a better price to certain 
investors.\13\ To address this issue, the Commission granted a de 
minimis exemption from the trade-through provisions of the ITS Plan 
with respect to transactions in the QQQs, DIAMONDs and SPDRs that are 
effected at a price no more than three cents away from the best bid and 
offer quoted in the Consolidated Quote System (``CQS''). This 
exemption, which went into effect on September 4, 2002 and will remain 
in effect until June 4, 2003, allows Participants to execute 
transactions, through automatic execution or otherwise, without 
attempting to access the quotes of other Participants when the expected 
price improvement would not be significant.\14\
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    \13\ Id.
    \14\ Id. at 56608.
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B. Applicability to the Phlx

    Phlx Rule 229.10(a)(iii) requires a Phlx specialist to execute 
certain orders that are traded-through by another market center.\15\ 
Although the Exchange Rule imposes this obligation on the specialist, 
the specialist is entitled to satisfaction of those orders pursuant to 
Section 8(d) of the ITS Plan. However, for trade-throughs that are 
enumerated in the ITS Exemption Order and therefore are no longer 
prohibited by the ITS Plan, the specialist does not have recourse to 
seek satisfaction for these orders and is alone responsible for those 
executions. Therefore, the Phlx believes that its provision 
guaranteeing an execution no longer makes sense, and further believes 
that the provision now unduly burdens specialists by requiring a 
specialist to execute orders in situations where the specialist does 
not have access to trading at that price. Thus, the Exchange is 
proposing to amend Phlx Rule 229 Supplementary Material Section 
10(a)(iii) to state that the obligations described therein shall not 
apply to the ETFs that are the subject of the ITS Exemption Order for 
so long as the exemption granted in the order remains in effect.
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    \15\ Specifically, this Rule provides that if 100 or more shares 
print through the limit price on any exchange(s) eligible to compose 
the PACE Quote, which is the best bid/ask quote among the Amex, BSE, 
Cincinnati, CSE, NYSE, PCX, Phlx, and the Intermarket Trading 
System/Computer Assisted Execution System (``ITS/CAES''), after the 
time of entry of any such order into PACE, the specialist shall 
execute all such orders at the limit price without waiting for an 
accumulation of 1000 shares to price at the limit price on the NYSE. 
See also Phlx Rule 229, Supplementary Material Section .10(a)(ii).
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III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange. 
\16\ In particular, the

[[Page 68224]]

Commission finds that the proposed rule is consistent with the 
requirements of Section 6(b)(5) of the Act \17\ because it is designed 
to facilitate transactions in securities; to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system; and, in general, to protect investors and the public interest; 
and is not designed to permit unfair discrimination between customers, 
issuers, brokers or dealers.
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    \16\ In approving this rule proposal, the Commission notes that 
it has also considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78f(b)(5).
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    By adopting the proposed exemption, the Exchange removes the 
specialist's obligation to provide trade-through protection in 
situations where it will not be permitted to seek satisfaction through 
ITS from the primary market. This obligation was one the Phlx assumed 
voluntarily in order to make its market more attractive to sources of 
order flow, not an obligation the Act imposes on a market. The 
Commission believes that the business decision to potentially forego 
order flow by no longer providing print protection is a judgment the 
Act allows the Phlx to make.\18\
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    \18\ The Commission notes that the Phlx's proposed rule change 
will remain in effect only until the expiration of the Commission's 
ITS Exemption Order on June 4, 2003.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\19\ that the proposed rule change (SR-Phlx-2002-49) is approved.
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    \19\ 15 U.S.C. 78f(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 02-28427 Filed 11-7-02; 8:45 am]
BILLING CODE 8010-01-P