[Federal Register Volume 67, Number 219 (Wednesday, November 13, 2002)]
[Notices]
[Pages 68898-68901]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-28747]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46763; File No. SR-Phlx-2002-04]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change and Amendments No. 1 
Through 7 Thereto and Notice of Filing and Order Granting Accelerated 
Approval to Amendment No. 8 Relating to Electronic Interface With AUTOM 
for Specialists and Registered Options Traders

November 1, 2002.

I. Introduction

    On January 15, 2002, 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 relating to an electronic 
interface with the Exchange's Automated Options Market (``AUTOM'') \3\ 
for specialists and Registered Options Traders (``ROTs'').\4\ On March 
6, 2002, the Exchange filed Amendment No. 1 to the proposed rule 
change.\5\ On March 14, 2002, the Exchange filed Amendment No. 2 to the 
proposed rule change.\6\ On March 26, 2002, the Exchange filed 
Amendment No. 3 to the proposed rule change.\7\ On April 2, 2002, the 
Exchange filed Amendment No. 4 to the proposed rule

[[Page 68899]]

change.\8\ On May 16, 2002, the Exchange filed Amendment No. 5 to the 
proposed rule change.\9\ On June 12, 2002, the Exchange filed Amendment 
No. 6 to the proposed rule change.\10\ On June 19, 2002, the Exchange 
filed Amendment No. 7 to the proposed rule change.\11\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ AUTOM is the Exchange's electronic order delivery and 
reporting system, which provides for the automatic entry and routing 
of equity option and index option orders to the Exchange trading 
floor. Orders delivered through AUTOM may be executed manually, or 
certain orders are eligible for AUTOM's automatic execution feature 
(``AUTO-X''). Equity option and index option specialists are 
required by the Exchange to participate in AUTOM and its features 
and enhancements. Option orders entered by Exchange members into 
AUTOM are routed to the appropriate specialist unit on the Exchange 
trading floor.
    \4\ A ROT is a regular member or a foreign currency options 
participant of the Exchange located on the trading floor who has 
received permission from the Exchange to trade in options for his 
own account. See Phlx rule 1014(b).
    \5\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division of Market 
Regulation (``Division''), Commission, dated March 5, 2002 
(``Amendment No. 1'').
    \6\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, 
dated March 13, 2002 (``Amendment No. 2'').
    \7\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, 
dated March 25, 2002 (``Amendment No. 3'').
    \8\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, 
dated April 1, 2002 (``Amendment No. 4'').
    \9\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, 
dated May 15, 2002 (``Amendment No. 5'').
    \10\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, 
dated June 11, 2002 (``Amendment No. 6'').
    \11\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission, 
dated June 18, 2002 (``Amendment No. 7'').
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    The proposed rule change and Amendments No. 1-7 were published for 
comment in the Federal Register on June 27, 2002.\12\ No comments were 
received on the proposed rule change or Amendments No. 1-7. The 
Exchange filed Amendment No. 8 to the proposed rule change on November 
1, 2002.\13\
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    \12\ See Securities Exchange Act release No. 46095 (June 20, 
2002), 67 FR 43372.
    \13\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Deborah Lassman Flynn, Assistant Director, Division, 
Commission, dated October 31, 2002 (``Amendment No. 8''). In 
Amendment No. 8, the Phlx proposes to eliminate the language 
contained in proposed Phlx rule 1014(g)(i)(B)(5) regarding the use 
of ``best efforts'' in the allocation of orders. The Phlx has 
determined that the proposed language is unnecessary because the 
price-improving ROT's identification information will be input into 
the system at the time the ROT's order is placed on the limit order 
book and, therefore, will be available to the person responsible for 
the allocation of orders at the time that an execution occurs at 
that price.
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II. Description of the Proposal

    The Exchange proposes to amend Phlx rule 1080 to enable a ROT or 
specialist to improve the Phlx bid or offer by enabling ROTs and 
specialists to place limit orders on the electronic limit order book 
\14\ through an electronic interface with AUTOM (``Price Improving ROT/
Specialist'').
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    \14\ The electronic ``limit order book'' is the Exchange's 
automated specialist limit order book, to which all unexecuted limit 
orders routed to the Exchange through AUTOM are displayed on the 
basis of price-time priority. Orders not delivered through AUTOM 
also may be entered onto the limit order book. See Phlx rule 1080, 
commentary.02.
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    Currently, Phlx rule 1080 provides that, generally, only agency 
orders \15\ may be entered into AUTOM and only Exchange options 
specialists may access the limit order book electronically. A Phlx ROT 
(or a floor broker on the ROT's behalf) may only place an order for an 
ROT's account on the limit order book maintained by the specialist by 
requesting the specialist to do so. In addition, Phlx ROTs cannot 
improve the Phlx's displayed bid or offer, except by asking the 
specialist to do so. Specifically, under existing Phlx rules, Phlx ROTs 
are able to improve the Phlx market with respect to a given option 
series only by verbally announcing their trading interest in a loud and 
audible fashion. The specialist is then required by Phlx rules to 
reflect this trading interest in the displayed quote.
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    \15\ The Exchange has defined an agency order as any order 
entered on behalf of a public customer, and does not include any 
order entered for the account of a broker-dealer, or any account in 
which a broker-dealer or an associated person of a broker-dealer has 
any direct or indirect interest. See, e.g., Phlx rule 229.02. See 
also, Securities Exchange Act release No. 40970 (January 25, 1999), 
64 FR 4922 (February 1, 1999) (File No. SR-Phlx-98-44).
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    The proposal would limit the need for specialist involvement by 
providing that on-floor orders for the proprietary account(s) of ROTs, 
up to 1,000 contracts, are eligible for delivery via AUTOM, through the 
use of Exchange approved proprietary systems. To be displayed, on-floor 
orders for the proprietary accounts of ROTs delivered via AUTOM would 
be required to be for a minimum size of, at least, the lesser of: (i) 
The AUTO-X guarantee for the option that is the subject of such an 
order, or (ii) 20 contracts.\16\
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    \16\ This requirement applies only to Phlx ROT and specialist 
orders entered via electronic interface.
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    Proposed paragraph (g) of Phlx rule 1014 provides that a Price-
Improving ROT/Specialist that enters an order through an electronic 
interface with AUTOM that results in an improvement in the then-
prevailing market disseminated by the Exchange (i.e., raises the bid or 
lowers the offer) must announce, loudly and audibly in the crowd, that 
he has improved the displayed market. The proposal also requires that 
an ROT or specialist that posts a bid or offer through electronic 
interface with AUTOM, and subsequently elects to cancel such a bid or 
offer, cancel such bid or offer through the electronic interface.
    In addition, the proposal would allow specialists to improve the 
prevailing market by placing price-improving orders via a similar 
electronic interface with AUTOM as that used by ROTs. The use of a 
specific electronic interface is intended to distinguish the 
specialists' price improving orders under the instant proposed rule 
from their general two-sided quoting obligations, including quotes 
generated by Auto-Quote or specialized quote feed.\17\
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    \17\ A specialist may establish a specialized connection with 
AUTOM, known as a specialized quote feed, which enables the 
specialist to provide quotations based on a proprietary pricing 
model, by-passing the Exchange's Auto-Quote System. See Phlx rule 
1080, Commentary. 01(c).
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    Inbound orders eligible for execution against ROT or specialist 
orders entered into AUTOM via electronic interface would be executed by 
the specialist and allocated, initially, by the individual responsible 
for allocating trades under existing Exchange rules.\18\ No later than 
January 2004, the Exchange will modify the AUTO-X system \19\ and will 
automatically execute incoming orders against ROT and specialist orders 
that improve the disseminated price, as well as orders that match such 
price-improving orders.
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    \18\ Currently, under the Exchange's Option Floor Procedure 
Advice (``OFPA'') F-2, the largest participant in a trade is 
responsible for allocating contracts to crowd participants. In a 
separate rule proposal, the Exchange has proposed amendments to OFPA 
F-2 and rule 1014(g) regarding who is responsible for allocating a 
trade. Under that proposal, if a trade involved a floor broker, the 
floor broker would be responsible for allocating contracts among 
crowd participants but could delegate the responsibility to the 
specialist or an assistant to the specialist under the specialist's 
direct supervision (``Assistant''), provided that the specialist (or 
Assistant) agrees to be responsible for allocating the trades. In 
all other cases where the specialist is a participant, the 
specialist or Assistant would allocate the trade. If neither the 
specialist nor floor broker is involved, but there is more than one 
buyer or seller, the largest participant would be responsible for 
allocating trades. If neither the specialist nor floor broker is 
involved, and there is only one buyer and seller, the seller would 
be responsible for allocating trades. See File no. SR-Phlx-2001-28.
    \19\ The Exchange will deploy the modified system over a 15-
month period. Proposed commentary .04 to Phlx rule 1080.
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Price-Improving, ``Matching,'' and Special Parity Rule

    The other crowd participants (including the specialist) may match a 
price-improving order through an electronic interface with AUTOM, but 
must loudly and audibly announce their intention to do so, as well as 
their size. If Auto-Quote or Specialized Quote Feed matches a price-
improving order, the specialist and crowd participants on that quote 
would be deemed to be matching the price-improving order. In such a 
situation, the ``Special Allocation'' would entitle the Price Improving 
ROT/Specialist to receive the largest number of contracts among all 
crowd participants that have matched a price-improving order, subject 
to size.\20\

[[Page 68900]]

Any partial contracts would be rounded up in favor of the Price 
Improving ROT/Specialist. In no event would a Price Improving ROT/
Specialist or crowd participant that matches a price-improving order be 
required to participate in a trade above that Price Improving ROT/
Specialist's size.
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    \20\ Proposed Phlx rule 1014(g)(i)(B)(1) would entitle a Price 
Improving ROT/Specialist to participate in at least 60% of the 
contracts in the transaction if matched by one single crowd 
participant. If the Price Improving ROT/Specialist's order is 
matched by two or more crowd participants (including the 
specialist), the Price Improving ROT/Specialist would be entitled to 
participate in at least 40% of the contracts in the transaction; a 
matching specialist would be entitled to participate in 30%, and 
other crowd participants on parity with the Price Improving ROT/
Specialist would be entitled to participate in 30% of the contracts 
in the transaction, in the aggregate. If matched by two or more 
crowd participants (but not the specialist), the Price Improving 
ROT/Specialist would be entitled to participate in 40% of the 
contracts in the transaction, and the other crowd participants would 
be entitled to participate in 60% of the transaction, in the 
aggregate.
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    The Special Allocation would remain in effect until: (1) The lesser 
of 20 contracts or the AUTO-X guarantee for the option that is the 
subject of the price-improving quote have been executed against the 
price-improving quotes eligible to receive an allocation; (2) the ROT 
or specialist who improved the price cancels the price-improving order; 
or (3) the original price-improving order is superseded by a new price-
improving order, unless the new price-improving order is cancelled 
before at least one contract executes at the price of the new price-
improving order.\21\ If any of those conditions are satisfied, the 
Special Allocation would no longer be in effect, and crowd members with 
orders that have not been filled would be considered to be on parity. 
If the specialist were one of the crowd members, the specialist would, 
consistent with applicable exchange rules, be entitled to receive the 
specialist guarantee.\22\
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    \21\ See proposed Phlx rule 1014(g)(i)(B)(2). The Exchange 
represents that the purpose of this third condition is to eliminate 
the possibility that a crowd participant could, by placing and then 
immediately canceling a price-improving order, cause a Price 
Improving ROT/Specialist to lose its entitlement under the Special 
Allocation.
    \22\ Pursuant to Phlx rule 1014(g)(ii), the specialist is 
entitled to receive an allocation of up to 40% of an incoming order, 
when the specialist is on parity with the best quote.
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    Finally, the Exchange represents that it has determined to develop 
a proposal for an alternative model for ROT access, which would involve 
giving ROTs the ability to electronically post their own quotations in 
competition with the specialist and to have their own quotation 
generation models, as opposed to having their electronic access be 
limited to sending limit orders on a strike-by-strike basis.\23\
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    \23\ Under this approach, the Exchange would adopt a new trade 
allocation rule similar to that of the International Securities 
Exchange rule 713. Subject to approval under the governance 
requirements set forth in the Exchange's rules and in the Act, the 
Exchange would submit the proposal for Commission approval as the 
permanent solution to compliance with section IV.B.h.(i)(aa) of the 
Settlement Order.
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III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 8, including whether Amendment No. 8 
to the proposed rule change 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 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 such 
filing will also be available for inspection and copying at the 
principal office of the Phlx. All submissions should refer to File No. 
SR-Phlx-2002-04 and should be submitted by December 4, 2002.

IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended by Amendments No. 1 through 8, is consistent with 
the requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\24\ The Commission finds 
that the proposed rule change, which provides a mechanism for members 
of the trading crowd who improve the disseminated market, or match a 
price-improved market, to be directly allocated Auto-X order flow, is 
designed to remove impediments to and perfect the mechanism of a free 
and open market, promote just and equitable principles of trade, and in 
general, to protect investors and the public interest, is consistent 
with section 6(b)(5) of the Act.\25\
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    \24\ In approving the proposed rule change, the Commission notes 
that it has considered its impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \25\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change, once fully 
implemented,\26\ should substantially enhance incentives to quote 
competitively by automating the process by which trading crowd 
participants can improve the disseminated quote and by ensuring that 
the price-improving ROT is rewarded with incoming order flow.\27\ 
Specifically, the Phlx's proposal will allow ROTs to improve the 
disseminated quote by placing limit orders directly on the limit order 
book through an electronic interface with Exchange systems. Moreover, 
the Phlx has represented that it has determined to develop the 
capability to allow ROTs to electronically post their own quotations in 
competition with the specialist.
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    \26\ The Phlx plans to file for Commission approval a plan to 
fully implement the proposed rule change. See letter from Lanny A. 
Schwartz, Executive Vice President and General Counsel, Phlx, to 
Elizabeth King, Associate Director, Commission, dated October 31, 
2002.
    \27\ The Exchange filed this proposed rule change pursuant to 
the requirements of section IV.B.h.(i)(aa) of the Commission's 
September 11, 2000, Order Instituting Administrative Proceedings 
Pursuant to section 19(h)(1) of the Act, which required the Phlx (as 
well as other floor-based options exchanges) to adopt new, or amend 
existing rules to substantially enhance incentives to quote 
competitively and substantially reduce disincentives to act 
competitively (``Settlement Order''). See Securities Exchange Act 
release no. 43268 (September 11, 2000), Administrative Proceeding 
file no. 3-10282.
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    In addition, the Phlx proposal will ensure that price-improving 
ROTs are rewarded with incoming order flow. The Phlx proposal provides 
an incentive to improving the disseminated quote by providing the 
price-improving ROT with an execution of at least 40%, up to 20 
contracts, of an incoming order, regardless of whether other market 
participants, including the specialist, match the price-improving 
order. For these reasons, the Commission believes that the Phlx's 
proposal, once fully implemented, will satisfy section IV.B.h.(i)(aa) 
of the Settlement Order.
    Finally, the Commission finds good cause for approving Amendment 
No. 8 to the proposed rule change prior to the thirtieth day after the 
date of publication in the Federal Register. Amendment No. 8 eliminates 
language requiring a person responsible for the allocation of efforts 
to use best efforts to allocate orders to price-improving ROTs. The 
Exchange represents that this language is unnecessary because Phlx's 
system would identify the source of a price-improving order placed on 
the limit order book. If, for some reason, a specialist experienced any 
difficulty allocating an order to a price-improving ROT, the identity 
of the price-improving ROT could readily be determined by the system. 
Accordingly, there are no novel issues of regulatory concern and the 
Commission finds good cause for approving Amendment No. 8 to the 
proposed rule change on an accelerated basis.

[[Page 68901]]

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the Act 
\28\ that the proposed rule (SR-Phlx-2002-04), as amended by Amendments 
No. 1 through 7, is approved and Amendment No. 8 is approved on an 
accelerated basis.
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    \28\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-28747 Filed 11-12-02; 8:45 am]
BILLING CODE 8010-01X-P