[Federal Register Volume 68, Number 57 (Tuesday, March 25, 2003)]
[Notices]
[Pages 14459-14471]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-6990]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47499; File No. SR-Phlx-2001-39]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Nos. 1, 2, 3, 4, 5, and 6 Thereto by the 
Philadelphia Stock Exchange, Inc. Relating to the Allocation of Trades

March 13, 2003.
    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 12, 2001, 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 11, 2001, 
February 19, 2002, May 22, 2002, November 19, 2002, December 16, 2002, 
and February 25, 2003, Phlx submitted Amendment Nos. 1, 2, 3, 4, 5, and 
6 to the proposed rule change, respectively.\3\ The Commission is 
publishing this

[[Page 14460]]

notice to solicit comments on the proposed rule change, as amended, 
from interested persons.
---------------------------------------------------------------------------

    \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 10, 2001 (Amendment 
No. 1), February 15, 2002 (Amendment No. 2), May 21, 2002 (Amendment 
No. 3), November 18, 2002 (Amendment No. 4), December 12, 2002 
(Amendment No. 5), and February 24, 2003 (Amendment No. 6). The 
proposal, File No. SR-Phlx-2001-39, originally was filed to be 
immediately effective pursuant to section 19(b)(3)(A) of the Act. 15 
U.S.C. 78s(b)(3)(A). In Amendment No. 1, Phlx amended the status of 
the proposed rule change to be filed pursuant to section 19(b)(2) of 
the Act, 15 U.S.C. 78s(b)(2), and requested accelerated 
effectiveness. In Amendment No. 2, Phlx consolidated a companion 
proposal, File No. SR-Phlx-2001-29, with the instant proposal to 
become a single proposed rule change and made several modifications. 
Phlx made additional changes to the rule text in Amendment No. 3 
and, in Amendment No. 4, Phlx amended and restated the proposed rule 
change in its entirety. In Amendment No. 5, Phlx made revisions to 
clarify that all customer orders would be executed prior to the 
participation of the specialist and to delete references to Phlx 
rule 1064. In Amendment No. 6, Phlx made minor corrections to the 
rule text and narrative section of the proposal.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Phlx proposes to amend various provisions of Phlx rule 1014, 
``Obligations And Restrictions Applicable To Specialists And Registered 
Options Traders,'' and to make conforming changes to Options Floor 
Procedure Advice (``Advice'') B-6 relating to the allocation of trades 
on the Exchange's Options Floor.
    The text of the proposed rule change, as amended, follows.\4\ 
Additions are italicized, and deletions are enclosed in brackets.
---------------------------------------------------------------------------

    \4\ The proposed changes are set forth below as they would 
appear in the text of Phlx rule 1014 and in the text of Options 
Floor Procedure Advice B-6.
---------------------------------------------------------------------------

* * * * *

Rule 1014. Obligations and Restrictions Applicable to Specialists and 
Registered Options Traders

    (a)-(f)No change.

(g) Equity Option and Index Option Priority and Parity

    (i) (A) Exchange Rules 119 and 120 direct members in the 
establishment of priority of orders on the floor. In addition, equity 
option and index option orders of controlled accounts are required to 
yield priority to customer orders when competing at the same price, as 
described below.
    For the purpose of paragraph (g) of this Rule, ``Initiating Order'' 
means an incoming contra-side order. ``Remainder of the Order'' means 
the portion of an Initiating Order that remains following the 
allocation of contracts to customers that are on parity, in accordance 
with this Rule 1014(g)(i). The Remainder of the Order shall be 
allocated pursuant to this Rule 1014. [a]An account type is either a 
controlled account or a customer account. A controlled account includes 
any account controlled by or under common control with a broker-dealer. 
[Specialist accounts of PHLX Option Specialists, however, are not 
subject to yielding requirements placed upon controlled accounts by 
this Rule.] Customer accounts are all other accounts.
    Orders of controlled accounts must yield priority to customer 
orders[, except that, PHLX ROTs closing in-person are not required to 
yield priority to orders of customer accounts].
    Orders of controlled accounts are not required to yield priority to 
other controlled account orders[, except that when both an order of a 
PHLX ROT closing in-person and some other order of a controlled account 
are established in the crowd at the same price, and then a customer 
order is established at that price, the order of the controlled account 
must yield to the customer order while the order of the PHLX ROT 
closing in-person does not have to so yield].
    Orders of controlled accounts, other than ROTs and Specialists 
market making in person, must be (1) verbally communicated as for a 
controlled account when placed on the floor and when represented to the 
trading crowd and (2) recorded as for a controlled account by 
appropriately circling the ``yield'' field on the floor ticket of any 
such order.
    Several programs described below provide an Enhanced Specialist 
Participation to specialists, which refers to the portion of an options 
trade available for allocation to the specialist on parity, including a 
30% (which may actually result in a 40% or 60%) Enhanced Specialist 
Participation, New Unit/New Option Enhanced Specialist Participation, 
and New Product Enhanced Specialist Participation.
    The Enhanced Specialist Participation is a percentage of the 
Remainder of the Order to which the specialist is entitled, depending 
upon whether (g)(ii), (iii), or (iv) applies.
    (B) No change.
    (ii) Enhanced Specialist Participation--In equity and index option 
classes, when the registered specialist is on parity with a controlled 
account as defined in subparagraph (i) above, in accordance with 
Exchange Rules 119 and 120 and the number of contracts to be bought or 
sold is greater than five, the specialist is entitled to receive an 
enhanced participation of 30% of the [initiating order] Remainder of 
the Order (``Enhanced Specialist Participation''), except in the 
following circumstances: (1) where there is one controlled account on 
parity, the specialist is entitled to receive[s] 60% of the [initiating 
order] Remainder of the Order; or (2) where there are two controlled 
accounts on parity, in which case, the specialist is entitled to 
receive 40% of the [initiating order] Remainder of the Order. [Further, 
no customer order which is on parity may receive a smaller 
participation than any other crowd participant including the 
specialist.] Enhanced Specialist Participation will be effective for: 
(a) all newly listed issues, (b) all index options and (c) such issues 
selected by the specialist and approved by the Allocation, Evaluation 
and Securities Committee pursuant to section (A) below.
    (A) The Allocation, Evaluation and Securities Committee shall 
divide each equity and index option specialist's registered issues into 
trading volume quartiles based upon the most recent quarterly customer 
contract volume. Each specialist may then select 50% of the issues in 
each quartile to receive Enhanced Specialist Participation, rounded so 
that no more than 50% of the total number of such specialists' 
registered issues are selected. The Allocation, Evaluation and 
Securities Committee shall approve all specialist selections.
    (B) Pursuant to Exchange Rule 509, the Allocation, Evaluation and 
Securities Committee shall reduce the level of Enhanced Specialist 
Participation authorized under this Rule to a parity level of 
participation in accordance with Rules 119 and 120 with respect to any 
options class if the specialist in such class is determined to be 
performing below any minimum standards or not satisfying any conditions 
that the Exchange may establish with respect to any options class 
subject to Enhanced Specialist Participation. The Committee may 
reinstate Enhanced Specialist Participation for a particular options 
class if it determines that the specialist in such class is performing 
at or above all established minimum standards and is satisfying all 
established conditions.
    (C) New specialist units trading new options classes shall be 
entitled to receive an [e]Enhanced [parity split] Specialist 
Participation in accordance with subparagraph (iii) of this Rule. Once 
the specialist unit is no longer eligible to receive an [e]Enhanced 
[parity split] Specialist Participation in accordance with subparagraph 
(iii), the unit is automatically entitled to an Enhanced Specialist 
[p]Participation in accordance with this subparagraph (ii).
    (iii) New Unit/New Option Enhanced Specialist Participation--To 
encourage the establishment of new specialist units to trade equity and 
index option classes that heretofore have never been listed on the 
Exchange (``New Options Classes''), when such units are on parity with 
controlled accounts in such classes, the new specialist units will be 
entitled, for a period of six months following commencement of trading 
in New Option Classes, to the following [e]Enhanced [s]Specialist 
[p]Participation in a any such parity trade: (1) Fifty percent (50%) 
where there is one controlled account on parity and (2) Forty percent 
(40%) where there are two or more controlled accounts on parity[, 
except that no customer order

[[Page 14461]]

which is on parity may receive a smaller participation than any other 
crowd participant including the specialist]. The Allocation, Evaluation 
and Securities Committee may extend such [e]Enhanced [parity split] 
Specialist Participation for each applicable option beyond the initial 
six month period for one additional six month period upon petition by 
the specialist unit and a determination by the Committee that such 
extension is consistent with the promotion of just and equitable 
principles of trade and the public interest. Additionally, the 
Committee after granting such extension may at any time terminate such 
[e]Enhanced [parity split] Specialist Participation for any particular 
options class if the Committee determines that such action is 
consistent with the promotion of just and equitable principles of trade 
and the public interest.
    (A)-(B) No change.
    (C) a new specialist unit may receive the [e]Enhanced [s]Specialist 
[p]Participation in a New Options Class at the time that the New 
Options Class commences trading.
    (D) a new specialist unit will be entitled to receive the 
[e]Enhanced [s]Specialist [p]Participation for any additional New 
Options Classes so long as such options classes commence trading at a 
time when the unit is still entitled to receive the [e]Enhanced 
[s]Specialist [p]Participation on the first New Options Class it 
commenced trading.
    (iv) New Product Enhanced Specialist Participation--When a 
specialist unit develops and trades a new product, such specialist 
[will] is entitled to receive an [e]Enhanced [split] Specialist 
Participation in that option such that when the specialist is on parity 
with three or more controlled accounts in the crowd, the specialist is 
entitled to receive[s] 40% of the contracts and the controlled accounts 
are entitled to receive the remaining 60%; when the specialist is on 
parity with less than three controlled accounts in the crowd, the 
specialist is entitled to receive[s] 60% of the contracts and the 
controlled accounts are entitled to receive the remaining 40%. [In 
either of these situations, if a customer is on parity, the customer 
may not receive a lesser allotment than any other crowd participant, 
including the specialist.] In order for the [enhancement] Enhanced 
Specialist Participation to apply, the specialist must both develop and 
trade a new product. If one specialist unit develops a new product idea 
and another specialist is allocated specialist privileges in the 
product, the specialist unit trading the product would not be entitled 
to [this split] receive an Enhanced Specialist Participation. The 
Options Committee will determine whether a specialist ``developed'' a 
new product.
    (v) Allocation of the Remainder of the Order Among Specialist and 
ROTs on Parity. After the application of Rule 1014(g)(i) to an 
Initiating Order, the Remainder of the Order shall be allocated by the 
Allocating Participant (as defined in Rule 1014(g)(vi)) as follows:
    (A) Entitlement. ROTs and specialists on parity are entitled to 
their Defined Participation (as described below), subject to: (1) any 
Waiver, as described below; and (2) rounding, as described below.
    (B) Size. The term ``stated size'' in relation to a crowd 
participant and in respect of an order shall mean:
    (1) in the case of orders handled manually by the specialist:
    (a) if a crowd participant (including the specialist) has actually 
stated a size (``Actual Size''), such crowd participant's stated size 
shall be his or her Actual Size;
    (b) unless the specialist has an Actual Size, the stated size of 
the specialist shall be the amount (if any) by which the disseminated 
size exceeds the sum of (x) the aggregate size of limit orders included 
in the disseminated size and (y) the aggregate sizes of all ROTs who 
have Actual Sizes;
    (c) the stated size of an ROT who does not have an Actual Size is 
zero.
    (2) in the case of floor brokered orders, each crowd participant's 
stated size shall be his or her Actual Size.
    (C) Defined Participation. Defined Participation is the portion of 
the Remainder of the Order to which a crowd participant is entitled. 
Defined Participation is determined as follows:
    (1) in the case of a specialist entitled to an Enhanced Specialist 
Participation, the Enhanced Specialist Participation, up to the 
specialist's stated size, as set forth in sub-paragraphs (g)(ii), 
(iii), or (iv) of this Rule, as applicable. The specialist may decline 
to receive the Enhanced Specialist Participation, in which case the 
specialist shall be entitled to participate as one crowd participant, 
up to the specialist's stated size.
    (2) except as provided in (1) above, the Defined Participation of 
the specialist and ROTs on parity is determined as follows:
    (a) where all participants have equal stated sizes, their Defined 
Participations shall be equal;
    (b) where participants have unequal stated sizes, the Defined 
Participations shall equal their Base Participations (as defined below) 
plus their Supplemental Participations (as defined below):
    (i) the ``Base Participations'' of all of the participants shall 
equal the stated size of the smallest participant; to the extent that 
there remains any excess to be allocated after all participants have 
been allocated their Base Participations, the smallest participant 
shall have no Supplemental Participation, and the other participants 
shall have ``Supplemental Participations'' as determined under (ii) and 
(iii) below;
    (ii) if the remaining stated sizes (i.e., after taking into account 
Base Participations) of all participants having Supplemental 
Participations is equal, then their Supplemental Participations shall 
be equal; otherwise the initial Supplemental Participations of such 
participants shall equal the remaining stated size of the smallest such 
participant; to the extent that there remains any excess to be 
allocated after all participants have been allocated their initial 
Supplemental Participations, the smallest participant shall have no 
further Supplemental Participation, and the other participants shall 
have further ``Supplemental Participations'' as determined under (iii) 
below; and (iii) if the remaining stated sizes (i.e., after taking into 
account Base Participations and prior Supplemental Participations) of 
all participants having further Supplemental Participations is equal, 
then their further Supplemental Participations shall be equal; 
otherwise the next Supplemental Participations of such participants 
shall equal the remaining stated size of the smallest such participant; 
to the extent that there remains any excess to be allocated after all 
participants have been allocated the next Supplemental Participations, 
the smallest participant shall have no further Supplemental 
Participation, and the other participants shall have successive further 
Supplemental Participations determined in the same manner as provided 
in this clause (iii).
    The process described in clause (iii) shall be followed to 
determine successive further Supplemental Participations until the sum 
of the Defined Participations equals the amount of the Remainder of the 
Order.
    (iv) (a) If the sum of the Base Participations pursuant to sub-
paragraph (i) above exceeds the number of contracts remaining to be 
allocated, such contracts shall be divided equally among crowd 
participants who are entitled to receive Base Participations, subject 
to rounding.
    (b) If the sum of the Supplemental Participations pursuant to sub-
paragraph (ii) above exceeds the

[[Page 14462]]

number of contracts remaining to be allocated, such contracts shall be 
divided equally among crowd participants who are entitled to receive 
Supplemental Participations, subject to rounding.
    (c) If the sum of the further Supplemental Participations pursuant 
to sub-paragraph (iii) above exceeds the number of contracts remaining 
to be allocated, such contracts shall be divided equally among crowd 
participants who are entitled to receive further Supplemental 
Participations, subject to rounding.
    (3) Participation in additional contracts in excess of the 
Exchange's disseminated size among willing crowd participants shall be 
allocated under the applicable provisions of this Rule 1014. 
Notwithstanding the limitation set forth in sub-paragraph (C)(1) that 
limits the specialist's entitlement to his/her stated size, for all 
contracts executed in excess of the disseminated size, the specialist 
shall be entitled to receive the Enhanced Specialist Participation as 
set forth in sub-paragraphs (g)(ii), (iii), or (iv) of this Rule, as 
applicable, but not to exceed the specialist's Actual Size (if the 
specialist has an Actual Size) in such excess contracts.
    (D) Waiver. (1) Any ROT or specialist may, in his or her sole 
discretion, offer to waive, in whole or in part, any part of a trade to 
which they were entitled to be allocated (an ``Offer to Waive'').
    (a) Any Offer to Waive shall be made by stating it in a loud and 
audible voice to the other members of the trading crowd and the 
Allocating Participant.
    (b) If the Allocating Participant has determined that the other 
crowd participant(s) then on parity is willing to take the number of 
contracts that are subject to the Offer to Waive, the Allocating 
Participant may (but shall not be required to), accept such Offer to 
Waive by (i) allocating the Remainder of the Order in accordance with 
this rule 1014(g)(v), taking into account the Offer to Waive; or (ii) 
otherwise indicating, following the execution of the Remainder of the 
Order, that such Offer to Waive will be accepted (in which case, it 
shall be referred to as a ``Waiver''). No Offer to Waive shall be an 
effective Waiver until the Allocating Participant has allocated the 
order or otherwise indicated that it is accepted.
    (c)(i) In the case of an option which is not subject to an Enhanced 
Specialist Participation, as set forth in sub-paragraphs (g)(ii)-(iv) 
of this Rule, if the specialist or an ROT effects a Waiver in the 
manner provided above, the number of contracts to which such specialist 
or ROT is entitled under this Rule 1014(g)(v) shall be reduced by the 
number of contracts waived, and the entitlements of the other 
participants on parity shall be determined by redistributing the waived 
number of contracts to willing participants (including the specialist) 
in accordance with this Rule 1014(g)(v).
    (ii) In the case of an option which is subject to an Enhanced 
Specialist Participation, as set forth in sub-paragraphs (g)(ii)-(iv) 
of this Rule, and one or more ROTs effect Waivers of their entire 
entitlements (``Total Waivers''), the number of ROTs with whom the 
specialist is deemed to be on parity for purposes of determining the 
Enhanced Specialist Participation shall be reduced by the number of 
ROTs effecting Total Waivers and the following additional rules shall 
apply:
    (A) in the event that one or more ROTs on parity with the 
specialist effect a Total Waiver of their respective entitlements such 
that the specialist is on parity with three or more ROTs, the number of 
contracts to be allocated to each crowd participant shall be determined 
as provided in sub-paragraph (c)(i) above, provided that the maximum 
number of contracts to be allocated to the specialist shall be that 
which the specialist would be entitled to receive under Rule 
1014(g)(ii)-(iv), as if the specialist had been on parity with three 
ROTs.
    (B) in the event that one or more ROTs on parity with the 
specialist effect a Total Waiver of their respective entitlements such 
that the specialist is on parity with two ROTs, the number of contracts 
to be allocated to each crowd participant shall be determined as 
provided in sub-paragraph (c)(i) above, provided that the maximum 
number of contracts to be allocated to the specialist shall be that 
which the specialist would be entitled to receive under Rule 
1014(g)(ii)-(iv) as if the specialist had been on parity with two ROTs.
    (C) In the event that one or more ROTs on parity with the 
specialist effect a Total Waiver of their respective entitlements such 
that the specialist is on parity with one ROT, the number of contracts 
to be allocated to each crowd participant shall be determined as 
provided in sub-paragraph (c)(i) above, provided that the maximum 
number of contracts to be allocated to the specialist shall be that 
which the specialist would be entitled to receive under Rule 
1014(g)(ii)-(iv) as if the specialist had been on parity with one ROT. 
In no event shall any non-waiving ROT be required to participate in 
fewer contracts than he/she would have received absent the Waiver(s).
    (iii) Partial Waiver. In the case of an option which is subject to 
an Enhanced Specialist Participation, in the event that one or more 
ROTs effect a Waiver of a portion of their respective entitlements, but 
not a Total Waiver, in the manner provided above (a ``Partial 
Waiver''), the number of contracts to be allocated to each crowd 
participant shall be determined as provided in sub-paragraph (c)(i) 
above, provided that the specialist shall not be entitled to receive a 
number of contracts that is greater than 40% of the Remainder of the 
Order except in the situation referred to in the following sentence, 
unless all remaining crowd participants on parity have waived their 
entitlements or have been satisfied. In the case of the specialist 
being on parity with only one ROT, the specialist shall not be entitled 
to receive a number of contracts that is greater than 60% of the 
Remainder of the Order unless all remaining crowd participants on 
parity have waived their entitlements or have been satisfied.
    In no event shall any non-waiving ROT be required participate in 
fewer contracts than he/she would have received absent the Partial 
Waiver(s).
    (iv) In no event shall two or more crowd participants enter into 
any agreement regarding the number of contracts to be waived by any 
crowd participant (i.e., subject to the provisions of subparagraph 
(D)(1)(b) above, any decision by a crowd participant to waive all or a 
portion of such crowd participant's entitlement must be an individual 
decision, and not the subject of an agreement among crowd 
participants).
    (E) Rounding. In situations where the allocation of contracts 
pursuant to this Rule result in fractional amounts of contracts to be 
allocated to crowd participants, the number of contracts to be 
allocated shall be rounded in a fair and equitable manner.
    (F) Just and Equitable Principles of Trade. (1) It shall be 
considered conduct inconsistent with just and equitable principles of 
trade for a member: (a) to allocate initiating orders other than in 
accordance with this rule 1014; (b) to enter into any agreement with 
another member concerning allocation of trades; or (c) to harass, 
intimidate or coerce any member to enter into any Waiver, or to make or 
refrain from making any complaint or appeal.
    (2) A pattern or practice of waiving all or a portion of a crowd 
participant's entitlement, with the result that such crowd participant 
receives no allocation or a lesser allocation than he or she would 
otherwise have been entitled to, may be considered conduct inconsistent

[[Page 14463]]

with just and equitable principles of trade.
    (G) Notwithstanding the first sentence of Rule 1014(g)(i), neither 
Rule 119(b) and (c) concerning precedence based on the size of bids on 
parity, nor Rule 120 (insofar as it incorporates those provisions by 
reference) shall apply to the allocation of orders covered by this Rule 
1014(g)(v).
* * * * *

B-6 Priority of Options Orders for Equity Options and Index Options by 
Account Type (Equity Option and Index Option Only)

    (i) Exchange Rules 119 and 120 direct members in the establishment 
of priority of orders on the floor. In addition, equity option and 
index option orders of controlled accounts are required to yield 
priority to customer orders when competing at the same price, as 
described below.
    For the purposes of this Advice, ``Initiating Order'' means an 
incoming contra-side order. ``Remainder of the Order'' means the 
portion of an Initiating Order that remains following the allocation of 
contracts to customers that are on parity, in accordance with this Rule 
1014(g)(i). The Remainder of the Order shall be allocated pursuant to 
this Rule 1014. [a]An account type is either a controlled account or a 
customer account. A controlled account includes any account controlled 
by or under common control with a broker-dealer. [Specialist accounts 
of PHLX Option Specialists, however, are not subject to yielding 
requirements placed upon controlled accounts by this Rule.] Customer 
accounts are all other accounts.

Section A

    (i) Orders of controlled accounts must yield priority to customer 
orders[, except that, PHLX ROTs closing in-person are not required to 
yield priority to orders of customer accounts].
    (ii) Orders of controlled accounts are not required to yield 
priority to other controlled account orders[, except that when both an 
order of a PHLX ROT closing in-person and some other order of a 
controlled account are established in the crowd at the same price, and 
then a customer order is established at that price, the order of the 
controlled account must yield to the customer order while the order of 
the PHLX ROT closing in-person does not have to so yield].

Section B

    Orders of controlled accounts, other than ROTs and Specialists 
market making in-person, must be--
    (1) verbally communicated as for a controlled account when placed 
on the floor and when represented to the trading crowd and
    (2) recorded as for a controlled account by appropriately circling 
the ``yield'' field on the floor ticket of any such order.
    In any instance where an order is misrepresented in this fashion 
due to factors which give rise to the concern that it was the result of 
anything other than an inadvertent error, the Exchange may determine to 
bypass the fine schedule below and refer the incident to the Business 
Conduct Committee for possible disciplinary proceedings in accordance 
with those procedures set forth under the Exchange's Disciplinary Rule 
960.

Section C

    Several programs described below provide an Enhanced Specialist 
Participation to specialists, which refers to the portion of an options 
trade available for allocation to the specialist on parity, including a 
30% (which may actually result in a 40% or 60%) Enhanced Specialist 
Participation, New Unit/New Option Enhanced Specialist Participation, 
and New Product Enhanced Specialist Participation.
    The Enhanced Specialist Participation is a percentage of the 
Remainder of the Order to which the specialist is entitled, depending 
upon whether (g)(ii), (iii), or (iv) applies.
    Enhanced Specialist Participation--In equity and index option 
classes, when the registered specialist is on parity with a controlled 
account as defined in subparagraph (i) above, in accordance with 
Exchange Rules 119 and 120 and the number of contracts to be bought or 
sold is greater than five, the specialist is entitled to receive an 
enhanced participation of 30% of the [initiating order] Remainder of 
the Order (``Enhanced Specialist Participation''), except in the 
following circumstances: (1) where there is one controlled account on 
parity, the specialist is entitled to receive[s] 60% of the [initiating 
order] Remainder of the Order; or (2) where there are two controlled 
accounts on parity, in which case, the specialist is entitled to 
receive 40% of the [initiating order] Remainder of the Order. [Further, 
no customer order which is on parity may receive a smaller 
participation than any other crowd participant including the 
specialist.] Enhanced Specialist Participation will be effective for: 
(a) all newly listed issues, (b) all index options and (c) such issues 
selected by the specialist and approved by the Allocation, Evaluation 
and Securities Committee pursuant to section (A) below.

Section D

    New Product Enhanced Specialist Participation `` When a specialist 
unit develops and trades a new product, such specialist [will] is 
entitled to receive an[e]Enhanced [split] Specialist Participation in 
that option such that when the specialist is on parity with three or 
more controlled accounts in the crowd, the specialist is entitled to 
receive[s] 40% of the contracts and the controlled accounts are 
entitled to receive the remaining 60%; when the specialist is on parity 
with less than three controlled accounts in the crowd, the specialist 
is entitled to receive[s] 60% of the contracts and the controlled 
accounts are entitled to receive the remaining 40%. [In either of these 
situations, if a customer is on parity, the customer may not receive a 
lesser allotment than any other crowd participant, including the 
specialist.] In order for the [enhancement] Enhanced Specialist 
Participation to apply, the specialist must both develop and trade a 
new product. If one specialist unit develops a new product idea and 
another specialist is allocated specialist privileges in the product, 
the specialist unit trading the product would not be entitled to [this 
split] receive an Enhanced Specialist Participation. [The Options 
Committee will determine whether a specialist split.] The Options 
Committee will determine whether a specialist ``developed'' a new 
product.

Section E

    Allocation of the Remainder of the Order Among Specialist and ROTs 
on Parity. After the application of this Advice to an Initiating Order, 
the Remainder of the Order shall be allocated by the Allocating 
Participant (as defined in Rule 1014(g)(vi)) as follows:
    (A) Entitlement. ROTs and specialists on parity are entitled to 
their Defined Participation (as described below), subject to: (1) any 
Waiver, as described below; and (2) rounding, as described below.
    (B) Size. The term ``stated size'' in relation to a crowd 
participant and in respect of an order shall mean:
    (1) In the case of orders handled manually by the specialist:
    (a) if a crowd participant (including the specialist) has actually 
stated a size (``Actual Size''), such crowd participant's stated size 
shall be his or her Actual Size;
    (b) unless the specialist has an Actual Size, the stated size of 
the specialist shall be the amount (if any) by which

[[Page 14464]]

the disseminated size exceeds the sum of (x) the aggregate size of 
limit orders included in the disseminated size and (y) the aggregate 
sizes of all ROTs who have Actual Sizes;
    (c) the stated size of an ROT who does not have an Actual Size is 
zero.
    (2) in the case of floor brokered orders, each crowd participant's 
stated size shall be his or her Actual Size.
    (C) Defined Participation. Defined Participation is the portion of 
the Remainder of the Order to which a crowd participant is entitled. 
Defined Participation is determined as follows:
    (1) in the case of a specialist entitled to an Enhanced Specialist 
Participation, the Enhanced Specialist Participation, up to the 
specialist's stated size, as set forth in C and D of this Advice, as 
applicable. The specialist may decline to receive the Enhanced 
Specialist Participation, in which case the specialist shall be 
entitled to participate as one crowd participant, up to the 
specialist's stated size.
    (2) except as provided in (1) above, the Defined Participation of 
the specialist and ROTs on parity is determined as follows:
    (a) where all participants have equal stated sizes, their Defined 
Participations shall be equal;
    (b) where participants have unequal stated sizes, the Defined 
Participations shall equal their Base Participations (as defined below) 
plus their Supplemental Participations (as defined below):
    (i) the ``Base Participations'' of all of the participants shall 
equal the stated size of the smallest participant; to the extent that 
there remains any excess to be allocated after all participants have 
been allocated their Base Participations, the smallest participant 
shall have no Supplemental Participation, and the other participants 
shall have ``Supplemental Participations'' as determined under (ii) and 
(iii) below;
    (ii) if the remaining stated sizes (i.e., after taking into account 
Base Participations) of all participants having Supplemental 
Participations is equal, then their Supplemental Participations shall 
be equal; otherwise the initial Supplemental Participations of such 
participants shall equal the remaining stated size of the smallest such 
participant; to the extent that there remains any excess to be 
allocated after all participants have been allocated their initial 
Supplemental Participations, the smallest participant shall have no 
further Supplemental Participation, and the other participants shall 
have further ``Supplemental Participations'' as determined under (iii) 
below; and (iii) if the remaining stated sizes (i.e., after taking into 
account Base Participations and prior Supplemental Participations) of 
all participants having further Supplemental Participations is equal, 
then their further Supplemental Participations shall be equal; 
otherwise the next Supplemental Participations of such participants 
shall equal the remaining stated size of the smallest such participant; 
to the extent that there remains any excess to be allocated after all 
participants have been allocated the next Supplemental Participations, 
the smallest participant shall have no further Supplemental 
Participation, and the other participants shall have successive further 
Supplemental Participations determined in the same manner as provided 
in this clause (iii). 
    The process described in clause (iii) shall be followed to 
determine successive further Supplemental Participations until the sum 
of the Defined Participations equals the amount of the Remainder of the 
Order.
    (iv) (a) If the sum of the Base Participations pursuant to sub-
paragraph (i) above exceeds the number of contracts remaining to be 
allocated, such contracts shall be divided equally among crowd 
participants who are entitled to receive Base Participations, subject 
to rounding.
    (b) If the sum of the Supplemental Participations pursuant to sub-
paragraph (ii) above exceeds the number of contracts remaining to be 
allocated, such contracts shall be divided equally among crowd 
participants who are entitled to receive Supplemental Participations, 
subject to rounding.
    (c) If the sum of the further Supplemental Participations pursuant 
to sub-paragraph (iii) above exceeds the number of contracts remaining 
to be allocated, such contracts shall be divided equally among crowd 
participants who are entitled to receive further Supplemental 
Participations, subject to rounding.
    (3) Participation in additional contracts in excess of the 
Exchange's disseminated size among willing crowd participants shall be 
allocated under the applicable provisions of this Advice. 
Notwithstanding the limitation set forth in sub-paragraph (C)(1) that 
limits the specialist's entitlement to his/her stated size, for all 
contracts executed in excess of the disseminated size, the specialist 
shall be entitled to receive the Enhanced Specialist Participation as 
set forth in sections C and D of this Advice, as applicable, but not to 
exceed the specialist's Actual Size (if the specialist has an Actual 
Size) in such excess contracts.
    (D) Waiver. (1) Any ROT or specialist may, in his or her sole 
discretion, offer to waive, in whole or in part, any part of a trade to 
which they were entitled to be allocated (an ``Offer to Waive'').
    (a) Any Offer to Waive shall be made by stating it in a loud and 
audible voice to the other members of the trading crowd and the 
Allocating Participant.
    (b) If the Allocating Participant has determined that the other 
crowd participant(s) then on parity is willing to take the number of 
contracts that are subject to the Offer to Waive, the Allocating 
Participant may (but shall not be required to), accept such Offer to 
Waive by (i) allocating the Remainder of the Order in accordance with 
this Advice, taking into account the Offer to Waive; or (ii) otherwise 
indicating, following the execution of the Remainder of the Order, that 
such Offer to Waive will be accepted (in which case, it shall be 
referred to as a ``Waiver''). No Offer to Waive shall be an effective 
Waiver until the Allocating Participant has allocated the order or 
otherwise indicated that it is accepted.
    (c) (i) In the case of an option which is not subject to an 
Enhanced Specialist Participation, as set forth in sections C and D of 
this Advice, if the specialist or an ROT effects a Waiver in the manner 
provided above, the number of contracts to which such specialist or ROT 
is entitled under this Advice shall be reduced by the number of 
contracts waived, and the entitlements of the other participants on 
parity shall be determined by redistributing the waived number of 
contracts to willing participants (including the specialist) in 
accordance with this Advice.
    (ii) In the case of an option which is subject to an Enhanced 
Specialist Participation, as set forth in sections C and D of this 
Advice, and one or more ROTs effect Waivers of their entire 
entitlements (``Total Waivers''), the number of ROTs with whom the 
specialist is deemed to be on parity for purposes of determining the 
Enhanced Specialist Participation shall be reduced by the number of 
ROTs effecting Total Waivers and the following additional rules shall 
apply:
    (A) In the event that one or more ROTs on parity with the 
specialist effect a Total Waiver of their respective entitlements such 
that the specialist is on parity with three or more ROTs, the number of 
contracts to be allocated to each crowd participant shall be determined 
as provided in sub-paragraph (c)(i) above, provided that the maximum 
number of contracts to be allocated to the specialist shall be that 
which the specialist would be entitled to receive under this Advice, as 
if the

[[Page 14465]]

specialist had been on parity with three ROTs.
    (B) In the event that one or more ROTs on parity with the 
specialist effect a Total Waiver of their respective entitlements such 
that the specialist is on parity with two ROTs, the number of contracts 
to be allocated to each crowd participant shall be determined as 
provided in sub-paragraph (c)(i) above, provided that the maximum 
number of contracts to be allocated to the specialist shall be that 
which the specialist would be entitled to receive under this Advice as 
if the specialist had been on parity with two ROTs.
    (C) In the event that one or more ROTs on parity with the 
specialist effect a Total Waiver of their respective entitlements such 
that the specialist is on parity with one ROT, the number of contracts 
to be allocated to each crowd participant shall be determined as 
provided in sub-paragraph (c)(i) above, provided that the maximum 
number of contracts to be allocated to the specialist shall be that 
which the specialist would be entitled to receive under this Advice as 
if the specialist had been on parity with one ROT. In no event shall 
any non-waiving ROT be required to participate in fewer contracts than 
he/she would have received absent the Waiver(s).
    (iii) Partial Waiver. In the case of an option which is subject to 
an Enhanced Specialist Participation, in the event that one or more 
ROTs effect a Waiver of a portion of their respective entitlements, but 
not a Total Waiver, in the manner provided above (a ``Partial 
Waiver''), the number of contracts to be allocated to each crowd 
participant shall be determined as provided in sub-paragraph (c)(i) 
above, provided that the specialist shall not be entitled to receive a 
number of contracts that is greater than 40% of the Remainder of the 
Order except in the situation referred to in the following sentence, 
unless all remaining crowd participants on parity have waived their 
entitlements or have been satisfied. In the case of the specialist 
being on parity with only one ROT, the specialist shall not be entitled 
to receive a number of contracts that is greater than 60% of the 
Remainder of the Order unless all remaining crowd participants on 
parity have waived their entitlements or have been satisfied.
    In no event shall any non-waiving ROT be required participate in 
fewer contracts than he/she would have received absent the Partial 
Waiver(s).
    (iv) In no event shall two or more crowd participants enter into 
any agreement regarding the number of contracts to be waived by any 
crowd participant (i.e., subject to the provisions of sub-paragraph 
(D)(1)(b) above, any decision by a crowd participant to waive all or a 
portion of such crowd participant's entitlement must be an individual 
decision, and not the subject of an agreement among crowd 
participants).
    (E) Rounding. In situations where the allocation of contracts 
pursuant to this Rule result in fractional amounts of contracts to be 
allocated to crowd participants, the number of contracts to be 
allocated shall be rounded in a fair and equitable manner.
    (F) Just and Equitable Principles of Trade. (1) It shall be 
considered conduct inconsistent with just and equitable principles of 
trade for a member: (a) to allocate initiating orders other than in 
accordance with this Advice; (b) to enter into any agreement with 
another member concerning allocation of trades; or (c) to harass, 
intimidate or coerce any member to enter into any Waiver, or to make or 
refrain from making any complaint or appeal.
    (2) A pattern or practice of waiving all or a portion of a crowd 
participant's entitlement, with the result that such crowd participant 
receives no allocation or a lesser allocation than he or she would 
otherwise have been entitled to, may be considered conduct inconsistent 
with just and equitable principles of trade.
    (G) Notwithstanding the first sentence of this Advice, neither Rule 
119(b) and (c) concerning precedence based on the size of bids on 
parity, nor Rule 120 (insofar as it incorporates those provisions by 
reference) shall apply to the allocation of orders covered by this 
Advice.

Fine Schedule (Implemented on a Two-Year Running Calendar Basis) B-6

Section A:
    No fine applicable. Matters subject for review by the Business 
Conduct Committee.
Section B:
    1st Occurrence--$500.00
    2nd Occurrence--$1,000.00
    3rd Occurrence--$2,000.00
    4th Occurrence and thereafter--Sanction is discretionary with 
Business Conduct Committee.
Section C:
    Fine not applicable.
Section D:
    Fine not applicable.
Section E:
    Fine not applicable.
* * * * *

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 codify certain 
practices that have developed respecting the allocation of trades on 
the Exchange's options floor and the Exchange's parity and priority 
rule, Phlx rule 1014, ``Obligations And Restrictions Applicable To 
Specialists And Registered Options Traders.'' The proposed rule change 
also would make certain other changes to Phlx rule 1014 that would 
generally clarify option trade allocation procedures and make them 
easier to apply.\5\
---------------------------------------------------------------------------

    \5\ On September 11, 2000, the Commission issued an order in 
relation to settling In the Matter of Certain Activities of Options 
Exchanges, which requires the Exchange (among other respondent 
options exchanges) to implement certain undertakings. Order 
Instituting Public Administrative Proceedings Pursuant to section 
19(h)(1) of the Securities Exchange Act of 1934, Making Findings and 
Imposing Remedial Sanctions, Securities Exchange Act Release No. 
43268 (September 11, 2000) (``Order''). One such undertaking is to 
adopt new or amend existing rules to include any practice or 
procedure, not currently authorized by rule, whereby market makers 
trading any particular option class determine by agreement the 
spreads or option prices at which they will trade any option, or the 
allocation of orders in that option class. The proposed rule change, 
as amended, is intended to respond to this undertaking.
---------------------------------------------------------------------------

    As a general principle, in an auction market for standardized 
options like Phlx and other national securities exchanges operating a 
floor-based options marketplace, the first participant to quote the 
best price (highest bid or lowest offer) is entitled to priority, which 
refers to the right to participate fully in a contra-side order before 
anyone else. Phlx rules 119 and 120 and rule 1014(g) are the general 
rules concerning establishment of parity and priority in the execution 
of orders

[[Page 14466]]

on the options floor.\6\ In addition to addressing time priority, these 
rules provide that when bids or offers at the same price are made 
simultaneously, or when the order of time in which bids or offers were 
made cannot be determined, all such bids and offers will be on parity. 
Thus, parity means that none of the market participants bidding or 
offering at the best price has rights over the other members at that 
price in terms of trade participation. Although not specifically stated 
in Phlx rules currently, members on parity are generally entitled to 
receive equal shares of the contra-side participation.\7\
---------------------------------------------------------------------------

    \6\ Phlx rule 1067, which states that the highest bid and the 
lowest offer shall have precedence in all cases, does not address 
parity situations, nor does it address size precedence; thus, it is 
consistent with the proposal. Other Exchange rules, including Phlx 
rules 1017 and 1019, as well as Advices A-12 and A-14, deal with 
priority/parity on the opening.
    \7\ The Exchange notes that option orders that are automatically 
executed by the Exchange's AUTO-X system are generally subject to a 
separate allocation system known as the ``Wheel.'' Therefore, the 
Enhanced Specialist Participation programs described in this section 
apply only to non-AUTO-X trades. Non-AUTO-X trades include manually 
executed trades such as orders delivered by the AUTOM System, by the 
Floor Broker Order Entry (``FBOE'') System as well as manually to 
the specialist. See infra note 26 and Securities Exchange Act 
Release No. 41524 (June 14, 1999), 64 FR 33127 (June 21, 1999) (SR-
Phlx-99-11) (adopting the FBOE). See also Securities Exchange Act 
Release No. 45927 (May 15, 2002), 67 FR 36289 (May 23, 2002) (SR-
Phlx-2001-24).
    The Exchange further notes that rules relating to its ``ROT 
Access'' system, in which specialists and Registered Options Traders 
(``ROTs'') may place price improving limit orders and matching 
orders directly onto the limit order book via electronic interface 
with AUTOM, contain Special Allocation rules particular to orders 
executed against such price improving and matching orders. See 
Securities Exchange Act Release No. 46763 (November 1, 2002), 67 FR 
68898 (November 13, 2002) (SR-Phlx-2002-04).
---------------------------------------------------------------------------

    An ``Enhanced Specialist Participation'' is one type of exception 
to the general parity rules, allocating to the specialist a greater 
than equal share of the portion of an order that is divided among the 
specialist and any ``controlled accounts'' that are on parity.\8\ The 
Exchange currently has several Enhanced Specialist Participation 
programs, embodied in Phlx rule 1014(g) and described below. These 
programs establish specified percentages as the Enhanced Specialist 
Participation, depending on the category of option.
---------------------------------------------------------------------------

    \8\ A controlled account is currently defined as ``any account 
controlled by or under common control with a broker-dealer.'' See 
Phlx rule 1014(g)(i). Thus, the definition of controlled account 
includes the account of an ROT. See also Securities Exchange Act 
Release No. 45114 (November 28, 2001), 66 FR 63277 (December 5, 
2001) (SR-Phlx-2001-38) (re-defining ``controlled account''). For 
other examples of exceptions to the general parity principle, see 
Securities Exchange Act Release No. 43100 (July 31, 2000), 65 FR 
48778 (SR-Phlx-00-01) at IV.B.2.
---------------------------------------------------------------------------

    i. Enhanced Specialist Participation Programs. The Enhanced 
Specialist Participation provided under rule 1014(g)(ii) currently 
entitles the specialist to 30% of the portion of the initiating 
order,\9\ divided among the specialist and controlled accounts when 
three or more controlled accounts are on parity with the specialist and 
more than five contracts are to be bought or sold.\10\ This is 
generally known as the ``30% Enhanced Specialist Participation'' or the 
``30% split.'' If two controlled accounts are on parity with the 
specialist, the specialist is entitled to receive 40%, and if only one 
controlled account is on parity with the specialist, the specialist is 
entitled to receive 60%.
---------------------------------------------------------------------------

    \9\ The proposal would specify that the specialist is entitled 
to receive an Enhanced Specialist Participation as a percentage of 
the ``Remainder of the Order.''
    \10\ The 30% enhanced participation when three or more 
controlled accounts are on parity was approved by the Commission on 
April 18, 2000. See Securities Exchange Act Release No. 42700 (April 
18, 2000), 65 FR 24246 (April 25, 2000) (SR-Phlx-99-39). The 
Enhanced Specialist Participation in Phlx rule 1014(g)(ii) was 
originally approved by the Commission as a one-year pilot program 
for equity options. See Securities Exchange Act Release No. 34606 
(August 26, 1994), 59 FR 45741 (September 2, 1994) (SR-Phlx-94-12). 
It was later expanded to include index options. See Securities 
Exchange Act Release No. 35028 (November 30, 1994), 59 FR 63151 
(December 7, 1994) (SR-Phlx-94-57). The pilot rule provided for a 
``two-for-one'' split when the specialist was on parity with any 
number of controlled accounts, allocating to the specialist two 
contracts for every one allocated to a controlled account. The 
program was later revised to provide for the current 40% allocation 
when two controlled accounts are on parity and 60% allocation when 
one is on parity. See Securities Exchange Act Release No. 35429 
(March 1, 1995), 60 FR 12802 (March 8, 1995) (SR-Phlx-94-59). The 
pilot was renewed unaltered on three occasions. See Securities 
Exchange Act Release Nos. 36122 (August 18, 1995), 60 FR 44530 
(August 28, 1995) (SR-Phlx-95-54); 37254 (August 5, 1996), 61 FR 
42080 (August 13, 1996) (SR-Phlx-96-29); and 38924 (August 11, 
1997), 62 FR 44160 (August 19, 1997) (SR-Phlx-97-36). It was 
thereafter extended for another period with certain modifications. 
See Securities Exchange Act Release No. 39401 (December 4, 1997), 62 
FR 65300 (December 11, 1997) (SR-Phlx-97-48). The pilot was approved 
as a permanent program on July 1, 1999. See Securities Exchange Act 
Release No. 41588 (July 1, 1999), 64 FR 37185 (July 9, 1999) (SR-
Phlx-98-56).
---------------------------------------------------------------------------

    Another Enhanced Specialist Participation program on Phlx, 
originally adopted in May 1994 and embodied in current Phlx rule 
1014(g)(iii), is designed to encourage the establishment of new 
specialist units to trade options classes that have never been listed 
on the Exchange. For a period of six months following the commencement 
of trading in such a new options class, the new specialist unit is 
entitled to 50% of an order when one controlled account is on parity 
with the specialist, and 40% when two or more controlled accounts are 
on parity with the specialist.\11\
---------------------------------------------------------------------------

    \11\ See Securities Exchange Act Release No. 34109 (May 25, 
1994), 59 FR 28570 (June 2, 1994) (SR-Phlx-93-29).
---------------------------------------------------------------------------

    On July 1, 1999, still another enhanced participation program, the 
``New Product Enhanced Specialist Participation,'' was adopted.\12\ 
Under Phlx rule 1014(g)(iv), a specialist who develops and trades a new 
product is entitled to receive an Enhanced Specialist Participation of 
40% when three or more controlled accounts are on parity, and 60% if 
fewer than three controlled accounts are on parity. Currently, in 
either of these situations, if a customer is on parity, the customer 
may not receive a smaller participation than any other crowd 
participant, including the specialist.\13\
---------------------------------------------------------------------------

    \12\ See Securities Exchange Act Release No. 41588 (July 1, 
1999), 64 FR 37185 (July 9, 1999) (SR-Phlx-98-56).
    \13\ The instant proposal would afford the customer absolute 
priority over all controlled accounts by requiring controlled 
accounts (that would otherwise have priority or be on parity) to 
yield to customer accounts. See infra Section A.(iii). Telephone 
conversation between Richard S. Rudolph, Director and Counsel, Phlx, 
and Ira L. Brandriss, Division, Commission, on December 30, 2002 
(``Telephone conversation with Phlx'').
---------------------------------------------------------------------------

    The Exchange represents that the purpose of these programs is to 
attract and retain highly capitalized specialist units who can capture 
order flow for the Exchange. Because the specialist unit is currently 
the key party responsible for marketing to attract order flow in 
particular options, the Exchange seeks to provide the appropriate 
encouragement to specialists to plan, invest in, and effect marketing 
strategies. Therefore, the Exchange believes that these programs 
provide specialists with the appropriate incentive to create more depth 
and liquidity. Phlx states that the Commission has regularly 
acknowledged the need for well-capitalized specialist units, burdens 
and costs borne by specialists, and how the Enhanced Specialist 
Participation is intended to compensate specialists for these costs and 
burdens.\14\
---------------------------------------------------------------------------

    \14\ See, e.g., Securities Exchange Act Release No. 41588 (July 
1, 1999), 64 FR 37185 (July 9, 1999) (SR-Phlx-98-56).
---------------------------------------------------------------------------

    (ii) Clarifying Amendments. The Exchange proposes to make 
clarifying amendments to Phlx rule 1014(g) to state what portion of a 
trade a specialist on parity with other crowd participants ``is 
entitled to'' throughout the Enhanced Specialist Participation portions 
of the rule. Most of the provisions in Phlx rule 1014(g)(ii) state the 
Enhanced Specialist Participation in the form of an entitlement, but 
the provisions that erroneously do not are

[[Page 14467]]

proposed to be corrected. Specifically, the Exchange proposes to state 
in Phlx rule 1014(g)(ii) that where there is one controlled account on 
parity, the specialist is entitled \15\ to receive 60% of the Remainder 
of the Order after customer orders that are on parity at the Exchange's 
best bid/offer, in accordance with rule 1014(g)(i).
---------------------------------------------------------------------------

    \15\ The current rule text uses the phrase, ``the specialist is 
entitled to'' when referring to the 30% Enhanced Specialist 
Participation when three or more controlled accounts are on parity, 
and to the 40% Enhanced Specialist Participation when two controlled 
accounts are on parity. The Exchange represents that originally in 
the rule text submitted as File No. SR-Phlx-97-48, the portion of 
the text concerning the case where one controlled account is on 
parity also used the phrase, ``the specialist is entitled to 60%''; 
and in SR-Phlx-98-56, the text of the rule was inadvertently changed 
to ``receives 60%.'' Cf. Securities Exchange Act Release Nos. 39401 
(December 4, 1997), 62 FR 65300 (December 11, 1997) (SR-Phlx-97-48); 
and 41588 (July 1, 1999), 64 FR 37185 (July 9, 1999) (SR-Phlx-98-
56). Telephone conversation with Phlx.
---------------------------------------------------------------------------

    In Phlx rule 1014(g)(ii)(C), which cross-references another 
Enhanced Specialist Participation program (discussed in the next 
sentence), the Exchange proposes to state that new specialist units 
trading new options classes shall be entitled to receive an Enhanced 
Specialist Participation. Lastly, in the New Product Enhanced 
Specialist Participation provisions of Phlx rule 1014(g)(iv), the 
proposal would correct that entire provision to state that when a 
specialist unit develops and trades a new product, such specialist is 
entitled to receive an Enhanced Specialist Participation in that option 
such that, when the specialist is on parity with three or more 
controlled accounts in the crowd, the specialist is entitled to receive 
40% of the contracts and the controlled accounts are entitled to 
receive the remaining 60%; when the specialist is on parity with less 
than three controlled accounts in the crowd, the specialist is entitled 
to receive 60% of the contracts and the controlled accounts are 
entitled to receive the remaining 40%.\16\ The Exchange represents that 
all of these provisions were originally intended to be written in the 
permissive form, as evidenced by other types of Enhanced Specialist 
Participation programs.\17\ Thus, Phlx states, the ``entitlement'' is 
not mandatory.
---------------------------------------------------------------------------

    \16\ See Securities Exchange Act Release No. 41588 (July 1, 
1999), 64 FR 37185 (July 9, 1999) (SR-Phlx-98-56).
    \17\ The Exchange states that even Enhanced Specialist 
Participation programs proposed after the new product enhanced 
specialist participation used the language ``is entitled to.'' See 
Securities Exchange Act Release No. 43100 (July 31, 2000), 65 FR 
48778 (August 9, 2000) (SR-Phlx-2001-01) at Exhibit A, proposing to 
adopt a 50% Enhanced Specialist Participation and an 80% Enhanced 
Specialist Participation).
---------------------------------------------------------------------------

    Second, the Exchange proposes to add a reference to the Enhanced 
Specialist Participation programs and an explanation of how the 
Enhanced Specialist Participation is calculated. Specifically, the 
Exchange proposes to expressly state in Phlx rule 1014(g)(i) that 
several programs provide an Enhanced Specialist Participation to 
specialists. These programs include a 30% (or, in certain situations, 
40% or 60%) Enhanced Specialist Participation, New Unit/New Option 
Enhanced Specialist Participation,\18\ and New Product Enhanced 
Specialist Participation.\19\ The purpose of expressly listing these 
programs in Phlx rule 1014(g)(i) is to provide an introduction for ease 
of reference.
---------------------------------------------------------------------------

    \18\ See Securities Exchange Act Release No. 34109 (May 25, 
1994), 59 FR 28570 (June 2, 1994) (SR-Phlx-93-29).
    \19\ Enhanced specialist participation programs, which determine 
the portion of an options trade available for allocation to the 
specialist on parity with controlled accounts, including the 
mechanical operation of all existing enhanced specialist programs, 
are described more fully in Securities Exchange Act Release No. 
43100 (July 31, 2000), 65 FR 48778 (August 9, 2000) (SR-Phlx-00-01). 
In that proposal, Phlx attempted to codify a similar introductory 
provision, but that proposed rule change was withdrawn.
---------------------------------------------------------------------------

    The Exchange also proposes to better define how the Enhanced 
Specialist Participation would be calculated by stating that the 
Enhanced Specialist Participation is a percentage of the Remainder of 
the Order to which the specialist is entitled, depending upon whether 
Phlx rule 1014 (g)(ii), (iii), or (iv) applies. ``Remainder of the 
Order'' is proposed to be defined in order to be clear as to which 
portion of an ``Initiating Order'' (which is also proposed to be 
defined) the proposed trade allocation rules would apply.
    (iii) Customer Priority. Under the current structure of Phlx rule 
1014(g), in applying the Enhanced Specialist Participation, when an 
incoming order arrives on the floor and only the specialist and 
controlled accounts are on parity, the specialist is entitled to the 
specified percentage of the order before the controlled accounts divide 
the rest. However, when a customer order also is being represented in 
the crowd at the same bid or offer as the specialist and controlled 
accounts, other rules currently must be taken into account. 
Specifically, Phlx rule 1014(g)(i) currently provides that orders of 
controlled accounts must yield priority to customer orders, but that 
specialists and ROTs closing in person are currently not required to 
yield priority to customer orders. Thus, currently, a specialist and a 
ROT closing in person are not required to yield to a customer order 
represented in the trading crowd while other controlled accounts are. 
Nonetheless, pursuant to the Enhanced Specialist Participation 
provisions, currently a customer may not receive a smaller 
participation than any trading crowd participant, including an ROT 
closing in person.\20\
---------------------------------------------------------------------------

    \20\ See Phlx rule 1014(g)(ii).
---------------------------------------------------------------------------

    The Exchange is proposing to delete the clause in Phlx rule 
1014(g)(i) that allows specialists and ROTs closing in-person to be on 
parity with customer orders, and to make conforming changes to Phlx 
rules 1014(g)(ii), (iii), and (iv). The instant proposal would thus 
require the accounts of specialists and ROTs closing in-person to yield 
priority to all customer accounts. The purpose of this provision is to 
make the Exchange more attractive to customer orders.\21\
---------------------------------------------------------------------------

    \21\ See Amendment No. 5.
---------------------------------------------------------------------------

    (iv) Proposed New Rule 1014(g)(v). At this time, Phlx proposes to 
adopt new paragraph (g)(v) to Phlx rule 1014 to codify and detail how 
trade allocation functions for non-AUTO-X orders \22\ subject to 
allocation under Phlx rule 1014(g).\23\
---------------------------------------------------------------------------

    \22\ For a discussion of situations in which incoming orders 
would not be eligible for automatic execution via AUTO-X, see 
Securities Exchange Act Release No. 45927 (May 15, 2002), 67 FR 
36289 (May 23, 2002) (SR-Phlx-2001-24).
    \23\ See supra note 7.
---------------------------------------------------------------------------

    In order to explain how options trade allocation functions, it is 
necessary first to define and discuss the concepts of ``stated size'' 
and ``Defined Participation.''
    a. Stated Size. Currently, in situations in which the specialist 
handles AUTOM-delivered \24\ orders manually, the individual crowd 
participants do not in all cases quote a specific size prior to the 
execution of such an order, but rather the entire crowd is responsible 
for the disseminated price up to the disseminated size. The proposed 
rule change would, with one exception \25\ require, on a trade-by-trade

[[Page 14468]]

basis, each crowd participant to state a size for which they are firm 
at any time prior to an execution.
---------------------------------------------------------------------------

    \24\ 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.
    \25\ Proposed Phlx rule 1014(g)(v)(C)(3) would entitle the 
specialist to receive the Enhanced Specialist Participation for 
contracts executed in excess of the Exchange's disseminated size if 
the specialist does not state a size regarding such excess 
contracts. If the specialist states a size prior to the execution of 
such excess contracts, the specialist's entitlement would be limited 
by that size. See subparagraph b. below.
---------------------------------------------------------------------------

    In the context of this proposed rule change, ``stated size'' means, 
in the case of orders handled manually by the specialist (for example, 
in the case of an order that is delivered via AUTOM but is not eligible 
for execution via AUTO-X \26\) if a crowd participant (including the 
specialist) has actually stated a size (``Actual Size''), such crowd 
participant's stated size shall be his or her Actual Size.
---------------------------------------------------------------------------

    \26\ Phlx represents that other examples of orders handled 
manually by the specialist include orders delivered by the Floor 
Broker Order Entry system and orders placed manually on the limit 
order book.
---------------------------------------------------------------------------

    Unless the specialist has an Actual Size, the stated size of the 
specialist shall be the amount (if any) by which the disseminated size 
\27\ exceeds the sum of (x) the aggregate size of limit orders included 
in the disseminated size and (y) the aggregate sizes of the quotations 
at the disseminated price of all ROTs who have Actual Sizes.
---------------------------------------------------------------------------

    \27\ Currently, Phlx rule 1082(a)(ii) defines ``disseminated 
size'' as, respecting options subject to new technology (the ``new 
Auto-Quote'') and options subject to a proprietary quoting system 
provided for in Phlx rule 1080.02 (``Specialized Quote Feed''), at 
least the sum of limit orders at the Exchange's disseminated price. 
The specialist and crowd may determine to disseminate a size greater 
than the sum of limit orders. For instance, the disseminated size 
may include additional size disseminated by the specialist, one or 
more ROTs, or the total crowd size.
---------------------------------------------------------------------------

    The proposal further would provide that the stated size of an ROT 
who does not have an Actual Size is zero. Therefore, in the case of an 
order handled manually by the specialist and that is subject to 
allocation under Phlx rule 1014(g), if an ROT does not actually state 
the size for which he or she is firm at the disseminated price, such 
ROT would not be entitled to receive any contracts in such an order.
    The proposed rule would also provide that, in the case of floor-
brokered orders, each crowd participant's stated size shall be his or 
her Actual Size. Thus, when a floor broker enters a crowd and asks for 
a market, the specialist and ROTs would be required to state, along 
with the price for which they are firm, an Actual Size for which they 
are firm in order to be entitled to be allocated contracts resulting 
from the execution of the order. Again, in the case of orders 
represented in the crowd by a floor broker, if a crowd participant does 
not have an Actual Size, such crowd participant would not be entitled 
to receive any contracts.
    Once the stated size of the specialist and ROTs has been 
established under proposed Phlx rule 1014(g)(v)(B), the allocation of 
contracts would take place in accordance proposed sub-paragraph 
(g)(v)(C), ``Defined Participation.''
    b. Defined Participation. Under the proposal, ``Defined 
Participation'' would mean the portion of the Remainder of the Order to 
which a crowd participant is entitled.
    In the case of a specialist entitled to an Enhanced Specialist 
Participation, the Defined Participation would mean the Enhanced 
Specialist Participation, up to the specialist's stated size. This 
means that if the specialist's stated size is for a number of contracts 
that is less than the size of the Enhanced Specialist Participation, 
the specialist would be entitled to receive a number of contracts that 
is limited to the specialist's stated size, and not the full Enhanced 
Specialist Participation unless the situation described in Phlx rule 
1014(g)(v)(C)(3) applies.\28\
---------------------------------------------------------------------------

    \28\ See discussion, infra page 16.
---------------------------------------------------------------------------

    The Defined Participation for other crowd participants on parity 
would mean, where all participants have equal stated sizes, an equal 
share of the Remainder of the Order to be allocated after the 
specialist receives the Enhanced Specialist Participation, if 
applicable. Where participants have unequal stated sizes, the Defined 
Participations would equal their ``Base Participations,'' defined as 
the stated size of the smallest participant (provided that, if the sum 
of all Base Participations would exceed the number of contracts in the 
Remainder of the Order, then the Remainder of the Order would be 
divided equally among crowd participants on parity, subject to 
rounding) plus their ``Supplemental Participations.'' After the 
allocation of the Base Participation, the smallest participant would 
not be entitled to receive a Supplemental Participation, since that 
participant would have been allocated contracts equaling such 
participant's stated size. The other crowd participants who are on 
parity and who would be entitled to receive additional contracts would 
be entitled to receive Supplemental Participations.
    Supplemental Participations would be equal to the remaining stated 
size, after the allocation of the Base Participation, of the smallest 
remaining participant entitled to receive such a Supplemental 
Participation (provided that, if the sum of all initial Supplemental 
Participations would exceed the number of contracts remaining to be 
allocated, then such contracts would be divided equally among crowd 
participants on parity, subject to rounding). If the remaining stated 
sizes of all participants entitled to receive initial Supplemental 
Participations is equal, then their initial Supplemental Participations 
would be equal. The allocation of the Supplemental Participations would 
continue in this manner until the number of contracts to be allocated 
is exhausted.
    The proposed rule would provide that the specialist may decline to 
receive the Enhanced Specialist Participation, in which case the 
specialist would be entitled to participate as one crowd participant, 
up to (i.e., limited by) the specialist's stated size. The Exchange 
believes that this limitation should provide incentives for specialists 
to bid for and offer options contracts reflecting their true size, 
resulting in greater transparency in the Exchange's markets.
    When a market or marketable limit order is received with a size 
greater than the Exchange's disseminated size, some crowd participants 
may be willing to execute a larger size than the disseminated size.\29\ 
Where the Remainder of the Order is greater than the portion of the 
disseminated size that is attributable to the specialists and ROTs,\30\ 
the proposed rule change would provide that participation in additional 
contracts in excess of such size among willing crowd participants shall 
be allocated under the otherwise applicable provisions of Phlx rule 
1014.\31\
---------------------------------------------------------------------------

    \29\ Phlx rule 1082(e), Firm Quotations, provides that, if 
responsible brokers or dealers receive an order to buy or sell a 
listed option at the disseminated price in an amount greater than 
the disseminated size (for customer orders) or the quotation size 
(for broker-dealer orders), such responsible broker or dealer shall, 
within thirty (30) seconds of receipt of the order, (i) execute the 
entire order at the disseminated price (or better), or (ii) execute 
that portion of the order equal to the disseminated size (in the 
case of a customer order) or the quotation size (in the case of a 
broker-dealer order) at the disseminated price (or better), and 
revise its bid or offer. The Exchange filed with the Commission on 
October 4, 2002, a proposed rule change to codify the situation in 
which responsible brokers or dealers elect to execute a number of 
contracts greater than the disseminated size but not necessarily the 
size of the entire order. See File No. SR-Phlx-2002-60.
    \30\ Phlx defines disseminated size as, with respect to the 
disseminated price for any quoted options series, at least the sum 
of limit orders; however, the proposal would permit the specialist 
and crowd to disseminate a size greater than the sum of the limit 
orders. See Securities Exchange Act Release No. 46325, (August 8, 
2002), 67 FR 53376 (August 15, 2002) (approving File No. SR-Phlx-
2002-15).
    \31\ Telephone conversation with Phlx.
---------------------------------------------------------------------------

    Specifically, once the disseminated size is executed and allocated 
among crowd participants on parity, any crowd participants who wish to 
execute additional contracts in excess of the disseminated size may 
participate in a

[[Page 14469]]

``second round'' of bidding for or offering additional contracts in 
excess of the disseminated size (the ``excess contracts''). This subset 
of willing crowd participants would be entitled to participate under 
the same rules applicable to the Remainder of the Order. Once all crowd 
participants have been satisfied in the original allocation up to the 
disseminated size, the ``second round'' would constitute a new parity 
situation respecting the willing crowd participants in the excess 
contracts. The excess contracts would be allocated among those crowd 
participants who wish to participate in additional contracts, in 
accordance with the proposed rule. Therefore, if the specialist is a 
willing participant in the excess contracts, the specialist would be 
entitled to receive an Enhanced Specialist Participation in such excess 
contracts.
    Proposed Phlx rule 1014(g)(v)(C)(3) is intended to address this 
situation where an order is received via AUTOM and handled manually by 
the specialist for a number of contracts greater than the Exchange's 
disseminated size, and the specialist executes the entire order 
manually prior to stating a size. The proposed rule would provide that, 
if the specialist has no Actual Size, the specialist would nonetheless 
be entitled to receive the Enhanced Specialist Participation for all 
contracts executed in excess of the disseminated size. The proposed 
rule limits the specialist's entitlement if the specialist has an 
Actual Size. In such a situation, the specialist would be entitled to 
receive the Enhanced Specialist Participation, but not to exceed the 
specialist's Actual Size in such excess contracts.
    c. Waiver. The proposal is not intended to require, without 
exception, that crowd participants be allocated the number of contracts 
to which they would be entitled.\32\ The proposal would allow crowd 
participants, in their sole discretion, to offer to waive, in whole or 
in part, any part of a trade to which they were entitled to be 
allocated (an ``Offer to Waive''), by stating so in a loud and audible 
voice to the other members of the trading crowd and the Allocating 
Participant.\33\ In structuring the waiver provisions, the Exchange 
represents that it has incorporated basic contract principles,\34\ 
including communication of an offer, acceptance, and revocation.\35\
---------------------------------------------------------------------------

    \32\ Telephone conversation with Phlx.
    \33\ Options Floor Procedure Advice (``Advice'') F-2 currently 
provides that, generally, the largest participant allocates the 
trade. The Exchange has proposed to modify Phlx rule 1014(g) and 
Advice F-2 governing who allocates trades. See Securities Exchange 
Act Release No. 47500 (March 13, 2003) (notice of File No. SR-Phlx-
2001-28).
    \34\ See Corbin, Contracts section 1515 and 13 Pa. C.S.A. 
section 1102 (corresponding to section 1-102 of the Uniform 
Commercial Code) regarding variation by agreement, stating the basic 
principles of commercial and contract law that parties may generally 
waive rights or benefits to which they would otherwise be entitled. 
In order to ensure that no waiver is coerced, the Exchange is 
proposing to codify that it would be inconsistent with ``just and 
equitable principles of trade'' for a participant to harass, coerce 
or intimidate another participant to waive any rights.
    \35\ The Exchange notes that waiver also appears in disciplinary 
and membership rules, as well as in the Act. Under the disciplinary 
processes of the exchanges, there is a right to a hearing, which can 
be waived. See, e.g., Amex rule 590(f) and Chicago Stock Exchange 
Article XII, rule 9. See also CBOE rule 3.9(b) permitting clearing 
firms to waive the membership posting period. The proposed 
provisions do not implicate the anti-waiver provisions of section 
29(a) of the Act, 15 U.S.C. 78cc(a), which aims to prevent the 
waiver of the application of U.S. securities laws in certain 
situations where fraud is involved.
---------------------------------------------------------------------------

    For example, a crowd participant may make an Offer to Waive in 
situations in which hedging transactions become difficult or cumbersome 
due to lack of availability or liquidity in the underlying stock; 
additionally, a crowd participant may make an Offer to Waive to 
accommodate the execution of a particularly large sized order on the 
Exchange by larger crowd participants, or to accommodate a crowd 
participant closing out a position. At the same time, the proposed rule 
change would provide that a pattern or practice of waiving all or a 
portion of a crowd participant's entitlement may be considered conduct 
inconsistent with just and equitable principles of trade.\36\
---------------------------------------------------------------------------

    \36\ See proposed rule 1014(g)(v)(F)(2).
---------------------------------------------------------------------------

    If the Allocating Participant determines that the other crowd 
participant(s) then on parity is (are) willing to take the number of 
contracts that are subject to the Offer to Waive, the Allocating 
Participant may (but would not be required to), accept such Offer to 
Waive by (i) allocating the Remainder of the Order, taking into account 
the Offer to Waive, in accordance with proposed Phlx rule 1014(g)(v), 
or (ii) otherwise indicating, following the execution of the Initiating 
Order, that such Offer to Waive will be accepted.
    The proposed rule addresses both a Total Waiver, in which a crowd 
participant effects a Waiver of his or her entire entitlement, and a 
Partial Waiver, in which a crowd participant effects a Waiver of a 
portion of his or her respective entitlement but not a Total Waiver. If 
a crowd participant effects a Total Waiver or a Partial Waiver, the 
number of contracts to which such participant would otherwise be 
entitled would be reduced by the number of contracts waived. The 
entitlements of the other participants on parity (and who have not 
effected a Total or Partial Waiver) would be determined by 
redistributing the waived number of contracts to willing participants 
(including the specialist) based on the Defined Participation.\37\
---------------------------------------------------------------------------

    \37\ The proposal does not contemplate, and would not allow, a 
crowd participant to waive his/her entitlement to receive a given 
number of contracts to designate that the contracts subject to the 
Waiver be allocated to any other specific crowd participant or 
participants.
---------------------------------------------------------------------------

    d. Waiver and the Enhanced Specialist Participation. The proposed 
rule would provide that, in the case of an option which is subject to 
an Enhanced Specialist Participation, and one or more ROTs effect Total 
Waivers leaving the specialist on parity (after giving effect to such 
Total Waivers) with three or more ROTs, the Enhanced Specialist 
Participation to which the specialist would be entitled is as if the 
specialist had been on parity with three ROTs; similarly, if one or 
more ROTs effect Total Waivers leaving the specialist on parity (after 
giving effect to such Total Waivers) with two or more ROTs, the 
Enhanced Specialist Participation to which the specialist would be 
entitled is as if the specialist had been on parity with two ROTs, and 
if one or more ROTs effect Total Waivers leaving the specialist on 
parity (after giving effect to such Total Waivers) with one ROT, the 
Enhanced Specialist Participation to which the specialist would be 
entitled is as if the specialist had been on parity with one ROT. In no 
event, however, would a specialist that is on parity with one ROT be 
entitled to receive a number of contracts that is greater than the 
Enhanced Specialist Participation, unless the one ROT has waived his 
entitlement or has been satisfied.
    The proposed rule would make clear that, in no event would any non-
waiving ROT be required to participate in fewer contracts than he/she 
would have received absent the Waiver(s). The purpose of this provision 
is to ensure that the ROT that remains on parity with the specialist 
does not receive fewer contracts than such ROT would have received if 
not for the Waivers.
    e. Partial Waiver. The proposed rule would provide that, respecting 
options subject to the Enhanced Specialist Participation, in the event 
that one or more ROTs on parity with the specialist effect a Partial 
Waiver, the specialist would not be entitled to receive a number of 
contracts that is greater than 40% of the Remainder of the Order or, in 
the case of the specialist being on

[[Page 14470]]

parity with only one ROT, 60%, unless all other ROTs on parity have 
waived their entitlements or have received a number of contracts equal 
to their remaining size after the Partial Waiver(s). The proposal would 
provide, however, for the reasons stated above, that in no event shall 
a ROT be required to participate in fewer contracts than he/she would 
have received absent the Partial Waiver(s).
    f. Other Provisions. The proposal would provide that, in situations 
where the allocation of contracts result in fractional amounts of 
contracts to be allocated to crowd participants, the number of 
contracts to be allocated would be rounded in a fair and equitable 
manner.
    The proposal would also provide that it shall be considered conduct 
inconsistent with just and equitable principles of trade for a member: 
(a) To allocate initiating orders other than in accordance with Phlx 
rule 1014; (b) to enter into any agreement with another member 
concerning allocation of trades; or (c) to harass, intimidate or coerce 
any member to enter into or revoke any Waiver, or to make or refrain 
from making any complaint or appeal. A pattern or practice of waiving 
all or a portion of a crowd participant's entitlement, with the result 
that such crowd participant receives no allocation or a lesser 
allocation than he or she would otherwise have been entitled to, may be 
considered conduct inconsistent with just and equitable principles of 
trade. The Exchange notes that although it is proposing to expressly 
reference ``just and equitable principles of trade'' \38\ in this 
proposed rule,\39\ it does not intend to create an inference, with 
respect to other Exchange rules that do not contain such an express 
reference, that violations of such rules could not in appropriate 
instances also violate just and equitable principles of trade. The 
Exchange may, in the case of other Exchange rules where there is no 
express reference to ``just and equitable principles of trade,'' 
nonetheless determine that a violation of such other rules also 
constitutes conduct inconsistent with just and equitable principles of 
trade.\40\ The Exchange believes that this provision of the proposed 
rule is consistent with the requirement in the Order to promptly stop 
any practice or procedure relating to the allocation of orders if 
neither it nor a related practice or procedure that would supercede the 
existing practice or procedure has been submitted for approval or is 
not already authorized by rule.
---------------------------------------------------------------------------

    \38\ See Phlx rule 707.
    \39\ Other Exchange rules expressly reference just and equitable 
principles of trade. See, e.g., Phlx rules 1015(b), 1042.02 and 
1051(a).
    \40\ The lack of express reference in other Phlx rules should 
not be construed as waiving the ability to make a violation of Phlx 
rule 707 co-exist with any other violation, depending on the facts 
and circumstances of the case. The Exchange believes that a 
violation of the existing parity/priority provisions of its rules 
could be a violation of just and equitable principles of trade and 
could be subject to disciplinary action as such. In addition, a 
violation of Phlx rule 1014(g)(v), for instance, can be in and of 
itself a stand-alone violation.
---------------------------------------------------------------------------

    Finally, the proposal would provide that, notwithstanding the first 
sentence of Phlx rule 1014(g)(i), neither Phlx rule 119(b) and (c) 
concerning precedence based on the size of bids at parity, nor Phlx 
rule 120 (insofar as it incorporates those provisions by reference) 
shall apply to the allocation of orders covered by this Phlx rule 
1014(g)(v).
2. Statutory Basis
    The Exchange believes that the proposed rule change would codify 
existing practices concerning options trade allocation where ROTs and 
specialists are on parity, and would provide a fair process for trade 
allocation among floor traders (specialists and ROTs). It would provide 
for the waiver of minimum trade allocation entitlements where 
appropriate while establishing a process that would help ensure fair 
and equitable trade allocation in such case.\41\ This process would 
include, for instance, the requirement that Offers to Waive be 
vocalized and accepted. Further, the Exchange believes that trade 
allocation is, in part, a process in the functioning of an auction 
market. In its role as a facility for options trading, the Exchange 
believes that the approach proposed herein is appropriate and 
consistent with the Act.\42\ The Exchange believes that the approach 
represents a codification of practices that have developed as the 
options markets have evolved and changed.
---------------------------------------------------------------------------

    \41\ Telephone conversation with Phlx.
    \42\ The Exchange notes that the Commission has previously 
acknowledged that granting benefits like the Enhanced Specialist 
Participation is within the business judgment of the Exchange, as 
long as such advantages do not restrain competition and do not harm 
investors. See Securities Exchange Act Release No. 42700 (April 18, 
2000), 65 FR 24246 (April 25, 2000) (SR-Phlx-99-39); see also 
Securities Exchange Act Release No. 43100 (July 31, 2000), 65 FR 
48778 (August 9, 2000) (publishing for notice and comment File No. 
SR-Phlx-00-01).
---------------------------------------------------------------------------

    In addition to being necessary and appropriate, the Exchange 
believes that its approach has certain benefits and results that would 
foster and achieve the objectives of section 6(b)(5) of the Act.\43\ 
Specifically, proposed Phlx rule 1014(g)(v) expressly would provide a 
fair and equitable mechanism to allocate trades among floor traders on 
parity.\44\ Such a mechanism is necessary to the functioning of a 
trading crowd in an auction market and, thus, to the maintenance of 
deep, liquid and orderly options markets.
---------------------------------------------------------------------------

    \43\ 15 U.S.C. 78f(b)(5).
    \44\ The Exchange believes that self-regulatory organizations 
(``SROs'') should be afforded the broadest latitude to adopt trading 
rules that its governing bodies determine are most appropriate to 
the needs of the marketplace and its competitive position, and notes 
that, in its recent proposal to promulgate new rule 19b-6 under the 
Act, SROs would be permitted to file ``trading rules'' as effective 
upon filing, without staff review or Commission order, unless such a 
trading rule would ``make fundamental structural changes to the 
market.'' For purposes of the proposed rule, the term ``trading 
rule'' includes rules governing member trading * * * such as rules 
governing * * * priority of orders, bids and offers See proposed 
rule 19b-6(b)(6) and (g)(1) at Securities Exchange Act Release No. 
43860 (January 19, 2001), 65 FR 8912 (February 5, 2001). The 
Commission notes that it has not taken final action on proposed rule 
19b-6.
---------------------------------------------------------------------------

    The Exchange states that its ability to attract order flow hinges 
to a great extent on its ability to execute a large number of trades of 
various sizes, including very large trades, efficiently and 
expeditiously. The Exchange states that trading crowds facilitate those 
executions far better than could individual market makers, because a 
trading crowd usually represents much more liquidity than an individual 
market maker. The proposed rule would codify certain trade allocation 
entitlements, and the ability of crowd participants to waive such 
entitlements where appropriate, but not to the extent that such waiver 
becomes a pattern or practice. This, in turn, would maximize smooth 
functioning of trading crowds and efficient executions.\45\
---------------------------------------------------------------------------

    \45\ Telephone conversation with Phlx.
---------------------------------------------------------------------------

    Phlx believes that the proposed rule should promote fair and 
orderly markets by: (1) Establishing clear trade allocation rules; and 
(2) specifying when and how floor traders may decline to receive any 
part of a trade to which they otherwise would have been entitled.
    For these reasons, the Exchange believes that its proposal is 
consistent with section 6(b) of the Act,\46\ in general, and section 
6(b)(5) of the Act,\47\ in particular, in that it is designed to 
promote just and equitable principles of trade, remove impediments to 
and perfect the mechanism of a free and open market and protect 
investors and the public interest by codifying a trade allocation 
approach that best facilitates fair and orderly markets.
---------------------------------------------------------------------------

    \46\ 15 U.S.C. 78f(b).
    \47\ 15 U.S.C. 78f(b)(5)

---------------------------------------------------------------------------

[[Page 14471]]

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.

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-2001-39 and should be 
submitted by April 15, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\48\
Margaret H. McFarland,
Deputy Secretary.
---------------------------------------------------------------------------

    \48\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

[FR Doc. 03-6990 Filed 3-24-03; 8:45 am]
BILLING CODE 8010-01-P