[Federal Register Volume 68, Number 93 (Wednesday, May 14, 2003)]
[Notices]
[Pages 25924-25927]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-11996]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47819; File No. SR-Phlx-2002-17]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Order Granting Approval of Proposed Rule Change and Amendment Nos. 1, 
2, and 3 Thereto and Notice of Filing of and Order Granting Accelerated 
Approval to Amendment Nos. 4, 5, 6, and 7 Thereto Relating to Crossing, 
Facilitation, and Solicited Orders

May 8, 2003.

I. Introduction

    On March 18, 2002, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act

[[Page 25925]]

of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule 
change relating to crossing, facilitation, and solicited orders. On May 
2, 2002, July 24, 2002, and August 20, 2002, Phlx submitted Amendment 
Nos. 1, 2, and 3 to the proposed rule change, respectively.\3\ On May 
2, 2002, notice of the proposed rule change, as amended by Amendment 
Nos. 1, 2, and 3, was published in the Federal Register.\4\ The 
Commission received no comments on the proposed rule change. On 
November 6, 2002, February 25, 2003, March 19, 2003, and April 23, 
2003, Phlx submitted Amendment Nos. 4, 5, 6, and 7 to the proposed rule 
change, respectively.\5\ This notice and order solicits comment on 
Amendment Nos. 4, 5, 6, and 7 and approves the proposed rule change, as 
amended, on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letters from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division of Market 
Regulation (``Division''), Commission, dated May 1, 2002 
(``Amendment No. 1''); and to Ira Brandriss, Special Counsel, 
Division, Commission, dated July 23, 2002 (``Amendment No. 2''), and 
August 19, 2002 (``Amendment No. 3'').
    \4\ See Securities Exchange Act Release No. 45824 (April 25, 
2002), 67 FR 22144 (``Notice'').
    \5\ See letters from Richard S. Rudolph, Director and Counsel, 
Phlx, to Ira Brandriss, Special Counsel, Division, Commission, dated 
November 5, 2002 (``Amendment No. 4''), February 24, 2003 
(``Amendment No. 5''), March 18, 2003 (``Amendment No. 6''), and 
April 22, 2003 (``Amendment No. 7'').
    Amendment No. 4 replaced the text of the proposed rule change 
with new text that made revisions to proposed Commentary .03. The 
text of proposed Commentary .03 was further amended by Amendment 
Nos. 5, 6, and 7. As discussed infra, the final text of proposed 
Commentary .03 as set forth in Amendment No. 7 is intended to 
clarify that the provision would apply to any transaction in which a 
floor broker is crossing a public customer order with an order that 
is not a public customer order.
    In Amendment No. 6, Phlx also amended proposed Commentary .02(i) 
to Phlx Rule 1064, as discussed infra, to reflect that the proposed 
provision to entitle a floor broker to cross a certain percentage of 
a customer order with a facilitation order from the originating firm 
would apply only to public customer orders, not all customer orders.
---------------------------------------------------------------------------

II. Description of Proposal

    The proposed rule change would amend Phlx Rule 1064, ``Crossing, 
Facilitation and Solicited Orders,'' which governs the crossing of 
equity option orders by floor brokers. Rule 1064, among other things, 
sets forth the procedures by which a floor broker who holds a customer 
order (``original order'') may cross such order with either another 
customer order or orders from the same originating firm, or with a 
contra side order provided by the originating firm from its own 
proprietary account.\6\
---------------------------------------------------------------------------

    \6\ When the contra side is provided by the originating firm 
from its own proprietary account, the transaction is known as a 
``facilitation.''
---------------------------------------------------------------------------

    As explained by the Phlx, under the current rule, a floor broker 
seeking to cross buy and sell orders for the same options series must 
first bring the transaction to the trading floor and request markets 
from the trading crowd for all components of the order. After providing 
the crowd with the opportunity to make such markets, the floor broker 
must announce that he or she holds an order subject to crossing or 
facilitation, and then must propose a price at which to cross the 
original order that improves upon the price provided by the crowd. 
However, before the floor broker can effect the cross, the registered 
options traders (``ROTs'') in the crowd are given the opportunity to 
take all or part of the transaction at the proposed price.
    Under these rules, if the crowd does not want to participate in the 
trade, the floor broker may proceed with the cross. If the crowd wants 
to participate in part of the order, however, the crowd has priority 
and the floor broker may cross only that amount remaining after the 
crowd has taken its portion. If the crowd wants to participate in the 
entire order, the floor broker will not be able to cross or facilitate 
any part of the order.
    The Phlx proposes to adopt new Commentary .02 to Rule 1064 to 
entitle the floor broker, under certain conditions, to cross a 
specified percentage of an original order with another customer order 
or orders, or with an order of the originating firm, before ROTs in the 
crowd can participate in the transaction. The percentage of the floor 
broker's guarantee would depend upon whether the price at which the 
order is ultimately traded is at the crowd's best bid or offer in 
response to the floor broker's initial request, or at an improved 
price.
    Where the floor broker proposes the cross at a price that improves 
the crowd's market, and the crowd then wants to take part in some or 
all of the order at the improved price, the floor broker would be 
entitled to cross 40% of the contracts.\7\ Where the trade takes place 
at the market provided by the crowd, the floor broker would be entitled 
to cross 20% of the contracts. These entitlements would apply only with 
respect to any portion of the original order that remained after all 
public customer orders in the limit order book and represented in the 
trading crowd at the time the market was established were satisfied.
---------------------------------------------------------------------------

    \7\ After the floor broker proposed to cross the order, he or 
she would be required again to give the crowd a reasonable 
opportunity to bid or offer for the order. Telephone conversation 
between Richard S. Rudolph, Director and Counsel, and Dawn Kelly 
Reim, Market Surveillance Investigator, Phlx, and Ira Brandriss, 
Special Counsel, and Frank N. Genco, Attorney, Division, Commission, 
on October 21, 2002. If the crowd improved upon the floor broker's 
price, and the floor broker then proposed to match the crowd's 
price, the floor broker would be entitled to cross 20% of the 
contracts. Telephone conversation between Richard S. Rudolph, 
Director and Counsel, Phlx, and Ira Brandriss, Special Counsel, and 
Frank N. Genco, Attorney, Division, Commission, on November 21, 
2002.
---------------------------------------------------------------------------

    The proposed rule change would apply to transactions in equity 
options and would initially apply to customer orders of a minimum size 
of 500 contracts. The Exchange's Options Committee would be authorized 
to determine, on an option by option basis, the eligible size for an 
order that could be transacted pursuant to the proposal. However, the 
eligible order size could not be less than 500 contracts. In the case 
of a complex order, such as a spread or a straddle, the proposed rule 
change would require that at least one leg of such an order, standing 
alone, would need to meet the eligible size requirement.
    The proposed rule change also provides that if the same member 
organization of the Exchange is both the originating firm and the 
specialist for the option in which the transaction takes place, and the 
floor broker acting on behalf of the originating firm crosses or 
facilitates under the proposed rule, the specialist would not be 
entitled to any Enhanced Specialist Participation pursuant to Phlx Rule 
1014(g) \8\ with respect to the particular cross transaction.
---------------------------------------------------------------------------

    \8\ The Enhanced Specialist Participation programs in Phlx Rule 
1014(g) allocate to the specialist, in certain options classes, a 
greater than equal share of the portion of the order that is divided 
among the specialist and any ``controlled accounts'' that are on 
parity. A ``controlled account'' is an account controlled by or 
under common control with a broker-dealer.
---------------------------------------------------------------------------

    If the specialist is not the same member organization as the 
originating firm, and the trade takes at the specialist's disseminated 
bid or offer when the specialist is on parity with one or more 
controlled accounts, the specialist may be entitled to an Enhanced 
Specialist Participation, but in no case would the specialist be 
guaranteed a percentage that, when combined with the percentage crossed 
by the floor broker, exceeds 40% of the original order after relevant 
public customer orders have been satisfied.

[[Page 25926]]

    Other provisions of the proposed rule change are patterned after 
similar rules on other exchanges.\9\
---------------------------------------------------------------------------

    \9\ See Notice.
---------------------------------------------------------------------------

    Amendment No. 6 to the proposed rule change specifies that the 
provisions of Commentary .02 to permit the floor broker to cross a 
specified percentage of an original order with a facilitation order of 
the originating firm would apply where the original order is a public 
customer order.
    The Exchange further proposes to adopt Commentary .03 to Phlx Rule 
1064. As set forth in Amendment No. 7 to the proposed rule change, 
Commentary .03 would state that a floor broker crossing a public 
customer order with an order that is not a public customer order, when 
providing a reasonable opportunity for the trading crowd to participate 
in the transaction, must disclose the public customer order that is 
subject to crossing prior to the execution of the order.

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange. Specifically, 
the Commission finds that the proposal is consistent with the 
requirements of sections 6(b)(5) of the Act \10\ that the rules of an 
exchange, among other things, be designed to promote just and equitable 
principles of trade, to remove impediments to and perfect the 
mechanisms of a free and open market and a national market system, and, 
in general, to protect investors and the public interest.\11\
---------------------------------------------------------------------------

    \10\ 15 U.S.C. 78f(b)(5).
    \11\ In approving the proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Commission believes that Phlx's proposal to grant crossing 
guarantees and participation rights to member firms seeking to execute 
crosses on the Exchange, under the proposed conditions, is reasonable. 
As noted above, other options exchanges have similar rules, and the 
proposed rule change should enable Phlx to compete with these exchanges 
in attracting order flow of broker-dealer firms seeking to cross or 
facilitate customer orders.
    The Commission notes that, in approving member firm participation 
rights and other guaranteed participations in the past, it has found 
that rules entitling a market participant or participants to up to 40% 
of an order are not inconsistent with the statutory standards of 
competition and free and open markets.\12\ The Commission has raised 
concerns, on the other hand, about participation guarantees that ``lock 
up'' a larger percentage of an order, and thereby reduce the number of 
contracts for which the trading crowd can compete.\13\ The proposed 
rule change guarantees an allocation of no more than 40% of an order to 
a member firm seeking to facilitate an order. Moreover, the proposal 
includes a provision that limits the number of contracts to be 
allocated to the facilitating firm and the specialist in the aggregate 
to no more than 40% of the order. The rule for which the Phlx seeks 
approval is consistent with the Commission's position with respect to 
participation guarantees.
---------------------------------------------------------------------------

    \12\ See, e.g., Securities Exchange Act Release Nos. 42455 
(February 24, 2000), 65 FR 11388 (March 2, 2000); 42894 (June 2, 
2000), 65 FR 36850 (June 12, 2000); 42835 (May 26, 2000), 65 FR 
35683 (June 5, 2000); 42848 (May 26, 2000), 65 FR 36206 (June 7, 
2000).
    \13\ See, e.g., Securities Exchange Act Release No. 43100 (July 
31, 2000), 65 FR 48778 (August 9, 2000).
---------------------------------------------------------------------------

    The Commission finds good cause for granting accelerated approval 
of Amendment Nos. 4, 5, 6, and 7 to the proposed rule change. Amendment 
No. 4 restated the text of the proposed rule change as set forth in the 
Notice, and made revisions only to Commentary .03. Amendment Nos. 5 and 
6 also revised proposed Commentary .03. To the extent that the 
revisions made by these amendments were retained in the final version 
of proposed Commentary .03 set forth in Amendment No. 7, they are 
discussed below.
    Amendment No. 6 also amended proposed Commentary .02 to establish 
that the member firm participation guarantee would apply only when the 
floor broker is seeking to cross a facilitation order from the member 
firm with a public customer order. The Commission notes that Phlx Rule 
1064(b), governing facilitation crosses, refers specifically to 
transactions in which a floor broker is holding an options order for a 
public customer that he or she is seeking to cross with a contra side 
order. The text of proposed new Commentary .02 as originally submitted 
also referred to the facilitation of a public customer order. Although 
in an earlier amendment the Exchange deleted the word ``public'' from 
proposed Commentary .02,\14\ the Exchange has now determined to restore 
the term. The Commission believes that this change is reasonable and 
also eliminates a possible inconsistency between Phlx Rule 1064(b) and 
proposed Commentary .02.
---------------------------------------------------------------------------

    \14\ See Amendment No. 2.
---------------------------------------------------------------------------

    The Commission also finds good cause for accelerating approval of 
Amendment No. 7 to the proposed rule change. Amendment No. 7 would 
amend the text of proposed Commentary .03 to state that a floor broker 
crossing a public customer order with an order that is not a public 
customer order, when providing for a reasonable opportunity for the 
trading crowd to participate in the transaction, shall disclose the 
public customer order that is subject to crossing prior to the 
execution of the order. As discussed in the Notice, the Phlx believes 
that ``[i]f the customer order is disclosed first, the trading crowd 
may be more likely to bid or offer competitively as contra side to that 
customer's order, thus benefiting the customer.'' As originally 
proposed, Commentary .03, referred only to facilitation orders. 
Amendment No. 7 establishes that the provision would apply to all 
crossing transactions in which the floor broker is crossing a public 
customer order with an order that is not a public customer order.\15\ 
The Commission believes that it is appropriate to accelerate approval 
of Amendment No. 7.
---------------------------------------------------------------------------

    \15\ Commentary .03 also was amended by the Phlx to distinguish 
the disclosure requirement of proposed Commentary .03 from the 
provision of proposed Commentary .02(iv) requiring the floor broker 
to disclose all components of the customer order initially, before 
requesting that the trading crowd provide its market.
---------------------------------------------------------------------------

    Accordingly, the Commission finds that good cause exists, 
consistent with sections 6(b)(5) and 19(b)(2) of the Act,\16\ to grant 
accelerated approval of Amendment Nos. 4, 5, 6, and 7 to the proposed 
rule change prior to the thirtieth day after publication in the Federal 
Register.
---------------------------------------------------------------------------

    \16\ 15 U.S.C. 78f(b)(5) and 78s(b)(2).
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 4, 5, 6 and 7, including whether 
Amendment Nos. 4, 5, 6 and 7 are 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 Amendment Nos. 4, 5, 
6, and 7 that are filed with the Commission, and all written 
communications relating to these amendments between the Commission and 
any person, other than those that may be withheld from the public in

[[Page 25927]]

accordance with the provisions of 5 U.S.C. 552, will be available for 
inspection and copying in the Commission's Public Reference Room. 
Copies of such filing will also be available for inspection and copying 
at the principal office of the Exchange. All submissions should refer 
to File No. SR-Phlx-2002-17 and should be submitted by June 4, 2003.

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\17\ that the proposed rule change (File No. SR-Phlx-2002-17), as 
amended, is hereby approved.
---------------------------------------------------------------------------

    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
---------------------------------------------------------------------------

    \18\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-11996 Filed 5-13-03; 8:45 am]
BILLING CODE 8010-01-P