[Federal Register Volume 68, Number 163 (Friday, August 22, 2003)]
[Notices]
[Pages 50813-50819]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-21450]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48355; File No. SR-BSE-2002-15]


Self-Regulatory Organizations; Notice of Filing of Amendment No. 
3 to the Proposed Rule Change by the Boston Stock Exchange, Inc. 
Establishing Trading Rules for the Boston Options Exchange Facility

August 15, 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 August 15, 2003, the Boston Stock Exchange, Inc. (``BSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') Amendment No. 3 to the proposed rule change, as 
described in Items I, II, and III below, which Items have been prepared 
by the Exchange. The BSE submitted the proposed rule change to the 
Commission on October 31, 2002. On December 18, 2002, the BSE filed 
Amendment No. 1 that entirely replaced the original rule filing.\3\ On 
January 9, 2003, the BSE filed Amendment No. 2 that entirely replaced 
the original rule filing and Amendment No. 1.\4\ Amendment No. 2 was 
published in the Federal Register on January 22, 2003 (``BOX Proposing 
Release'').\5\ The Commission received 43 comment letters.\6\ In 
response to the concerns raised in the comment letters and discussions 
with Commission staff, the BSE filed Amendment No. 3. The Commission is 
publishing this notice to solicit comments on Amendment No. 3 from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from George W. Mann, Jr., Executive Vice 
President and General Counsel, BSE, to Annette Nazareth, Director, 
Division of Market Regulation (``Division''), Commission, dated 
December 18, 2002 (``Amendment No. 1'').
    \4\ See Letter from George W. Mann, Jr., Executive Vice 
President and General Counsel, BSE, to Annette Nazareth, Director, 
Division, Commission, dated January 8, 2003 (``Amendment No. 2'').
    \5\ Securities Exchange Act Release No. 47186 (January 14, 
2003), 68 FR 3062 (``BOX Proposing Release'').
    \6\ See Letters to Jonathan G. Katz, Secretary, Commission, from 
Paul Fred, CEO, PFTC Trading, LLC, dated January 24, 2003; Myron 
Wood, Statistician, Changes, LLC, dated January 30, 2003; Mike 
Ianni, dated February 2, 2003; Shawn Gibson, Senior VP, Equity 
Derivatives, Scott & Stringfellow, dated February 6, 2003; CSFB Next 
Fund, Inc., Interactive Brokers Group, LLC, LabMorgan Corporation, 
Salomon Brothers Holding Company, Inc., UBS (USA) Inc., dated 
February 6, 2003; Sallerson-Troob, LLC, dated February 9, 2003; 
Christopher D. Bernard, dated February 10, 2003; George Papa, 
Director, PEAK6 Investments, dated February 10, 2003; Frank Hirsch, 
CBOE Market Maker, dated February 10, 2003; Richard W. Cusack, 
Operations Manager, Sparta Group of Chicago, LP, dated February 11, 
2003; Paul Britton, CEO, MAKO Global Derivatives LLC, dated February 
11, 2003; John Colletti, Samuelson Trading, dated February 11, 2003; 
Robert S. Smith, Chief Technology Officer, GETCO, LLC, dated 
February 11, 2003; Phillip Sylvester, CBOE Market Maker, dated 
February 11, 2003; Keith Fishe, DRW Holdings, LLC, dated February 
11, 2003; Daniel C. Bigelow, president, Monadnock Capital 
Management, dated February 11, 2003; Erich Tengelsen, Chicago 
Trading Company, dated February 12, 2003; Thomas Peterffy, Chairman, 
David M. Battan, Vice President and General Counsel, Interactive 
Brokers LLC, dated February 12, 2003; John T. Thomas, Van Der Moolen 
USA LLC, dated February 12, 2003; Robert C. Sheehan, Electronic 
Brokerage Systems LLC, dated February 12, 2003; Thomas J. Murphy, 
TJM Investments, LLC, dated February 12, 2003; Meyer S. Frucher, 
Chairman and Chief Executive Officer, Philadelphia Stock Exchange, 
Inc., dated February 12, 2003; Michael Resch, dated February 12, 
2003; Todd Silverberg, General Counsel, Susquehanna International 
Group LLP, dated February 12, 2003; Michael J. Simon, Senior Vice 
President and Secretary, International Securities Exchange, Inc. 
(``ISE''), dated February 12, 2003; Juan Carlos Pinilla, Managing 
Director, Equity Derivatives Trading, JP Morgan, dated February 12, 
2003; Marc J. Liu, Options Specialist, AGS Specialist Partners, 
dated February 12, 2003; Jan-Joris Hoefnagel, President, Optiver 
Derivatives Trading, dated February 13, 2003; Steve Tumen, CEO, and 
David Barclay, General Counsel, Equitec Group, LLC, dated February 
14, 2003; Michael J. Ryan, Jr., Executive Vice President & General 
Counsel, American Stock Exchange LLC (``Amex''), dated February 14, 
2003; Williams J. Brodsky, Chairman and Chief Executive Officer, 
Chicago Board Options Exchange, Inc. (``CBOE''), dated February 14, 
2003; Paul Roesler, Lead Market Maker, Pacific Exchange, Inc. 
(``PCX''), dated February 14, 2003; Andrew W. Lo, dated February 15, 
2003; Nicholas Bonn, Executive Vice President, State Street Global 
Markets, LLC, dated February 21, 2003; Robert Bellick, Christopher 
Gust, Wolverine Trading, LLC, dated February 27, 2003; Philip D. 
DeFeo, Chairman and CEO, PCX, dated February 27, 2003; Thomas N. 
McManus, Executive Director and Counsel, Morgan Stanley, dated March 
3, 2003; Philip C. Smith, Jr., Vice President, Options, The 
Interstate Group, dated March 7, 2003; Bryan Rule, dated March 11, 
2003; Michael J. Ryan, Jr., Executive Vice President & General 
Counsel, Amex, dated March 13, 2003; David Hultman, dated March 25, 
2003; Stephen D. Barret, dated March 26, 2003; and John Welker, June 
11, 2003.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    As described in the BOX Proposing Release, the BSE proposes to 
create a new electronic options trading facility of the Exchange, 
called the Boston Options Exchange (``BOX''). The text of Amendment No. 
3 to the proposed rule change is available for inspection at the Office 
of the Secretary, the BSE, the Commission's Public Reference Room, and 
on the Commission's Internet Web site (http://www.sec.gov/rules/sro/shtml).

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 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
    As discussed in detail in the BOX Proposing Release,\7\ the BSE 
proposes to

[[Page 50814]]

establish rules for BOX,\8\ a new exchange facility, as that term is 
defined in Section 3(a)(2) of the Act.\9\ BOX would be operated by 
Boston Options Exchange Group, LLC (``BOX LLC''). BOX would administer 
a fully automated trading system for standardized equity options 
intended for the use of Options Participants.\10\ It would conduct an 
auction market similar to the ones conducted by the options exchange 
markets currently in operation, although the BOX auction would occur 
electronically and not on a floor. BOX would provide automatic order 
execution capabilities in the options securities listed or traded on 
the BSE.
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    \7\ See supra note 5.
    \8\ The term ``BOX'' means the Boston Options Exchange or Boston 
Stock Exchange Options Exchange, an options trading facility of the 
Exchange under Section 3(a)(2) of the Act. Proposed BOX Rules, 
Chapter I, General Provisions, Section 1(a)(6) (definition of 
``BOX'').
    \9\ 15 U.S.C. 78c(a)(2).
    \10\ The term ``Options Participant'' or ``Participant'' means a 
firm, or organization that is registered with the Exchange pursuant 
to Chapter II of the BOX Rules for purposes of participating in 
options trading on BOX as an ``Order Flow Provider'' or ``Market 
Maker''. See Proposed BOX Rules, Chapter I, General Provisions, 
Section 1(a)(39) (definition of ``Options Participant'').
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    In Amendment No. 3, the BSE has made certain minor changes, like 
renumbering and fixing typographical errors. In addition, the BSE also 
proposes the following, more substantive changes to the proposed rules 
set forth in the BOX Proposing Release. For ease of reference, the BSE 
has referenced each section or paragraph, which has been added to, or 
changed, in any substantial way.
    Proposed Chapter I, Section 1 The BSE proposes to add or amend the 
following definitions:
    Proposed definition (21) has been amended to state ``The term 
``Directed Order'' means any Customer Order to buy or sell which has 
been directed to a particular Market Maker by an OFP.'' This definition 
was added in order to clarify that an OFP may send an order to BOX and 
have it routed to a particular Market Maker for an opportunity for 
price improvement pursuant to proposed Chapter VI, Section 5.
    Proposed definition (46) has been amended to state that ``The terms 
`Order Flow Provider' or `OFP' mean those Options Participants 
representing as agent Customer Orders on BOX and those non-Market Maker 
Participants conducting proprietary trading.'' This definition was 
amended in order to clarify that OFPs may conduct business with the 
public on an agency basis and may also conduct a proprietary trading 
business or may conduct only either business.
    Proposed definition (54) has been amended to state that ``The term 
``Request for Quote'' or ``RFQ'' shall mean a message that may be 
issued by an Options Participant in order to signal an interest in an 
options series and request a response from other Participants. The RFQ 
contains only the series symbol and quantity and is broadcast to all 
Participants.'' This definition was added in order to delineate the 
meaning of the RFQ function pursuant to its use under Chapter VI, 
Section 6(b)(ii).
    Proposed Chapter II, Section 2(b)--In order to eliminate any 
confusion that may have arisen from the interpretation of this rule 
regarding customer-carrying firms, the BSE has amended this paragraph 
so that Options Participants must be registered as broker-dealers. 
Additionally, as also discussed below under proposed Chapter XI, the 
BSE has clarified that its sales practice rules (``Doing Business with 
the Public'') apply only to those Options Participants who are 
permitted under the BOX Rules to deal directly with the public, that 
is, OFPs. It was never the intention that participation in BOX be 
limited to customer-carrying firms.
    Proposed Chapter II, Section 2(e), (g), and (h)--In several places, 
the BSE has added requirements regarding Options Participants. 
Primarily for the purpose of examinations, the BSE has set forth 
requirements for Options Participants who, though they must be U.S. 
registered broker-dealers, do not maintain an office within the United 
States and are responsible for preparing and maintaining financial and 
other reports required to be filed with the Commission, BOXR, and the 
Exchange. In such cases, the Options Participant must maintain all such 
documents in English and U.S. dollars, provide an individual fluent in 
English and knowledgeable in securities and financial matters, and 
reimburse the Exchange for any expense incurred in connection with 
examinations of the Participant to the extent that such expenses exceed 
the cost of examining a Participant located within the continental 
United States.
    Also, the BSE has set forth that Options Participants must have as 
the principal purpose of being an Options Participant the conduct of a 
public securities business. These requirements are consistent with 
those in place on other options exchanges and which have been 
previously approved by the Commission.\11\ In light of the current 
focus in the market place on corporate governance, and non-U.S. based 
market participants, the BSE has determined that these provisions would 
serve to add important investor protections to the BOX Market, while 
not limiting or inhibiting the low barriers to access unique to BOX vis 
a vis the other options markets.
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    \11\ See e.g., ISE Rule 301.
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    Proposed Chapter V, Section 9--The BSE realizes that in this 
section it had made a typographical error and used the term ``Market-
On-Open'' Order, while in Chapter V, Section 14, the same order is 
called a ``Market-On-Opening'' Order. The BSE has corrected this error 
so that the name of the order in Section 9 is also ``Market-On-
Opening.'' In addition, the BSE notes that it has not changed any other 
parts of this section, including paragraph (b), which states ``BOX will 
determine a single price at which a particular series will be opened.''
    Proposed Chapter V, Section 14--In this section, the BSE has 
changed the name of the Market Order. Formerly, the BSE proposed to 
define a Market Order as an order, which is ``entered into the BOX Book 
and executed at the best price available in the market for the total 
quantity available from any contra bid(offer). Any residual volume is 
automatically converted to a limit order at the price at which the 
original market order was exhausted.'' Since this definition differs 
from the commonly used concept of ``market order'' in the U.S.-based 
options market, the BSE has changed the name of this order type to 
``BOX-Top'' Order, to eliminate the possibility of confusion on the 
part of investors and other options market participants. The BOX Market 
will not have a ``market order,'' as that term is typically used, that 
can be executed at successive price levels. A BOX-Top Order will not 
receive a price inferior to that which a typical market order would 
have received in the BOX Market. Moreover, as a result of BOX's trade-
through filter process (see discussion below of Chapter V, Section 
16(b)) and the Intermarket Linkage, no BOX-Top Order will receive a 
price inferior to the national best bid or offer (``NBBO''). Indeed, 
due to BOX's Price Improvement Period mechanism, orders submitted to 
BOX have the potential to be executed at a price superior to the NBBO.
    In addition, the BSE has clarified the definition of Market-on-
Opening Order by adding ``any residual volume left after part of a 
Market-on-Opening Order has been executed is automatically converted to 
a limit order at the price at which the original Market-on-Opening 
Order was executed.''

[[Page 50815]]

    Proposed Chapter V, Section 16(b)--The BSE has added to this 
section rules governing the BSE's proposed filtering of in-bound orders 
to prevent executions on the BOX at prices inferior to the NBBO. All 
in-bound orders to BOX from Customers as well as inbound Principal 
(``P'') and Principal as Agent (``P/A'') orders received via the 
InterMarket Linkage will be filtered by BOX prior to entry on the BOX 
Book in order to ensure that these orders will not execute at a price 
outside the current NBBO (``trade-throughs''). In this manner, the BSE 
believes that it has added an extra level of efficiency to its BOX 
trading engine, which will serve to enhance both the best execution of 
orders as well as BOX's participation in the Intermarket Linkage. The 
filter will operate by analyzing each in-bound Customer Order, P Order 
or P/A Order as follows:
    Step 1: The filter will determine if the order is executable 
against the NBBO (by definition the answer is ``yes'' in the case of a 
BOX-Top Order).
    [sbull] If NO, then the order would be placed on the BOX Book.
    [sbull] If YES, then the filter will proceed to Step 2.
    Step 2: The filter will determine whether there is a quote on BOX, 
which is equal to the NBBO.
    [sbull] If NO, then the order is exposed on the BOX Book at the 
NBBO for a period of three seconds, during which time any Options 
Participant may execute against the order. At the conclusion of the 
three-second period, if there is any remaining quantity, the filter 
will proceed to Step 3.
    [sbull] If YES, then the order would execute against the quote/
orders on the BOX Book.
    Step 3: If there is any unexecuted quantity at the end of three 
seconds, then:
    [sbull] In the case of Public Customer orders, a P/A Order will be 
generated and sent to the away exchange that is displaying the NBBO.
    [sbull] In the case of P and P/A Orders, any unexecuted portion 
will be returned to the originating exchange.
    In determining the length of time for an exposure period for orders 
which might otherwise trade through NBBO, but are ``caught'' by the 
filter, the BSE has determined that three seconds is ample time, in an 
electronic trading environment, for an Options Participant to match the 
NBBO in those instances in which BOX is not quoting at the NBBO. This 
exposure period will give all the BOX Market Makers, as well as 
Participants in general, an opportunity to trade at the NBBO should 
they choose to do so.
    Proposed Chapter V, Section 17 (c)--The BSE has eliminated the 
provision, which imposed a surcharge on Options Participants that 
submitted orders on behalf of broker-dealers in excess of two times the 
number of Public Customer contracts they executed in a given month. 
Similar to the rationale for the elimination of a charge to Market 
Makers set forth in Chapter VI, Section 4(e), discussed below, the BSE 
is concerned that such surcharges could be construed as a barrier to 
entry to BOX's flat and open marketplace.
    Proposed Chapter V, Section 17, Supplementary Material .03--
Concurrent with changes to certain sections regarding Information 
Barriers and Directed Orders (see discussion below of Chapter VI, 
Section 5(c)), the BSE has added a provision detailing the obligations 
of OFPs and Market Makers in regards to communications of information 
about orders being submitted to the PIP, or otherwise directed. The 
obligations are set forth as follows:

    Prior to submitting an order to a PIP, an OFP cannot inform an 
Options Participant of any of the terms of the order, except as 
provided for in Chapter VI, Section 5(c) of these Rules. (See BSE 
Rules, Chapter II, ``Dealings on the Exchange'', Section 36, 
``Specialist Member Organizations Affiliated with an Approved 
Person'').

    The BSE is confident that these measures, along with other 
protections set forth elsewhere in the BOX Rules, will ensure that 
adequate measures are in place to protect against the use or misuse of 
any material, non-public information by any BOX Participant in regard 
to any order entrusted to him/her.
    Proposed Chapter V, Section 18(b)--The Exchange is not changing or 
adding language to this section, but notes that this section is not 
intended to replace best execution principles. Rather, the BSE is 
supplementing best execution standards by the language set forth 
herein.
    Proposed Chapter V, Section 18(c)--Similar to the above discussion, 
the BSE has added language in this section regarding orders for which 
matching business has been found. Previously, the provision limited 
Participants to only utilizing the PIP for these types of orders. To 
allow more flexibility to OFPs, the BSE has determined that OFPs can 
execute such orders on the BOX Book, but only after one of the 
following two prerequisites have been met ``(i) agency orders are first 
exposed to the BOX book for at least thirty (30) seconds, or (ii) the 
OFP has been bidding or offering on BOX for at least thirty (30) 
seconds prior to receiving an agency order that is executable against 
such bid or offer.'' These two alternatives are not applicable to 
Market Makers, rather they must abide by the requirements of Chapter 
VI, Section 5(b) and (c), regarding Directed Orders, discussed below. 
The first alternative in this section requires exposing the order on 
the BOX Book for a period of thirty seconds before attempting to 
execute against it. Under the second alternative, the OFP can execute 
the order immediately on the BOX Book if that OFP has been bidding or 
offering on the BOX Book for at least thirty seconds prior to receiving 
an agency order that is executable against such bid or offer. 
Additionally, the provisions state that an OFP must not otherwise 
deliberately attempt to effect a transaction, either under a single 
Participant or between two Participants, without following PIP 
procedures. With these provisions, the BSE is offering an OFP the 
flexibility of best-execution decision making, coupled with protections 
to ensure that Information Barriers are not breached, and that 
Participants are not acting in any way contrary to their customer's 
best interests.
    Proposed Chapter V, Section 18(e)--In order to maximize the 
potential for price improvement of orders submitted to the PIP (which 
already, by definition, price improves all orders by at least one cent 
better than the NBBO), the BSE is requiring that in order for a PIP to 
commence there be at least three Market Makers quoting in a relevant 
series at the time a Participant submits a Primary Improvement Order to 
initiate a PIP. The BSE is confident that this requirement will be 
easily satisfied, given the accessibility to the BOX Market for Market 
Makers. Additionally, the BSE has clarified that a PIP will commence 
upon the dissemination of a broadcast message by BOX, which states 
``(1) that a Primary Improvement Order has been processed by BOX, (2) 
which contains information concerning series, size, price and side of 
market, and (3) states when a PIP will conclude.''
    Proposed Chapter V, Section 18(g)--The BSE has added a new 
paragraph to Chapter V, Section 18. This new paragraph provides that 
OFPs may access the PIP on behalf of customers that are not broker-
dealers (i.e., Public Customers) via a new order type, the Customer PIP 
Order, or ``CPO.'' CPOs shall include terms that state a price in 
standard increments (five or ten cents) at which the order will be 
placed on the BOX Book, as well as a price in pennies at which the 
Public Customer wishes to participate in any PIPs that may occur while 
his/her order is on the BOX Book. In order for a CPO to be eligible for

[[Page 50816]]

participation in a PIP, the CPO must be priced at or better than the 
NBBO. If a PIP commences in a relevant series and the CPO is at or 
better than the NBBO, then the OFP may, on behalf of the Public 
Customer, submit the CPO to the PIP for participation. Upon submission, 
the CPO will be treated similar to a Market Maker Improvement Order in 
the PIP; however, its terms cannot be cancelled or amended during the 
PIP.
    The BSE believes that this provision will permit Public Customers 
greater control and flexibility in how their orders are handled on BOX. 
Public Customers will now be able to participate in PIPs. In addition, 
the BSE believes that offering to OFPs the prospect of this service on 
behalf of Public Customers will serve to increase the number of 
Participants competing in PIPs, ultimately leading to greater price 
improvement for orders on BOX.
    The additions are as follows:
    (a) ``OFPs may provide access to the PIP on behalf of a customer 
that is not a broker-dealer (``Public Customer'') in the form of a 
Customer PIP Order (``CPO'') provided that:
    i. The terms of each CPO shall include a price stated in rounded 
five cent or ten cent increments, as appropriate, (``standard tick'') 
at which the order shall be placed in the BOX Book (``BOX Book 
Reference Price'') as well as a specific price stated in one cent 
increments (``penny tick'') at which the Public Customer wishes to 
participate in any PIPs (``CPO PIP Reference Price'') that may occur 
while his order is on the BOX Book and displayed at the BOX Book 
Reference Price;
    ii. The terms of each CPO shall include a specific order size 
(``CPO Total Size''). The number of contracts that may be entered into 
a PIP must be equal to the lesser of (a) the CPO Total Size remaining 
on the BOX Book or (b) the size of the Primary Improvement Order 
submitted to the PIP;
    iii. In order for the CPO to be eligible for participation in a PIP 
in the subject options series, the BOX Book Reference Price for a CPO 
at the time a PIP commences must be equal to the NBBO.
    iv. The CPO may only participate in a PIP on the same side of the 
market as the Primary Improvement Order.
    v. Upon initiation of a PIP for which a CPO is eligible to 
participate pursuant to paragraphs (i)-(iv) above, the OFP who 
submitted the CPO to the BOX Book must submit a CPO to the PIP at the 
CPO PIP Reference Price.
    vi. The terms of any CPO submitted to a PIP may not be amended or 
cancelled at any time during a PIP.''
    Proposed Chapter V, Section 19(a)--To clarify that a Market Maker 
Prime cannot be both the Market Maker Prime and the party who initiated 
the process in the same PIP, thereby guarantying receipt of more than 
40% of any allocation resulting from that PIP, the BSE has added a 
provision that ``the Market Maker Prime must not have submitted the 
Primary Improvement Order to commence the relevant PIP.''
    Proposed Chapter V, Section 27(b)(i)--In order to remain consistent 
with similar rules regarding Complex Orders on other options exchanges, 
the BSE has added an exception which sets forth that Complex Orders 
with net price increments that are not multiples of the minimum 
increments are not entitled to trade ahead of other interest at the BOX 
best bid and offer.
    Proposed Chapter VI, Section 4 (e)--The BSE deleted the provision, 
which imposed a monetary penalty on Market Makers who transacted 
business in classes outside of their appointments. Rather than a 
specific monetary penalty, which may have been construed as a barrier 
to entry to the BOX Market, the BSE has chosen to mirror provisions 
common on other options exchanges that permit Market Makers to trade 
outside of their appointments. This amendment also sets forth an 
execution percentage requirement that Market Makers must meet within 
the classes to which they are appointed. The additions are as follows:

    Market Makers may transact business outside of their 
appointments, but the total number of contracts executed during a 
quarter by a Market Maker in options classes to which it is not 
appointed may not exceed twenty-five percent (25%) of the total 
number of contracts traded by such Market Maker.

    Proposed Chapter VI, Section 5(b) and (c); Section 10(g) and (h)--
To clarify the intention that Market Makers would be able to handle 
orders on an agency basis directed to them by OFPs, the BSE has changed 
``Customer Order'' to ``Directed Order'' throughout Section 5, as well 
as in Section 10, which addresses Information Barriers. As previously 
discussed above, in the Definitions section of Chapter I, a Directed 
Order would be defined as an order directed to a Market Maker by an 
OFP. An OFP would send a Directed Order to BOX with a designation of 
the Market Maker to whom the order is to be directed. BOX would route 
the Directed Order to the appropriate Market Maker.
    Proposed Sections 5(b) and (c) concern the requirements for a 
Market Maker who would handle a Directed Order. To address any concerns 
regarding informational barriers and the transfer of information, 
intended or not, which may accompany a Directed Order, under proposed 
Section 5(c)(i) the BSE would prohibit a Market Maker from rejecting a 
Directed Order. Under proposed Section 5(c)(ii), a Market Maker has 
only two choices when he receives a Directed Order: (1) submit the 
order to the PIP process; or (2) send the order back to BOX for 
placement onto the BOX Book. If a Market Maker chooses to submit the 
Directed Order to the PIP process and he is currently quoting at a 
price equal to the NBBO, he must not adjust his quote prior to 
submitting such Directed Order to the PIP process.
    Proposed Section 5(c)(iii) addresses the requirements when a Market 
Maker chooses not to enter the Directed Order into the PIP process, and 
therefore, must send the Directed Order to BOX for placement on the BOX 
Book. The following steps describe the Directed Order process from this 
point:
    Step 1: Does the Market Maker who is sending the Directed Order to 
BOX have a quote on the opposite side of the Directed Order equal to 
the NBBO?
    [sbull] If YES, then proceed to Step 4.
    [sbull] If NO, then proceed to Step 2.
    Step 2: The Market Maker would submit the Directed Order to BOX. 
The BOX trading engine would determine if the Directed Order were 
executable against the NBBO (the answer is ``yes'' in the case of a 
Directed Order that is also a BOX-Top Order).
    [sbull] If NO, then BOX would place the Directed Order on the BOX 
Book to be treated as any other order.
    [sbull] If YES, then BOX would proceed to Step 3.
    Step 3: BOX would determine whether there are any quotes/orders on 
the BOX Book, which are equal to the NBBO.
    [sbull] If NO, then BOX would submit the Directed Order to the 
trade-through filter process pursuant to proposed Chapter V, Section 
16(b), described above.
    [sbull] If YES, then BOX would execute the Directed Order against 
the quotes/orders on the BOX Book. If there is still any quantity 
remaining of the Directed Order, it would be filtered against trading 
through the NBBO according to the procedures set forth in Chapter V, 
Section 16(b) of these Rules and, if applicable, placed on the BOX 
Book.
    Step 4: If a Market Maker's quote on the opposite side of the 
market from the Directed Order is equal to the NBBO, then the Market 
Maker would determine if the Directed Order is executable against the 
NBBO.
    [sbull] If NO, then the Market Maker must send the Directed Order 
to BOX for placement on the BOX Book to be treated as any other order.

[[Page 50817]]

    [sbull] If YES, then the Market Maker must guarantee execution of 
the Directed Order at the current NBBO for at least the size of his 
current quote. This guarantee would be defined as a Guaranteed Directed 
Order (``GDO'').
    Step 5: The Market Maker must then immediately send the Directed 
Order and the GDO to BOX.
    Step 6: Upon receipt of the Directed Order and the GDO, BOX would 
execute the Directed Order against any quotes/orders already on the BOX 
Book, except the quote of the Market Maker who submitted the Directed 
Order and GDO.
    Step 7: If there were any quantity remaining of the Directed Order, 
then BOX would send to all BOX Participants a Directed Order Broadcast 
(``DOB'') message indicating the side (buy/sell), remaining size, and 
guaranteed price of the Directed Order.
    Step 8: The Market Maker would be prohibited from executing for his 
proprietary account against the Directed Order for at least three 
seconds. During that time the Market Maker would not be allowed to 
decrement the size or worsen the price of his GDO. However, he would be 
able to increase the size of his GDO or improve its price (in standard 
five or ten cent increments only). During that period, any BOX 
Participant, except the Market Maker who submitted the Directed Order 
to BOX, may submit an order to the BOX Book in response to the DOB. 
Such a DOB response order would be treated as a BOX Limit Order. During 
that three-second period, any order submitted to the BOX Book that 
matches any order(s) on the BOX Book, except the Market Maker's GDO, 
would be executed.
    If the Market Maker received a subsequent Directed Order during 
this period, pursuant to subparagraphs (c)(ii) and (iii), he would be 
able to either submit it to the PIP process or send it to the BOX Book, 
following the same process as for the first Directed Order. BOX would 
process any subsequent Directed Orders in sequence as they are 
submitted to BOX for either the PIP process or for placement on the BOX 
Book. Any remaining quantity of a Directed Order that may be placed on 
the BOX Book, such as at the end of either step 3 (above) or step 9 
(below), is treated like other orders placed on the BOX Book. 
Therefore, the remaining quantity may execute against another Directed 
Order on the opposite side of the market, whether that second Directed 
Order is submitted to the PIP process or placed on the BOX Book.
    Step 9: Three seconds after sending the DOB, BOX would release the 
remaining quantity of the Directed Order to the BOX Book. At that time, 
BOX would immediately execute any orders on the BOX Book, including 
those submitted in response to the DOB, against the Directed Order on a 
price-time priority basis. However, the BOX trading engine would ensure 
that the GDO would yield priority to all such competing orders at the 
same price. If there is still any quantity remaining of the Directed 
Order, it would be filtered against trading through the NBBO according 
to the procedures set forth in Chapter V, Section 16(b) of these Rules 
and, if applicable, placed on the BOX Book.
    The BSE believes that use of the DOB and the exposure of the 
Directed Order to the BOX market will serve to ensure that a Market 
Maker would not be able to act against the Directed Order using any 
privileged or other information regarding that order. In addition, the 
BSE has eliminated the exemption in Section 10(g) and amended Section 
10(h) in order to clarify that Market Makers must comply with all 
provisions of the Section 10 when they receive and handle Directed 
Orders. In total, these amendments will ensure that Directed Orders are 
not disadvantaged or treated inconsistent with the BOX or BSE Rules.
    The pertinent rule additions are as follows: Section 5--
    (c) When acting as agent for a Directed Order, a Market Maker must 
comply with subparagraphs (i)-(iii) of this Paragraph (c).
    i. A Market Maker that receives a Directed Order shall not, under 
any circumstances, reject the Directed Order.
    ii. Upon receipt of a Directed Order a Market Maker must either:
    (1) Submit the Directed Order to the PIP process, pursuant to 
Chapter V, Section 18 of these Rules. Under this option, if the Market 
Maker is currently quoting at a price on the opposite side of the 
Directed Order equal to the NBBO, he is prohibited from adjusting his 
quotation prior to submitting the Directed Order to the PIP process.
-or-
    (2) Send the Directed Order to the BOX Book pursuant to 
subparagraph (c)(iii) below.
    iii. When a Market Maker chooses not to enter the Directed Order 
into the PIP process, and therefore, must send the Directed Order to 
BOX for placement on the BOX Book, the following requirements shall 
apply:
    (1) If the Market Maker's quotation on the opposite side of the 
market from the Directed Order is not equal to the NBBO, then the 
Market Maker must send the Directed Order to BOX.
    a. The Trading Host will determine if the Directed Order is 
executable against the NBBO.
    1. If the order is not executable against the NBBO, then the 
Trading Host will enter the Directed Order onto the BOX Book for 
processing consistent with all non-executable orders.
    2. If the Directed Order is executable against the NBBO, then the 
Trading Host will determine if there are any orders on the BOX Book 
equal to the NBBO.
    i. If there are no orders on the BOX Book equal to the NBBO, then 
the Trading Host will filter the Directed Order against trading through 
the NBBO according to the procedures set forth in Chapter V, Section 
16(b) of these Rules.
    ii. If there are orders on the BOX Book equal to the NBBO, then the 
Trading Host will execute the Directed Order against those orders. Any 
remaining quantity will be filtered against trading through the NBBO 
according to the procedures set forth in Chapter V, Section 16(b) of 
these Rules and, if applicable, placed on the BOX Book.
    (2) If the Market Maker's quotation on the opposite side of the 
market from the Directed Order is equal to the NBBO, then the Market 
Maker will determine if the Directed Order is executable against the 
NBBO.
    a. If the order is not executable against the NBBO, then the Market 
Maker must send the Directed Order to BOX for placement on the BOX Book 
for processing consistent with all non-executable orders.
    b. If the order is executable against the NBBO, then the Market 
Maker shall guarantee execution of the Directed Order at the current 
NBBO for at least the size of his quote. This guarantee shall be called 
a Guaranteed Directed Order (``GDO''). The Market Maker must 
immediately send the Directed Order with the GDO to the Trading Host.
    1. The Market Maker who submitted the Directed Order and the GDO to 
the Trading Host:
    i. Shall not submit to the BOX Book a contra order to the Directed 
Order for his proprietary account until the Directed Order is released 
to the BOX Book pursuant to subparagraph (c)(iii)(2)(b)(4) below.
    ii. Shall not decrement the size or worsen the price of his GDO.
    iii. May increase the size of his GDO.
    iv. May improve the price of his GDO (only in five or ten cent 
minimum trading increments, as applicable pursuant to Chapter V, 
Section 6 of these Rules).
    v. Upon receipt of a subsequent Directed Order, may either submit 
it to the PIP process or send it to the BOX

[[Page 50818]]

Book pursuant to subparagraphs (c)(ii) and (iii).
    2. Upon receipt of the Directed Order, the Trading Host will 
execute the Directed Order against any matching orders on the BOX Book, 
except the order of the Market Maker who submitted the Directed Order.
    3. If there is any quantity remaining of the Directed Order, then 
BOX will send to all BOX Participants a Directed Order Broadcast 
(``DOB'') message indicating the side (buy/sell), remaining size, and 
guaranteed price of the Directed Order. For the following three 
seconds, any BOX Participant, except the Market Maker who submitted the 
Directed Order, may submit an order to the BOX Book in response to the 
DOB. Such a DOB response order will be treated as a BOX Limit Order.
    4. During the three-second period following the DOB, any order 
submitted to the BOX Book that matches an order already on the BOX Book 
will be executed. Three seconds after the DOB, the Trading Host will 
release the remaining quantity of the Directed Order to the BOX Book. 
At that time, the Trading Host will immediately execute any orders on 
the BOX Book against the Directed Order on a price-time priority basis. 
The GDO shall yield priority to all such competing orders at the same 
price. Any remaining quantity of the Directed Order will be filtered 
against trading through the NBBO according to the procedures set forth 
in Chapter V, Section 16(b) of these Rules and, if applicable, placed 
on the BOX Book.
    Proposed Chapter VI, Section 6(b) and (f)--BOX Market Makers 
undertake a meaningful obligation to provide continuous two-sided 
markets. These obligations include the requirement that quotations be 
for a size of at least ten contracts, and within the legal width of the 
market. Under the amendments to the proposed rules, a Market Maker must 
respond to a Request for Quote (``RFQ'') message within fifteen 
seconds, with a similarly valid quotation. The Exchange believes that 
this fifteen-second period is ample time for a Market Maker to respond 
in an automated market, particularly given other BOX features, such as 
the PIP, which require a much shorter response time. Nevertheless, 
realizing that an RFQ may require a Market Maker to furnish a quote 
where he might not otherwise choose to, the BSE is proposing that 
fifteen seconds is a sufficient amount of time in which to enable a 
Market Maker to generate a meaningful quotation response. Although the 
BSE is confident that it has provided a marketplace, which will be 
robust and liquid, the delineated responsibilities added to this 
section will serve to guarantee that Market Makers provide liquidity to 
the market, and do so on a continuous basis.
    The added language to Section 6(b) is set forth as follows:

    ii. If a Market Maker is not already posting a valid (i.e. for 
ten contracts, within the legal width of the market, as applicable) 
two-sided quote in a series in a class in which he is appointed as 
Market Maker, he must post a valid two-sided quote within fifteen 
(15) seconds of receiving any RFQ message issued. The valid two-
sided quote so posted must be retained by the Market Maker for at 
least thirty (30) seconds.
    iii. Every RFQ message issued, and every responsive quote, must 
be for a minimum size of at least ten contracts, and must be within 
the legal width of the market, as applicable.

    In paragraph (f) the BSE has changed the time period to six months 
for which the Board would have exemptive authority to grant Market 
Makers exemptions from the requirements of paragraph (e)(iii) of this 
Section 6.
    Proposed Chapter VIII, Section 7--The BSE has added anti-money 
laundering provisions similar to the rules in place on other exchanges.
    Proposed Chapter XI--To clarify that OFPs, as opposed to Options 
Participants generally, are the only types of Participants that can 
deal directly with the public, the BSE has changed the references to 
``Options Participants'' to ``OFPs'' throughout Chapter XI, ``Doing 
Business with the Public.''
    Proposed Chapter XII--As with all options exchanges, the BSE is 
adding Intermarket Linkage Rules to the BOX Rules. These rules are 
substantially similar to the rules in place on all of the options 
exchanges. Several Comment Letters expressed concern regarding BOX's 
participation in the Intermarket Linkage Plan. Subject to Commission 
approval, BOX, through the BSE, would become a full participant in the 
Intermarket Linkage Plan (``Linkage'' or ``Plan'') for the options 
markets. As such, BSE would comply with the obligations of the Plan and 
has added Intermarket Linkage Rules to the BOX Rules. The following is 
an overview of how the BOX Market would interact in the Plan and is not 
intended to be a comprehensive discussion of how the proposed 
Intermarket Linkage Rules of Chapter XII of the BOX Rules \12\ apply to 
Options Participants:
---------------------------------------------------------------------------

    \12\ See Proposed BOX Rules, Chapter XII (Intermarket Linkage 
Rules).
---------------------------------------------------------------------------

    Principal (``P'') Orders Sent From BOX to Away Markets. A BOX 
Eligible Market Maker (``BEMM'') \13\ may submit a P order to the BOX 
trading engine for routing to one or more away markets provided the 
following conditions are satisfied:
---------------------------------------------------------------------------

    \13\ A BOX Market Maker who meets the requirements of an 
Eligible Market Maker as set forth in the Plan.
---------------------------------------------------------------------------

    [sbull] The BEMM is a BOX Market Maker on the class for which the P 
order is submitted.
    [sbull] The BEMM has complied with the Plan's ``80/20 rule'' for 
the previous calendar quarter.
    [sbull] Prior to sending the P order, the BEMM is posting a bid and 
an offer for at least ten contracts within the allowable price spread 
for the class.
    Provided the above conditions are met, the BOX trading engine would 
automatically route the BEMM's P order to the designated exchange and 
transmit back any responses (e.g., order executions, rejections) that 
BOX receives from the away market via OCC.
    P Orders Sent From Away Markets to BOX. Orders sent to BOX by 
Eligible Market Makers (as set forth in the Plan) from away exchanges 
via the Linkage are processed as though they were orders received 
directly from a BOX Participant. That is, these orders would execute 
automatically on the BOX trading engine against any orders on the BOX 
Book up to either the quantity on the BOX Book at that price or the 
actual quantity of the P order, whichever is less, but in no event for 
less than ten contracts. BOX would automatically attempt to fill any 
remaining quantity by exposing the unexecuted portion at the NBBO for 
three seconds to all BOX Participants.
    Principal-as-Agent (``PA'') Orders Sent From BOX to Away Markets. 
To ensure that there is an Eligible Market Maker per Eligible Class (as 
those terms are defined in the Plan) for the submission of PA and 
Satisfaction orders to away markets, BOX would specifically designate a 
BEMM in each Eligible Class traded on BOX responsible for such orders. 
The BEMM would adhere to the responsibilities of an Eligible Market 
Maker as set forth in the Plan.
    Only orders submitted by BOX Participants on behalf of Public 
Customer accounts may generate a PA order. Each Public Customer order 
is checked against the NBBO using BOX's trade-through filter mechanism 
as set forth in chapter V, section 16(b) (described above). If BOX is 
not matching the away best price, the order is exposed to BOX 
Participants for three seconds at the NBBO price.
    At the end of this three-second period, if the order is not fully 
executed

[[Page 50819]]

and a better price exists at an away exchange(s), a PA order is 
generated automatically by the BOX and routed to the away exchange with 
the required BEMM, clearing and valid-clearing-firm (``VCF'') 
information included. Each execution received from an away exchange 
results in the automatic generation of a trade execution on BOX between 
the original Public Customer Order and the BEMM.
    PA Orders Sent From Away Markets to BOX. In the case when BOX 
receives PA orders from away markets, but BOX is no longer quoting at 
the NBBO, then such PA orders are filtered against trade-throughs in 
the same manner as Public Customer orders submitted by BOX Participants 
as set forth in Chapter V, section 16(b), described above. If their 
execution would cause a trade-through, the PA orders are exposed to BOX 
Participants for three seconds at the NBBO price. If PA orders are not 
fully executed at the end of this period, the residual quantity is 
canceled back to the originating away exchange. In this manner, PA 
orders are afforded the same opportunity for execution as Box Public 
Customer orders.
    Satisfaction (``S'') Orders Sent From BOX to Away Markets. Each BOX 
Participant may request, on behalf of a Public Customer, that BOX route 
an S order to an away market for orders on BOX that were traded through 
by the away market. BOX would systemically verify the validity of the 
request (e.g., as to Public Customer status, time stamp of order prior 
to report of trade-through), and, if valid, generate an S order with 
the required BEMM, clearing and VCF information included. As execution 
confirmation is received from the away market, the BOX trading engine 
would automatically generate offsetting trades between the original BOX 
Public Customer order and the BEMM.
    Satisfaction Orders Sent From Away Markets to BOX. S orders 
received from away markets are systemically verified (e.g., as to 
Public Customer status, time of trade-through on BOX). Once verified, 
the BOX Participant that caused the trade-through is identified and, 
within three minutes, the S order is executed against that BOX 
Participant. Where there were multiple S orders, the executions are 
made pro rata with the total not to exceed the lesser of the trade, 
which caused the trade-through or the total quantity of the S orders.
    Proposed Chapter XIII--The BSE is adding a new Chapter, entitled 
``Margin Requirements,'' to its proposed BOX Rules. Similar to the 
approach of at least one other options exchange,\14\ the BSE proposes 
to require that BOX Participants and associated persons, among other 
things, adhere to the requirements of either the New York Stock 
Exchange (``NYSE'') or the Chicago Board Options Exchange (``CBOE''), 
as those rules may be in existence from time to time. Additionally, in 
order to ensure that the BOX Rules adequately address situations 
involving Joint Back Office (``JBO'') arrangements for Participants who 
are not an NYSE member and have elected to be bound by CBOE margin 
requirements, the BSE has included in the BOX margin requirements a set 
of rules specifically addressing JBO arrangements. In this way, the 
Exchange is ensuring that its margin rules cross-reference other 
exchanges' rules as appropriate, and, where not sufficient, adequately 
provide for the necessary requirements.
---------------------------------------------------------------------------

    \14\ See e.g., ISE Rule 1202.
---------------------------------------------------------------------------

2. Statutory Basis
    The Exchange believes that the proposed rule change, as amended, is 
consistent with the requirements under Section 6(b) of the Act,\15\ in 
general, and furthers the objective of Section 6(b)(5) of the Act,\16\ 
in particular, in that it is designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transaction in 
securities, to remove impediments to and perfect the mechanism for a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest.
---------------------------------------------------------------------------

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

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 burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.

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

    The Exchange did not solicit or receive written comments on the 
proposed rule change, as amended.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the Exchange consents, the Commission will:
    (A) by order approve such proposed rule change, 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 Amendment No. 3, including whether Amendment No. 3 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room. Copies of such filings will also be available 
for inspection and copying at the principal office of the Exchange. All 
submissions should refer to File No. SR-BSE-2002-15 and should be 
submitted by September 12, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
---------------------------------------------------------------------------

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

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-21450 Filed 8-21-03; 8:45 am]
BILLING CODE 8010-01-P