[Federal Register Volume 68, Number 216 (Friday, November 7, 2003)]
[Notices]
[Pages 63141-63143]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-28073]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48740; File No. SR-Amex-2002-09]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change and Amendments No. 1 through 11 thereto by the American Stock 
Exchange LLC Relating to Registered Options Traders Use of the 
Electronic Entry Device

November 3, 2003.

I. Introduction

    On February 12, 2002, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change relating to registered options 
traders use of the electronic entry device. The Exchange submitted 
Amendments No. 1, 2, 3, 4, 5, 6, 7, 8 \3\ 9,\4\ 10,\5\ and 11 \6\ on 
February 25, 2002, May 6, 2002, May 29, 2002, June 18, 2002, July 17, 
2002, September 16, 2002, January 21, 2003, July 15, 2003, July 25, 
2003, August 26, 2003, and September 12, 2003, respectively. The 
proposed rule change and Amendments No. 1 through 11 were published for 
comment in the Federal Register on September 25, 2003.\7\ The 
Commission received no comments on the proposal. This order approves 
the proposed rule change and Amendments No. 1 through 11.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ For Amendments No. 1 through 8, the Exchange filed a new 
Form 19b-4 each time, which replaced and superseded the original 
proposal and all previous amendments in their entirety.
    \4\ Letter from Claire P. McGrath, Senior Vice President and 
Deputy General Counsel, Amex, to Elizabeth King, Associate Director, 
Division of Market Regulation (``Division''), Commission, dated July 
24, 2003 (``Amendment No. 9''). Amendment No. 9 transfers to the 
list of rules enforced by the Amex Enforcement Department under 
paragraph (g) of Amex Rule 590 the requirement set forth in proposed 
Amex Rule 933, Commentary .04(d) that the specialist use his best 
efforts to attempt to ensure that the registered options trader 
responsible for disseminating the best bid or offer receives an 
allocation of the next automatic execution.
    \5\ The Exchange filed a new Form 19b-4, which replaced and 
superseded the original proposal and all previous amendments in 
their entirety.
    \6\ Letter from Claire P. McGrath, Senior Vice President and 
Deputy General Counsel, Amex, to Elizabeth King, Associate Director, 
Division, Commission, dated September 11, 2003 (``Amendment No. 
11''). Amendment No. 11 revises proposed changes to Amex Rule 590(g) 
to clarify that a specialist who fails to properly allocate executed 
contracts to the price-improving registered options trader must pay 
restitution in amount calculated by multiplying the number of 
contracts that should have been allocated to the price-improving 
registered options trader by the number of underlying shares 
represented by each contract, which would then be multiplied by half 
of the spread between the option's bid and offer at the time the 
order was executed.
    \7\ Securities Exchange Act Release No. 48495 (September 16, 
2003), 68 FR 55422.
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II. Description of the Proposed Rule Change

    Given the number of series traded for each option class and the 
necessity for the re-calculating and re-quoting of each series in 
response to changes in the price of the underlying security, the 
Exchange developed an automated quotation updating system known as 
XTOPS. The specialist and registered options traders rely upon XTOPS to 
calculate and disseminate a single immediately updated quotation for 
each option series. XTOPS uses option valuation formulas (such as the 
Black-Scholes Model) to generate options quotations based on a number 
of variables.\8\ It is the specialist's responsibility to determine for 
each option class the variables used in the XTOPS formula. However, the 
quotations generated and displayed by XTOPS may result in firm quote 
obligations of both the specialist and registered options traders to 
buy or sell options at quoted prices and sizes.\9\ The dissemination of 
an XTOPS quote can be overridden when a customer limit order represents 
the best bid or offer or when a registered options trader chooses on a 
series-by-series basis to better the disseminated bid or offer.
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    \8\ These variables include the price of the underlying stock, 
time remaining to expiration, interest rates (or ``cost to carry'', 
the amount of interest on the money used to pay for the options 
position during the period prior to expiration of the option 
series), dividends (both declared and anticipated) and volatility.
    \9\ See Rule 11Ac1-1 under the Act (``Quote Rule''), 17 CFR 
240.11Ac1-1, and Amex Rule 958A.
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    The Exchange is now proposing new Commentary .04 to Amex Rule 933, 
to allow registered options traders' direct access to the Electronic 
Entry Device (``EE Device'') to input their own quotes for 
dissemination as the best bid or offer.\10\ The EE Device would be

[[Page 63142]]

available for registered options traders to use in all option classes 
traded on the Exchange.\11\ In active option classes where there is 
currently an Exchange-employed systems clerk, registered options 
traders would either input their own quotes or instruct a systems clerk 
to do so on their behalf. Only registered options traders physically 
located in the trading crowd would be permitted to directly input 
quotes into the EE Device or give such instructions to a systems clerk.
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    \10\ The Exchange submitted the proposed rule change in response 
to subparagraph IV.B.h(i)(aa) of the Commission's September 11, 2000 
Order (``Order''), which requires the Exchange to ``adopt new, or 
amend existing, rules concerning its automated quotation and 
execution systems which substantially enhance incentives to quote 
competitively and substantially reduce disincentives for market 
participants to act competitively.'' 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).
    \11\ The EE Device is currently used by Exchange-employed 
systems clerks in busy option classes to input individual quotes 
from the specialist on a series by series basis that better the 
quote being calculated and disseminated by XTOPS. A quote entered 
using the EE Device is sent directly to the Exchange's Market Data 
System for immediate dissemination to the Options Price Reporting 
Authority. This quote, when it betters the market being disseminated 
by XTOPS, will override or displace the XTOPS quote.
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    Once the registered options trader or systems clerk inputs the 
quote into the EE Device, the proposed rule would require that: (i) The 
price improving registered options trader announce loudly and audibly 
in the crowd that he has improved the displayed market to ensure that 
other crowd participants are aware that the market has been improved, 
enabling other crowd participants to also quote competitively; and (ii) 
the specialist be specifically alerted so that a ``book bid or offer'' 
indicator is activated and the next otherwise Auto-Ex eligible trade is 
routed directly to the Amex Options Display Book (``AODB'') for 
allocation to the registered options trader that caused the improved 
quote to be disseminated. In addition to blocking an otherwise eligible 
Auto-Ex order from being executed and allocated by the Auto-Ex system, 
activation of the ``book bid or offer'' indicator would block an XTOPS 
calculated quote that is worse than the registered options trader's 
disseminated quote from being disseminated. Activation would not, 
however, block a quote that is better than the registered options 
trader's disseminated quote from being disseminated.
    Once an execution occurs and/or the price improving registered 
options trader is no longer entitled to priority, the specialist would 
be required to remove the ``best bid or offer'' indicator so that Auto-
Ex eligible orders would again be sent to Auto-Ex and the dissemination 
of XTOPS calculated quotes is resumed. The EE Device would not 
automatically decrement the size of the disseminated quote when an 
execution occurs. The quote would be required to be manually adjusted 
to reflect any revision to the disseminated size.
    The price improving registered options trader would be permitted to 
cancel his quote at any time prior to the execution of a trade through 
the use of the EE Device (regardless of whether inputted by the 
registered options trader or the systems clerk), if that was the method 
in which the quote was entered, or through the specialist, if that was 
the method chosen. The registered options trader would be required also 
to alert the specialist that he is removing his quote, so the 
specialist can in turn remove the ``book bid or offer'' indicator in 
XTOPS, and announce loudly and audibly that he is canceling his quote.
    Pursuant to the requirements of the Quote Rule and Exchange Rule 
958A, the registered options trader as the responsible broker or dealer 
is obligated to execute any customer order at his bid or offer up to 
the disseminated size. To be relieved of that obligation with respect 
to a specific quote, one of the exceptions to the Quote Rule must 
apply, which generally provide that the responsible broker or dealer 
must communicate a revised quotation to the Exchange prior to the 
presentation of an order. Thus, a registered options trader using the 
EE Device to disseminate quotes would continue to be obligated pursuant 
to the Quote Rule until he has communicated a revised quote to the 
Exchange through the removal or cancellation of the quote on the EE 
Device.
    Registered options traders would be required to improve the best 
bid or offer by an amount equal to at least the minimum price variation 
as set forth in Exchange Rule 952 for the quote to be inputted into the 
EE Device. The minimum size quote that could be inputted into the EE 
Device by or on behalf of a registered options trader would be 20 
contracts, unless the Auto-Ex eligible size parameter for that option 
class is less than 20 contracts, in which case the minimum quote size 
would be the same as the lesser Auto-Ex eligible size parameter for 
that option class. Currently, the EE Device disseminates a default size 
for each new quote. The disseminated size may be set at a higher or 
lower amount or increased by the specialist to reflect additional 
liquidity at that quote. The default size would be set at the minimum 
quote size as discussed above.
    The Exchange represents that there is at least one EE Device unit 
at every trading post and multiple units at posts where active option 
classes trade and that the number of devices currently in place on the 
trading floor would be sufficient to provide registered options traders 
with ready and easy access to a means for disseminating their quotes. 
However, since this is a new use for the EE Device, the Exchange 
represents that it will monitor the uses of the EE Device by registered 
options traders and activity in the option classes at each trading post 
and will add additional devices when necessary. The Exchange is able to 
install additional EE Devices at the trading posts with, preferably, a 
one-day notice so that they can be installed either before or after 
trading hours.
    The specialist in a given option class may also disseminate or 
cause to be disseminated his own individual, price improving quote 
separate from the XTOPS calculated quote, provided he is physically 
located at the trading post at the time he inputs his quote, has only 
disseminated one quote per series on the same side of the market, has 
announced loudly and audibly to the crowd that he has improved the 
disseminated bid or offer, has improved the best bid or offer by an 
amount equal to at least the minimum price variation set forth in Rule 
952, and has disseminated the minimum quote size. The specialist would 
not be able to use the EE Device to disseminate his individual price 
improving quote since he already has the means to input a quote into 
the Market Data System through XTOPS in the same manner used today to 
disseminate a customer limit order. Once the specialist has caused his 
individual quote to be disseminated, he will activate the ``book bid or 
offer'' indicator and the next otherwise Auto-Ex eligible trade is 
routed directly to the AODB for allocation to the specialist.
    The specialist would be required to use best efforts to attempt to 
ensure that the registered option trader responsible for disseminating 
the best bid or offer receives an allocation of the next incoming order 
for the amount he is entitled to pursuant to Exchange rules. A 
specialist who failed to use best efforts to attempt to ensure that the 
next Auto-Ex execution is appropriately allocated to the price 
improving registered options trader would be fined pursuant Amex Rule 
590(g) of the Exchange's Minor Rule Violation Fine System. In addition 
to the fine assessed pursuant to the Minor Floor Violation Fine System, 
violations of this provision would require the payment of

[[Page 63143]]

restitution. Restitution would be calculated by multiplying the number 
of contracts that should have been allocated to the price-improving 
registered options trader by the number of underlying shares 
represented by each contract, which would then be multiplied by half of 
the spread between the option's bid and offer at the time the order was 
executed.
    If more than one registered options trader and/or the specialist 
has disseminated or caused to be disseminated the same price improving 
quote, priority would be established for the registered options traders 
in the order in which the quotes were announced loudly and audibly to 
the trading crowd. If, however, the sequence in which the disseminated 
quotes were made cannot be reasonably determined, priority would be 
afforded to the price improving registered options traders and/or 
specialist as a group. Exchange Rule 950(d), Commentary .06 and 
Exchange Rule 950(n), Commentary .03 govern allocations of contracts 
when more than one registered options trader and/or the specialist has 
disseminated the same price improving quote and time priority cannot be 
established.
    However, pursuant to the proposed rule change, the price improving 
registered options traders' quote would retain priority until one of 
the following occurs: (i) Auto-Ex execution depleted the disseminated 
size; (ii) an amount equal to the minimum quote size has been 
allocated; (iii) the registered options trader withdraws the quote; 
(iv) the quote is matched or improved by the specialist's automated 
quotation system quote, provided specialists using an Exchange-approved 
proprietary automated quotation updating system have not programmed the 
system to immediately match or improve the price improving registered 
options trader's quote; (v) the quote is improved by another registered 
options trader; or (vi) the market is improved by an order placed on 
the limit order display book. With respect to subparagraph (iv) above, 
the Exchange represents that it will monitor the use of proprietary 
automated quotation updating systems through the review of complaints 
from members in the trading crowd as well as observations of Floor 
Officials and Exchange personnel to determine if the system has been 
programmed to immediately match or improve the price improving 
registered options trader's quote.
    The Exchange notes that Exchange rules regarding customer priority 
and parity would continue to apply to the allocation of trades pursuant 
to the proposed rule change. Exchange Rule 111, Commentary .07 provides 
that a registered options trader, when establishing or increasing a 
position, may not retain priority over or have parity with an off-Floor 
order. Thus, only registered options traders closing or decreasing a 
position may be on parity with a customer order.

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the Act and the rules and 
regulations promulgated thereunder applicable to a national securities 
exchange and, in particular, with the requirements of Section 6(b) of 
the Act.\12\ Specifically, the Commission finds that approval of the 
proposed rule change, as amended, is consistent with Section 6(b)(5) of 
the Act \13\ in that it is designed to facilitate transactions in 
securities; 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 transactions in securities; to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system; and in general, to protect investors and the public interest.
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    \12\ 15 U.S.C. 78f(b). In approving this proposal, the 
Commission has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \13\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposed rule change, by 
permitting registered options traders to use an EE Device at the 
trading post to input their own quotes for dissemination as the best 
bid or offer and then providing price improving registered options 
traders with an allocation of the next Auto-Ex execution, should help 
to encourage competitive quoting. In addition, the Commission believes 
that providing a method for specialists to input their own price 
improving quotes separate from the autoquote, and then routing the next 
otherwise Auto-Ex eligible order to the AODB for allocation to the 
specialist, should provide an additional incentive for specialists to 
quote competitively. The Commission believes that the proposal is an 
important first step towards achieving compliance with the Order's 
directive to substantially enhance incentives to quote competitively 
and substantially reduce disincentives for market participants to act 
competitively.
    The Commission notes that the proposal requires the specialist to 
use best efforts to ensure that a price improving registered options 
trader receives his allocation. The Commission believes that imposition 
of a fine, under the Exchange's Minor Rule Violation Plan, on a 
specialist who fails to use best efforts to ensure that the next Auto-
Ex execution is appropriately allocated, as well as the requirement 
that such specialist pay restitution to the injured registered options 
trader, should provide sufficient safeguards to help ensure that the 
manual allocation to the appropriate registered options trader occurs.

IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, with Section 6(b)(5) of the Act.\14\
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    \14\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-Amex-2002-09) and Amendments 
No. 1 through 11 are approved.
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    \15\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-28073 Filed 11-6-03; 8:45 am]
BILLING CODE 8010-01-P