[Federal Register Volume 68, Number 232 (Wednesday, December 3, 2003)]
[Notices]
[Pages 67720-67732]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-30062]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48847; File No. SR-Phlx-2003-73]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Nos. 1 and 2 Thereto by the Philadelphia Stock 
Exchange, Inc. Relating to the Demutualization of the Philadelphia 
Stock Exchange, Inc.

November 26, 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 November 17, 2003, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the Exchange. On 
November 24, 2003, the Phlx submitted Amendment No. 1 to the proposed 
rule change.\3\ On November 26, 2003, the Phlx submitted Amendment No. 
2 to the proposed rule change.\4\ The Commission is publishing this 
notice to solicit comments on the proposed rule change, as amended, 
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 Edith Halihan, Deputy General Counsel, Phlx 
to Nancy Sanow, Assistant Director, Commission, Division of Market 
Regulation (``Division'') dated November 21, 2003. (``Amendment No. 
1''). In Amendment No. 1, the Phlx made technical conforming changes 
to the exhibits of the proposed rule change.
    \4\ See Letter from Edith Halihan, Deputy General Counsel, Phlx 
to Nancy Sanow, Assistant Director, Commission, Division dated 
November 26, 2003. (``Amendment No. 2''). In Amendment No. 2, the 
Phlx amended the proposed rule change to reflect that on November 
25, 2003, the members of the Phlx (as that term is defined in 
Section I-1(b) of the current By-laws of the Phlx, the ``Members'') 
approved the Plan of Conversion, the Merger, and all transactions to 
be effected in connection therewith. Also, on November 18, 2003, 
holders of equitable title (``Owners'') to memberships in the Phlx 
(each such membership a ``Seat'') voted to approve the Plan of 
Demutualization as a whole.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx, pursuant to Section 19(b)(1) and Rule 19b-4 
thereunder,\5\ proposes to: (i) First amend Article FOURTH of its 
Certificate of Incorporation to eliminate the terms providing that it 
is ``not for profit'' and that ``no dividend shall ever be paid by the 
Corporation'' (``Plan of Conversion'' and such amendment to the 
Certificate of Incorporation, the ``Conversion Amendment''); and (ii) 
subsequently merge a newly created, wholly-owned shell subsidiary of 
the Phlx with and into the Phlx, with the Phlx surviving as a 
``demutualized'' \6\ Delaware stock corporation (the ``Merger,'' and 
together with the Plan of Conversion, the ``Plan of Demutualization'') 
pursuant to an Agreement and Plan of Merger (``Merger Agreement'').\7\ 
In connection with the Plan of Demutualization, the Phlx will amend its 
Certificate of Incorporation (``Certificate of Incorporation''), By-
laws (``By-laws'') and Rules of the Board of Governors, Option Rules, 
ITS Rules and Options Floor Procedure Advices (collectively, the 
``Rules'').\8\ The Phlx will, upon completion of the Demutualization, 
issue pursuant to the Merger Agreement 100 shares of its Class A Common 
Stock to each equitable titleholder of an Exchange membership. As 
discussed more fully below, the Phlx will also issue one share of 
Series A-1 Preferred Stock, par value $0.01 (``Series A Preferred 
Stock'') to the ``Phlx Member Voting Trust'' (the ``Trust'') in 
accordance with an Amended and Restated Trust Agreement (``Trust 
Agreement'').
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    \5\ 17 CFR 240.19b-4.
    \6\ This process is also referred to in this notice as the 
``Demutualization.''
    \7\ Under the existing Certificate of Incorporation and By-laws 
and applicable law, the approval of the Owners is not required to 
effect the Plan of Demutualization.
    \8\ In certain limited cases, the proposed rule change also 
reflects the deletion of obsolete provisions and other necessary 
updates in the By-laws and the Phlx Rules that are not directly 
related to the Plan of Demutualization and are summarized in greater 
detail below.
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    The proposed changes to the Certificate of Incorporation, the By-
laws and the Rules, as well as the Trust Agreement and the Conversion 
Amendment are collectively referred to herein as the ``Proposed Rule 
Change.'' The text of the amendments to the Certificate of 
Incorporation, By-laws and Rules is available at the Office of the 
Secretary, the Phlx, and at the Commission.

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 Phlx 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 
Exchange has prepared summaries, set forth in Sections A, B, and C 
below, of the most significant aspects of such statements. The text of 
the proposed rule change is available at the Office of the Secretary, 
the Phlx, at the Commission, and on the Commission's website.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The purpose of the Proposed Rule Change is to implement the Plan of 
Demutualization of the Phlx. In connection with such Plan of 
Demutualization, trading privileges will be separated from corporate 
ownership of the Phlx and will be made available exclusively through 
trading permits, as described in greater detail below. \9\
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    \9\ The Exchange, however, does plan to retain its existing 
Foreign Currency Option (``FCO'') participations (as defined in 
Section 1-1(m) of the current By-laws). After the Demutualization, 
the ability to trade FCOs on the Phlx will also be available through 
a Series A-1 Permit, as set forth in proposed Rule 908(b).
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    As a result of the Demutualization, the total of 50,500 shares of 
Class A Common Stock (100 shares per Seat) issued to existing equitable 
Seat holders will represent 100% of the common equity ownership in the 
Phlx outstanding immediately after the Demutualization, and all Members 
and holders of equity trading permits \10\ who are affiliated with 
Member Organizations and are not suspended will be entitled to receive 
new Series A-1 Permits (described further below) to enable them to 
continue their activities on the Exchange without interruption. 
Similarly, Member Organizations will maintain their status upon their 
compliance with certain deposit and registration requirements, as 
described in greater detail below.
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    \10\ Pursuant to Rule 23 of the existing Phlx Rules, the 
Exchange has issued equity trading permits (``ETPs''), four of which 
are currently outstanding. As described in greater detail below, in 
the Demutualization, these ETPs will be eliminated in accordance 
with existing Rule 23 and pursuant to proposed Rule 971, and the 
rights and privileges of ETPs will be conferred on existing ETP 
holders by Permits, as described below.
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    After the effective date of the Demutualization, the Exchange will 
continue to be a national securities exchange registered under Section 
6 of the Act.\11\ Except as will be necessary to implement the new 
permit structure to replace the existing structure of owning and 
leasing Seats as a basis for trading rights and Exchange memberships, 
the

[[Page 67721]]

Exchange is not proposing any significant changes to its existing 
operational and trading structure in connection with the 
Demutualization. Also, the Demutualization will not affect the 
functions of the Exchange as a self-regulatory organization (``SRO'') 
and will not affect the designation of the Exchange as ``designated 
examining authority'' (``DEA'') for the Member Organizations for which 
the Exchange is the DEA today. In particular, the Exchange is not 
proposing to make any changes to the existing disciplinary system, 
fines or the related appellate process in connection with the Plan of 
Demutualization.\12\
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    \11\ 15 U.S.C. 78f.
    \12\ Separately, the Exchange intends to file a proposed rule 
change to adopt fees applicable to Series A-1 Permits and to make 
conforming changes to its fee schedule as a result of the 
Demutualization. Accordingly, the Merger Agreement provides that the 
effectiveness of the Merger (and thus the Plan of Demutualization in 
general) will be, inter alia, conditioned upon such filing becoming 
effective or being approved by the Commission, as the case may be.
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    The Exchange proposes to effect the Plan of Demutualization and the 
Proposed Rule Change for the following reasons: (i) The Phlx is facing 
significant financial challenges, and without the Demutualization the 
Phlx's viability in its current operating structure is questionable; 
(ii) without the Demutualization, the Phlx will be limited, to a large 
degree, to its current base of Members and Owners as a source of 
capital and revenue; (iii) the Demutualization of the Phlx will 
potentially facilitate the Exchange's ability to enter into 
relationships with strategic or financial partners who may be crucial 
for the Exchange's future development, capital formation and viability; 
(iv) the new permit structure may facilitate the introduction of new 
products on the Exchange and will potentially increase transaction 
volume and Exchange revenues; and (v) a demutualized Exchange will be 
better positioned to react to new opportunities and challenges.
    In addition to those portions of the Proposed Rule Change which 
relate directly or indirectly to the Plan of Demutualization, described 
below under ``Summary of Demutualization--Related Changes,'' the 
Exchange is also proposing certain other revisions to the By-laws and 
the Rules as part of the Proposed Rule Change, which are primarily 
related to the deletion of out-dated or otherwise obsolete provisions 
in the By-laws and Rules, including changes required to conform the By-
laws to requirements under the Act. These changes are summarized below 
under ``Summary of Non-Demutualization-Related Changes.''
i. Summary of Demutualization-Related Changes
    The following summarizes the proposed material changes to the 
Certificate of Incorporation, the By-laws and the Rules (collectively, 
the ``Governing Documents'') of the Exchange in connection with the 
Plan of Demutualization:

A. Capital Structure of the Demutualized Phlx

    Changes to the capital structure of the Phlx, as set forth in 
Article FOURTH of the proposed Certificate of Incorporation, generally 
reflect the proposed conversion of the Phlx from a non-stock Delaware 
corporation to a demutualized Delaware stock corporation. As discussed 
in greater detail below, the single share of the Series A Preferred 
Stock, issued to the Trust governed by the Trust Agreement, is designed 
to facilitate the exercise by Members and Member Organizations of their 
rights to fair representation in the selection and removal of On-Floor 
Governors of the Exchange and to facilitate the administration of the 
affairs of the Exchange in accordance with the Act. The voting 
arrangements implemented through the Trust Agreement and the Series A 
Preferred Stock are designed to give ``members'' (as defined in Section 
3(a)(3)(A) of the Act)\13\ a voice in the management of the Exchange 
after the Demutualization. These arrangements are necessary for two 
reasons: (i) Under Delaware law, only stockholders can elect the 
directors of a Delaware corporation; and (ii) after the 
Demutualization, Members and Member Organizations that were not Owners 
at the time of the Demutualization will not be stockholders of the 
Exchange.
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    \13\ 15 U.S.C. 78c(a)(3)(A).
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Authorized and Issued Capital Stock
    Pursuant to Article FOURTH of the proposed Certificate of 
Incorporation, after the Merger, the authorized capital stock of the 
Phlx will consist of:
    [sbull] 50,500 shares of Class A Common Stock;
    [sbull] 949,500 shares of Class B Common Stock, par value $0.01 per 
share (``Class B Common Stock,'' and together with the Class A Common 
Stock, the ``common stock''); and
    [sbull] 100,000 shares of preferred stock, par value $0.01 per 
share, one of which will be designated as ``Series A Preferred Stock.''
    Upon consummation of the proposed Demutualization, the only capital 
stock outstanding will be the 50,500 shares of Class A Common Stock and 
the single share of Series A Preferred Stock. The Exchange proposes to 
authorize more shares of common stock (in the form of the Class B 
Common Stock) and preferred stock to allow for a more flexible approach 
to third-party investments and strategic relationships, which the 
Exchange believes will be critically important to its survival. Article 
FOURTH of the proposed Certificate of Incorporation will allow the 
Board of Governors to create and issue in the future additional classes 
or series of preferred stock without stockholder approval. In a 
separate undertaking, however, the Exchange has agreed to submit any 
such creation and issuance of additional classes or series of preferred 
stock to the Commission pursuant to Section 19(b) of the Act.\14\ The 
issuance and the sale, transfer or other disposition of the Exchange's 
capital stock will be subject to certain voting and ownership 
limitations, described below.
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    \14\ 15 U.S.C. 78s(b).
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Common Stock
    Class A Common Stock and Class B Common Stock. Pursuant to Article 
FOURTH(b)(i) of the proposed Certificate of Incorporation, the Class A 
Common Stock and the Class B Common Stock will be identical in all 
respects and will have equal rights and privileges, except for the 
right to receive the Contingent Dividend (as defined below). Pursuant 
to Article FOURTH (b)(vi) of the proposed Certificate of Incorporation, 
each share of Class A Common Stock will automatically convert into one 
share of Class B Common Stock on the third anniversary of the closing 
of the Plan of Demutualization (the ``Dividend Termination Date''). 
\15\ Before the automatic conversion, the proposed Certificate of 
Incorporation will provide that the Exchange will have to notify the 
holders of the Class A Common Stock in accordance with certain specific 
requirements set forth in the Certificate of Incorporation.
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    \15\ The automatic conversion will be effected as a matter of 
administrative convenience to consolidate the common stock into a 
single class after the Contingent Dividend with respect to the Class 
A Common Stock is no longer potentially payable (i.e., on the 
Dividend Termination Date). At the time of conversion, because the 
Contingent Dividend will no longer be potentially payable, the Class 
A Common Stock and the Class B Common Stock will have identical 
rights and privileges.
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    Dividends (including the Contingent Dividend). Currently, the 
existing Certificate of Incorporation provides in Article FOURTH that 
the Phlx is ``not for profit'' and ``no capital stock shall ever be 
issued and no dividend shall ever be paid'' by the Phlx. After the

[[Page 67722]]

Demutualization, this restriction on paying dividends will be removed 
and pursuant to Article FOURTH (a)(i) and (b) of the proposed 
Certificate of Incorporation the Phlx's stockholders will have all 
dividend and other distribution rights of a stockholder in a Delaware 
stock corporation (except as may be limited by the rights any preferred 
stock may have, once issued).
    Section 30-4 of the proposed By-laws, however, will prohibit the 
payment of dividends from any revenues the Phlx derives from regulatory 
fines, fees or penalties.\16\ The Exchange will apply this limitation 
to its net income, prospectively only, commencing with the fiscal year 
in which the Merger occurs.\17\ To determine the amount of the 
limitation, the Phlx will first calculate: (i) The amount of regulatory 
fines, fees and penalties that it has accrued for the fiscal year in 
which the Merger occurs and later time periods (collectively, 
``Regulatory Fee Amount''),\18\ and (ii) the amount of regulatory costs 
and expenses \19\ accrued for the same time period (collectively, 
``Regulatory Cost Amount''). The Exchange will determine the applicable 
restriction by determining the excess, if any, of the Regulatory Fee 
Amount over the Regulatory Cost Amount, and applying that to the amount 
of its net income for the fiscal year in which the Merger occurs and 
later periods. This restriction concerning the payment of dividends 
shall not prevent the Exchange from paying dividends from (i) capital, 
surplus or retained earnings of the Exchange which were (without regard 
to this restriction) available for the payment of dividends at the time 
of the Merger, or (ii) capital contributions or other capital items, in 
each case, no portion of which is attributable to Regulatory Fees.
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    \16\ For another example of such a restriction, see In the 
Matter of the Application of The International Securities Exchange 
LLC for Registration as a National Securities Exchange, Securities 
Exchange Act Release No. 42455 at Part III.A (February 24, 2000), 65 
FR 11388. Securities Exchange Act Release No. 45803 (April 23, 
2002), 67 FR 21306 (April 30, 2002) (Restructuring of the 
International Securities Exchange LLC (``ISE'') from a limited 
liability company to a Delaware stockholder corporation and to 
``demutualize'' by separating the equity interest in the ISE from 
members'' trading rights).
    \17\ The rationales for applying this restriction prospectively 
are: (i) prior to the effectiveness of the Conversion Amendment, the 
Exchange's Certificate of Incorporation has provided that the 
Exchange is ``not for profit'' and has prohibited the payment of 
dividends altogether, and (ii) the Exchange has not compiled, and 
could not reasonably reconstruct, the information necessary for 
determining Regulatory Costs and Regulatory Fee Amounts (as defined 
herein) for prior periods.
    \18\ Regulatory fines and penalties will include such amounts 
imposed by the Business Conduct Committee and/or the Board, but not 
late charges or interest charged. Regulatory fees shall include the 
Exchange's fees relating to registered representative registration 
(currently, initial, renewal and transfer fees), as well as its off-
floor trader (currently, initial and annual) and examinations fees.
    \19\ These amounts include costs reasonably related to the 
Exchange's regulatory function. Specifically, the Exchange intends 
to include the direct and allocated costs and expenses of the 
regulatory and enforcement groups as well as an allocation of the 
direct and allocated costs of technology, legal, compliance and 
other departments that support the regulatory and enforcement groups 
and work on regulatory projects. The Exchange's cost allocation 
methodology includes an employee's compensation and benefits-related 
costs and the overhead attributable to that employee, such as, for 
example, occupancy costs, office supplies, and administrative 
support and an allocation of management costs (again, adding, for 
example, the secretary's and managers' direct and allocated costs).
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    Pursuant to Article FOURTH (b)(ii) of the proposed Certificate of 
Incorporation, the Class A Common Stock will carry with it the right to 
a contingent dividend (the ``Contingent Dividend'') payable in cash if 
a Liquidity Event occurs on or before the Dividend Termination Date. A 
``Liquidity Event'' will be any investment of net cash proceeds in the 
Phlx's capital or that of one of its subsidiaries, either by means of a 
public offering or private placement of the common or preferred stock 
of the Phlx or the common stock or other securities of the subsidiary. 
The amount payable as the Contingent Dividend will depend, as follows, 
on the aggregate amount of net cash proceeds received by the Phlx and/
or the subsidiary from all Liquidity Events occurring on or before the 
Dividend Termination Date:
    [sbull] If the aggregate net cash proceeds will be at least $50 
million but less than $100 million, the amount payable as a Contingent 
Dividend will be $7,500 for each 100 shares of Class A Common Stock 
($3,787,500 in the aggregate).
    [sbull] If the aggregate net cash proceeds will be at least $100 
million but less than $150 million, the amount payable as a Contingent 
Dividend will be $17,500 for each 100 shares of Class A Common Stock 
then outstanding ($8,837,500 in the aggregate).
    [sbull] If the aggregate net cash proceeds will be at least $150 
million, the amount payable as a Contingent Dividend will be $29,700 
for each 100 shares of Class A Common Stock then outstanding 
($14,998,500 million in the aggregate).
    If no Liquidity Event occurs on or before the Dividend Termination 
Date, the right to receive Contingent Dividends will terminate without 
further action on behalf of the Exchange and the Class A Common Stock 
will be automatically converted into Class B Common Stock, as indicated 
above.
    Liquidation Rights and Preferences. Currently, Owners have the 
right to receive all distributions upon a liquidation of the Exchange, 
on the basis of their pro-rata interest in the Phlx, except as such 
right may be limited by certain rights of the holders of FCO 
participations.\20\ After the proposed Demutualization, the Phlx common 
stock will have the right to receive all distributions upon a 
liquidation of the Phlx, subject to the rights of any preferred stock 
that may be issued in the future and by the rights of the holder of the 
Series A Preferred Stock, as described below.
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    \20\ See Article SEVENTEENTH(c) of the existing Certificate of 
Incorporation.
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    Voting Rights/Election of Directors. Currently, for the most part, 
non-Member Owners do not have voting rights under the Exchange's 
existing Certificate of Incorporation, By-laws and Rules with respect 
to any matters relating to the Exchange, with certain very limited 
exceptions.\21\ After the Demutualization, pursuant to Article FOURTH 
(b)(iii) of the proposed Certificate of Incorporation, the Phlx common 
stockholders will vote on all matters on which stockholders are 
entitled to vote except for the election and removal of the On-Floor 
Governors and, in the case of a contest for the position, the selection 
of the On-Floor Vice Chairman of the Exchange.
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    \21\ In addition, existing contractual arrangements between 
Owners of Seats or Member Organizations on the one hand and non-
Owner Members on the other hand, such as leases or A-B-C agreements, 
in all but one case contain a provision that may entitle the Seat 
Owner or the Member Organization, respectively, to direct the 
Member's vote with respect to the Plan of Demutualization.
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    The holders of the Class A Common Stock and Class B Common Stock 
will vote together as a single class on all matters, except that: (i) 
Any amendment, alteration or repeal of any of the provisions of the 
proposed Certificate of Incorporation that adversely affects the 
rights, powers or privileges of the Class A Common Stock (but not of 
the Class B Common Stock) will require the affirmative vote of a 
majority of the shares of the Class A Common Stock then outstanding, 
voting separately as a class; and (ii) any amendment, alteration or 
repeal of any of the provisions of the proposed Certificate of 
Incorporation that adversely affects the rights, powers or privileges 
of the Class B Common Stock (but not of the Class A Common Stock) will 
require the affirmative vote of a majority of the shares of Class B 
Common Stock then outstanding, voting separately as a class.
    In addition, pursuant to Section 22-1 of the proposed By-laws, the 
By-Laws may be amended by the affirmative vote

[[Page 67723]]

of a majority of the entire Board of Governors, or by the affirmative 
vote of the holders of a majority of the shares of common stock then 
issued and outstanding, at any regular or special meeting of the Board 
of Governors or the stockholders (as the case may be). Unlike pursuant 
to Section 22-1 of the existing By-laws, after the Demutualization, 
Members (or Member Organizations) will have no right to vote in 
relation to By-law amendments or to propose By-law amendments. Such 
change is consistent with the Exchange's proposed post-Demutualization 
structure as a Delaware stock corporation in accordance with applicable 
Delaware law.
    With respect to management equity awards post-Demutualization, 
Section 6-1 of the proposed By-laws provides that, the Exchange will 
not at any time adopt any stock incentive or option plan or 
arrangement, or any other equity based compensation plan or 
arrangement, for the benefit of its governors or officers that 
authorizes the issuance of stock, stock options or any other securities 
exercisable or exchangeable for or convertible into any equity interest 
in the Exchange representing more than 10% of the common stock 
outstanding at such time.
    The proposed Article FOURTH (b)(iii)(A) provides also that each 
stockholder will be entitled to one vote for each share of common or 
preferred stock held of record on the books of the Phlx, subject to the 
applicable voting restrictions as described below.
Voting Limitations
    In connection with the Demutualization, the Exchange proposes to 
include certain voting limitations as set forth in Article 
FOURTH(b)(iii)(B) of the proposed Certificate of Incorporation. The 
limitations will provide that, if any Person (as defined below) either 
alone or together with its Related Persons (as defined below), at any 
time owns of record or beneficially, whether directly or indirectly, 
more than 20% of the then outstanding shares of common stock (such 
shares of common stock in excess of such 20% limit being hereinafter 
referred to as ``Excess Shares''), that Person and its Related Persons 
will not have any right to vote, or to give any consent or proxy with 
respect to, the Excess Shares, and the Excess Shares will be deemed not 
to be present for the purposes of determining whether a quorum is 
present at any meeting or vote of the stockholders of the Exchange. For 
purposes of the proposed Certificate of Incorporation, ``Related 
Persons'' means: (i) With respect to any Person, all ``affiliates'' and 
``associates'' of such Person (as such terms are defined in Rule 12b-2 
under the Act); \22\ (ii) with respect to any natural person 
constituting a ``member'' (as such term is defined in the Act) of the 
Exchange, any broker or dealer with which such member is associated; 
and (iii) any two or more Persons that have any agreement, arrangement 
or understanding (whether or not in writing) to act together for the 
purpose of acquiring, holding, voting or disposing of shares of common 
stock. The term ``Person'' will be defined in the proposed Certificate 
of Incorporation to mean an individual, partnership (general or 
limited), joint-stock company, corporation, limited liability company, 
trust or unincorporated organization, and a government or agency or 
political subdivision thereof.
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    \22\ 17 CFR 240.12b-2.
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    Notwithstanding the foregoing, a Person, either alone or together 
with its Related Persons, owning of record or beneficially, whether 
directly or indirectly, more than 20% of the then outstanding shares of 
common stock will be allowed to exercise voting rights, and give 
proxies and consents, with respect to those shares exceeding 20%, 
provided that: That Person (and its Related Persons owning any common 
stock) has delivered to the Board of Governors a notice in writing, not 
less than 45 days (or any shorter period to which the Board of 
Governors shall expressly consent) before the proposed exercise of its 
voting rights, of its intention to do so; and
    [sbull] Before the intended exercise, the Board of Governors has 
adopted an amendment to the By-Laws adding a provision to expressly 
permit that Person's exercise of voting rights in excess of 20% and the 
amendment has been filed with the Commission as a proposed rule change 
under Section 19(b) of the Act \23\ and has become effective.
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    \23\ 15 U.S.C. 78s(b).
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    The Board of Governors will not be permitted to adopt any amendment 
to the proposed By-laws described in the foregoing paragraph unless the 
Board of Governors has determined that: (x) The exercise of those 
voting rights by the Person in question and/or its Related Persons will 
not impair the Exchange's ability to discharge its responsibilities 
under the Act and the rules and regulations thereunder and is otherwise 
in the best interests of the Exchange and its stockholders; (y) the 
exercise of those voting rights by that Person and/or its Related 
Persons will not impair the Commission's ability to enforce the Act; 
and (z) that Person and/or its relevant Related Persons are not subject 
to any applicable statutory disqualification. In making those 
determinations, the Board of Governors may impose on the Person in 
question and its Related Persons such conditions and restrictions as it 
may in its sole discretion deem necessary, appropriate or desirable in 
furtherance of the objectives of the Act and the governance of the 
Exchange. Under the proposed Certificate of Incorporation, however, in 
no event will a Person who is a Member of the Exchange or a Person 
affiliated with a Member Organization be permitted to vote shares 
representing in excess of 20% of the outstanding common stock.
    These voting limitations, together with the ownership and 
notification requirements described below, are intended to establish a 
system of supervision and control to effectively prevent acquisition of 
voting power of or assertion of control over the Exchange without the 
approval of both the Board of Governors and the Commission. In 
addition, the proposed change to the Certificate of Incorporation is 
designed to prevent any Member or Member Organization from dominating 
the Exchange.
Ownership Limitations and Notification Requirements
    No Person, either alone or together with its Related Persons, will 
be allowed to own, of record or beneficially, directly or indirectly, 
more than 40% of the then outstanding shares of common stock of the 
Phlx and to the extent any Person (or its Related Persons) purports to 
own more than 40% of the then outstanding shares of common stock, that 
Person (and its Related Persons) will not be allowed to exercise any of 
the rights or privileges incident to the ownership of shares of common 
stock with respect to the shares exceeding the 40% limit, unless:
    [sbull] That Person (as well as its Related Persons) has delivered 
to the Board of Governors a notice in writing, not less than 45 days 
(or such shorter period to which the Board of Governors expressly 
consents) before the acquisition of that ownership, of its intention to 
acquire the ownership; and
    [sbull] Before the intended exercise, the Board of Governors has 
adopted an amendment to the By-Laws, adding a provision to expressly 
permit that Person's ownership in excess of 40% and the amendment has 
been filed with the Commission as a proposed rule

[[Page 67724]]

change under Section 19(b) of the Act,\24\ which has become effective.
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    \24\ 15 U.S.C. 78s(b).
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    The Board of Governors will not be permitted to adopt any amendment 
to the proposed By-laws described in the foregoing paragraph unless the 
Board of Governors has determined that: (i) Such acquisition of such 
ownership by such Person in question and/or its Related Persons will 
not impair the Exchange's ability to discharge its responsibilities 
under the Act and the rules and regulations thereunder and is otherwise 
in the best interests of the Exchange and its stockholders; (ii) such 
acquisition of such ownership by such Person and its Related Persons 
will not impair the Commission's ability to enforce the Act; and (iii) 
that Person and its relevant Related Persons are not subject to any 
applicable statutory disqualification. In making those determinations, 
the Board of Governors may impose on the Person in question and its 
Related Persons such conditions and restrictions as it may in its sole 
discretion deem necessary, appropriate or desirable in furtherance of 
the objectives of the Act and the governance of the Exchange.
    In addition, no Member, either alone or together with its Related 
Persons, will be allowed to own, of record or beneficially, directly or 
indirectly, more than 20% of the then outstanding shares of common 
stock of the Phlx. To the extent any Member (or its Related Persons) 
purports to so own more than 20% of the then outstanding shares of 
common stock, that Member (and its Related Persons) will not be allowed 
to exercise any of the rights or privileges incident to the ownership 
of shares of common stock with respect to the shares exceeding the 20% 
limit.
    In making those determinations, as in the case of a By-Law 
amendment expressly permitting the exercise of voting rights exceeding 
the 20% limit, the Board will be allowed to impose such conditions and 
restrictions on that Person and its Related Persons as it may in its 
sole discretion deem necessary, appropriate or desirable in furtherance 
of the objectives of the Act and the governance of the Phlx.
    Unless the conditions specified above are met, if any Person 
exceeds the 40% threshold, either alone or together with its Related 
Persons, the Phlx will have the right, but not the obligation, to 
purchase from that Person and its Related Persons the shares of common 
stock that exceed the 40% threshold for a price equal to the par value 
of the shares of common stock.
    If any Member exceeds the 20% threshold, either alone or together 
with its Related Persons, the Phlx will have the right, but not the 
obligation, to purchase from that Member and its Related Persons the 
shares of common stock that exceed the 20% threshold for a price equal 
to the par value of the shares of common stock. Also, unlike ownership 
by non-Members in excess of 40%, the proposed Certificate of 
Incorporation does not contain a proviso allowing for Members to own 
shares in excess of 20% with appropriate notification and By-law 
amendment sanctioned by the Commission.
    Pursuant to Article FOURTH(b)(iv) and (v) of the proposed 
Certificate of Incorporation, any Person, either alone or together with 
its Related Persons, that at any time owns (whether by acquisition or 
by a change in the number of shares outstanding) of record or 
beneficially, directly or indirectly, 5% or more of the then 
outstanding shares of common stock will be required, immediately upon 
so owning 5% or more of the then outstanding shares of common stock, to 
give the Board of Governors written notice of that ownership and will 
be required to update the notice promptly after any ownership change. 
However, an updated notice will not have to be provided to the Board of 
Governors in the event of an increase or decrease of less than 1% (of 
the then outstanding shares of common stock) in the ownership 
percentage so reported (for that purpose, the increase or decrease will 
be measured cumulatively from the amount shown on the immediately 
preceding report) unless such increase or decrease of less than 1% 
results in the Person's owning more than 20% or more than 40% of the 
shares of common stock then outstanding (at a time when the Person so 
owned less than those percentages) or results in the Person's owning 
less than 20% or less than 40% of the shares of common stock then 
outstanding (at a time when the Person so owned more than those 
percentages). These proposed notification requirements will allow the 
Exchange to fulfill its reporting obligations to the Commission and to 
better monitor the voting and ownership limitations in the proposed 
Certificate of Incorporation described above.
    Transfer Restrictions. Pursuant to Section 29-1 of the proposed By-
laws, no stockholder of the Exchange may sell, transfer (by operation 
of law or otherwise) or otherwise dispose of any shares of Class A 
Common Stock except in blocks of 100 shares per sale, transfer or 
disposition. This transfer restriction is intended to ensure that the 
number of holders of common stock of the Exchange will not exceed the 
threshold for having to register the Exchange with the Commission under 
Section 12 of the Act.\25\ The Exchange believes that, at least for 
some period of time after the Demutualization, the obligation of being 
a public reporting company would be overly burdensome on the Exchange 
as compared to the advantages conferred by that status.
---------------------------------------------------------------------------

    \25\ 15 U.S.C. 78l.
---------------------------------------------------------------------------

    In addition, Article XXIX of the proposed By-laws contains other 
restrictions typical for a Delaware stock corporation to ensure 
compliance with the Securities Act of 1933, as amended (the 
``Securities Act''),\26\ and to allow for efficient future marketing of 
the capital stock by an underwriter in connection with and after a 
potential initial public offering of shares of capital stock of the 
Exchange.\27\ Accordingly, Section 29-2 of the proposed By-laws 
provides that after the Demutualization, no sale, transfer or other 
disposition of the capital stock of the Exchange may be effected 
except: (i) Pursuant to an effective registration statement under the 
Securities Act and in accordance with all applicable state securities 
laws; (ii) upon delivery to the Exchange of an opinion of counsel 
satisfactory to the Board that such sale, transfer or other disposition 
may be effected pursuant to a valid exemption from the registration 
requirements of the Securities Act and all applicable state securities 
laws; (iii) upon delivery to the Exchange of such certificates or other 
documentation as counsel to the Exchange shall deem necessary or 
appropriate in order to ensure that such sale, transfer or other 
disposition complies with the Securities Act and all applicable state 
securities laws; or (iv) pursuant to such procedures as the Chairman of 
the Board (or his designee) may adopt from time to time with respect to 
such transactions. In addition, no sale, transfer or other disposition 
of the capital stock of the Exchange may be effected by any holder of 
such stock until all amounts due and owing by such holder to the 
Exchange (whether any such amounts relate to such holder's status as a 
stockholder, Member, participant or Member (or participant) 
Organization of the Exchange or otherwise) shall have been paid in 
full.
---------------------------------------------------------------------------

    \26\ 15 U.S.C. 77.
    \27\ It should be noted that no such transaction is currently 
contemplated at the time of this proposed rule change.
---------------------------------------------------------------------------

    In addition, Section 29-3 of the proposed By-laws provides that no 
stockholders may, if requested by the Exchange or any underwriter of 
equity securities of the Exchange, sell or

[[Page 67725]]

otherwise transfer or dispose of any shares of capital stock of the 
Exchange held by such stockholder during the 180-day period following 
the effective date of a registration statement of the Exchange filed 
under the Securities Act in respect of that class of capital stock. If 
requested by the Exchange or any such underwriters, each stockholder 
will be required to execute an agreement to the foregoing effect. The 
Exchange may impose stop-transfer instructions with respect to the 
shares (or securities) subject to the foregoing restriction until the 
end of said 180-day period.
Series A Preferred Stock/Phlx Member Voting Trust
    Designation and Issuance of Series A Preferred Stock to Phlx Member 
Voting Trust/Trust Agreement. Article FOURTH (b) of the proposed 
Certificate of Incorporation will designate one share of preferred 
stock as the ``Series A Preferred Stock.'' The Series A Preferred Stock 
will have the sole power to (i) select the On-Floor Governors, and (ii) 
remove the On-Floor Governors in accordance with the procedures 
described below in connection with the removal of Governors.
    As set forth in the Trust Agreement, at the effective time of the 
Merger, the Exchange will issue the share of Series A Preferred Stock 
to the Trust. Pursuant to Section 4.1 of the Trust Agreement, the 
Trustee of the Trust will have to vote the share of Series A Preferred 
Stock with respect to the designated nominees for election as On-Floor 
Governors, or the removal of On-Floor Governors, as the case may be, as 
directed by the vote of the Member Organization Representatives of 
Member Organizations entitled to vote, as described below.
    The purpose of the Series A Preferred Stock is to establish a means 
by which the vote of the Member Organizations (in their capacities as 
such) can effectively elect and, subject to certain additional 
requirements described below, remove the five On-Floor Governors. Under 
Delaware law, the Governors of a stock corporation can be elected only 
by stockholders, and Member Organizations (in their capacities as such) 
will not be stockholders.
    Dividend Rights. Because the Series A Preferred Stock will be 
issued only to enable the non-stockholder Member Organizations to vote 
indirectly for the On-Floor Governors, Article FOURTH (a)(i) of the 
proposed Certificate of Incorporation will provide that the Series A 
Preferred Stock will not have the right to receive any dividends.
    Liquidation Preferences. Pursuant to Article FOURTH(a)(ii) of the 
proposed Certificate of Incorporation, upon liquidation of the Phlx the 
holder of the share of Series A Preferred Stock will be entitled to 
receive an amount equal to the par value of the share of Series A 
Preferred Stock (or $0.01) held by the holder after the payment of, or 
provision for, obligations of the Phlx and any preferential amounts 
payable to holders of any other class or series of outstanding shares 
of preferred stock.
    Transferability. Article FOURTH(a)(iv) of the proposed Certificate 
of Incorporation will provide that the Series A Preferred Stock will 
not be transferable (whether by sale, pledge, operation of law or any 
other disposition) without the prior written consent of the Board. If 
the Board determines that it is in the best interests of the Exchange 
or its stockholders for any holder of the share of Series A Preferred 
Stock to sell the share to the Exchange or any other person, the holder 
will be required under Article FOURTH(a)(iii) of the proposed 
Certificate of Incorporation to effect the sale as directed by the 
Board.

B. Corporate Governance of the Demutualized Phlx

    According to Article SIXTH of the proposed Certificate of 
Incorporation and Sections 4-1 and 4-4 of the proposed By-laws, the 
principal management of the Phlx after Demutualization will continue to 
rest with the Board and the Standing Committees of the Exchange.
    To ensure compliance with the Act in the context of a demutualized 
Exchange, Article SIXTH of the proposed Certificate of Incorporation 
will provide that, in managing the business and affairs of the Phlx, 
the Governors will have to consider applicable requirements for 
registration as a national securities exchange under Section 6(b) of 
the Act,\28\ including the requirements that (i) the rules of the Phlx 
be designed to protect investors and the public interest, and (ii) the 
Phlx be so organized and have the capacity to carry out the purposes of 
the Act and (except as otherwise provided in the Act or the rules and 
regulations thereunder) to enforce compliance by its Members and 
persons associated with its Members with the Act, the rules and 
regulations thereunder, and the rules of the Phlx.
---------------------------------------------------------------------------

    \28\ 15 U.S.C. 78s(b).
---------------------------------------------------------------------------

Board of Governors--Composition; Eligibility
    Article SIXTH of the proposed Certificate of Incorporation, 
together with Article IV of the proposed By-laws, will set forth the 
required number and composition of the Board. Pursuant to Section 4-1 
of the proposed By-laws, the composition of the Board will be the same 
as before the Demutualization and, as set forth in Section 4-3(b) of 
the proposed By-laws, will consist initially of the same individuals in 
office at the time of the Demutualization. According to Article SIXTH 
(a) of the proposed Certificate of Incorporation, the Board will 
continue to have a total of 22 Governors and be composed as follows:
    [sbull] The Chairman of the Board, who will be the individual then 
holding the office of Chief Executive Officer (``CEO'');
    [sbull] 11 Non-Industry Governors (of whom at least five will have 
to be public Governors); and
    [sbull] 10 Industry Governors, of which five will have to be On-
Floor Governors and five will have to be Off-Floor Governors).
    The criteria set forth in the Exchange's current By-laws for 
eligibility of persons to serve as a Governor within each category of 
Governor will remain the same after Demutualization.
Board of Governors--Classification and Term Limits
    According to Section 4-3(a) of the proposed By-laws, the Board will 
remain classified, with Governors serving staggered three-year terms. 
Governors (other than the Chairman) may serve for up to two consecutive 
three-year terms starting from the effective time of the Merger. In 
order to preserve continuity post-Demutualization, Section 4-3(b) of 
the proposed By-laws will provide that Governors who hold their 
positions at the effective time of the Merger will continue to hold 
those positions, in their respective classes, until their original 
terms expire and that the term limits will not take into consideration 
any service as Governor before the Demutualization but will only apply 
from and after the effective time of the Merger. The Exchange believes 
that this provision serves to ensure continuity in the governing body 
of the Exchange through such a significant corporate event as the 
Demutualization. The current Board of Governors has considered the 
Demutualization and the advantages and risks related to it, as well as 
the future strategy for the Exchange post-Demutualization, for a 
significant period of time.

[[Page 67726]]

Nomination and Election of Governors
    The nomination and election procedures of the Phlx will be revised 
to ensure continuing fair representation for Members and Member 
Organizations in the context of the demutualized Exchange, while at the 
same time adapting the Exchange to its proposed status as a 
demutualized business corporation with stockholders. Generally, the new 
nomination and election structure of the Exchange will be as follows:
    [sbull] The Non-Industry Governors, Off-Floor Governors and the 
Chairman of the Board will continue to be nominated by the Nominating 
and Elections Committee and will be elected by the holders of the 
common stock at meetings of stockholders, as described below.
    [sbull] Stockholders will be permitted to make independent 
nominations of Non-Industry and Off-Floor Governors upon written notice 
of the nominations not less than 90 nor more than 120 days before the 
first Monday in February of each year (or such other date as the Board 
may establish). These nominations will be subject to review by the 
Nominating and Elections Committee.
    Member Organizations, as described below, will designate the On-
Floor Governors in accordance with the following procedures:
    [sbull] On-Floor Governors will be nominated by the Nominating and 
Elections Committee from recommendations made: (i) By members of the 
Nominating and Elections Committee; or (ii) by any Member, participant 
or Member Organization Representative.
    [sbull] Independent nominations by Member Organization 
Representatives will be valid only if signed by Member Organization 
Representatives representing no less than 50 votes.
    [sbull] Member Organizations, through their authorized Member 
Organization Representative, will vote for designated On-Floor 
Governors among nominees so selected at the annual meeting of Members 
and Member Organizations.
    [sbull] Nominees for Governors receiving the highest numbers of 
votes for the category of Governor for which they were respectively 
nominated as candidates will be declared the ``Designated Nominees'' 
for those offices. In case of a tie, the Nominating and Elections 
Committee will make the selection as to who among the tying nominees 
shall be designated.
    [sbull] On-Floor Governors will then be elected by the Trust owning 
the share of Series A Preferred Stock based on the ``Designated 
Nominees'' elected by the Member Organization Representatives as 
described above.
Governors--Vacancies and Removal
    In accordance with Section 3-8 of the proposed By-laws, vacancies 
(including vacancies created by increases in the size of the Board of 
Governors) will continue to be filled by the Nominating and Elections 
Committee, upon approval by a majority of the Governors. With respect 
to the removal of Governors, Article SIXTH(b) of the proposed 
Certificate of Incorporation and Sections 3-3 and 4-4 of the proposed 
By-laws will provide that Governors may be removed only for cause or, 
under certain circumstances, upon recommendation by a majority of the 
Board of Governors. In addition, Governors may be removed only by a 
66\2/3\% vote of the group that elected them (i.e., the holders of 
common stock, in the case of the Non-Industry or Off-Floor Governors, 
or the shares of Series A Preferred Stock as instructed by a vote of 
the Member Organization Representatives, in the case of the On-Floor 
Governors).
    An On-Floor Governor may be removed at any annual or special 
meeting. A special meeting for the removal of an On-Floor Governor may 
be called by the Chairman of the Board of Governors or the Board of 
Governors or, only in the case of a special meeting of Member 
Organization Representatives for the purpose of voting on the removal 
of an On-Floor Governor, by the Member Organization Representatives 
representing a majority of the then issued and outstanding permits. If 
such a meeting is proposed to be called by Member Organization 
Representatives, such Member Organization Representatives must provide 
the Chairman written notice prior to calling any such meeting stating 
in reasonable detail the basis for, and the facts and circumstances 
purported to warrant, such removal of the relevant On-Floor Governor.
Committees
    No changes will be made in Board committee structure or composition 
as part of the Demutualization process, except as follows:
    [sbull] Pursuant to Sections 10-6 and 10-17 of the proposed By-
laws, respectively, at least half of the Admissions Committee and the 
Foreign Currency Options Committee, respectively, will have to be 
Members, participants or persons affiliated with Member Organizations 
or participant organizations;
    [sbull] Pursuant to Sections 10-20 and 10-16 of the proposed By-
laws, respectively, at least half of the Options Committee and the 
Floor Procedure Committee, respectively, will have to be Members or 
persons affiliated with Member Organizations;
    [sbull] Pursuant to Section 10-6 of the proposed By-laws, the 
Business Conduct Committee will share jurisdiction over the revocation 
of permits and foreign currency options participations in connection 
with disciplinary matters with the Admission Committee; and
    [sbull] Pursuant to Section 10-7(a) and (b) of the proposed By-
laws, certain term limits applicable to members of the Allocations 
Committees will be eliminated.
    The existing Governance Documents do not include any specification 
as to the composition of the Admissions Committee, Foreign Currency 
Options Committee, the Options Committee or the Floor Procedure 
Committee and, therefore, do not require the committees to include any 
Industry Governors. Accordingly, the Proposed Rule Change will ensure 
participation of Industry Governors in each of these committees, 
thereby allowing Industry Governors to influence decisions made in 
vital areas of day-to-day trading operations and membership matters. 
The elimination of term limits respecting the Allocations Committees is 
intended to achieve consistency with most other committees, which do 
not have such limits.
Management and Executive Officers
    The management structure of the Exchange, including its executive 
officers, will remain unchanged in the Demutualization in accordance 
with Article V of the proposed By-laws. The CEO position will continue 
to be a full-time position to be appointed by the Board, and the holder 
of this position will act as its Chairman. The person acting as CEO at 
the time of the Demutualization will be the only nominee for the 
position of Chairman of the Board, and will be elected by the votes of 
the holders of the common stock. The existing requirement that the CEO 
may not be a partner of a Member (or participant) Organization, nor an 
employee, agent, consultant, officer, director or stockholder of a 
Member (or participant) Organization will be retained. The CEO will 
appoint the other officers of the Exchange.
Limitation of Liability and Indemnification
    Articles FIFTEENTH and SIXTEENTH of the proposed Certificate of

[[Page 67727]]

Incorporation and Section 4-18 of the proposed By-laws will include 
provisions substantially similar to the Article EIGHTEENTH of the 
existing Certificate of Incorporation, in accordance with Section 145 
of the Delaware General Corporation Law. Such provisions eliminate the 
personal liability of Governors (and other persons mentioned below) for 
monetary damages for breach of fiduciary duty as a Governor, except for 
liability:
    [sbull] For any breach of the Governor's duty of loyalty to the 
Phlx or its stockholders;
    [sbull] For acts or omissions not in good faith or that involve 
intentional misconduct or a knowing violation of law;
    [sbull] Under Section 174 of the Delaware General Corporation Law 
regarding unlawful dividends and stock purchases; or
    [sbull] For any transaction from which the Governor obtained an 
improper personal benefit.
    The proposed Certificate of Incorporation and By-laws will further 
permit the Phlx to indemnify to the fullest extent permitted under and 
in accordance with the laws of the State of Delaware any Governor (or 
director) or officer of the Phlx, and any person that is or was serving 
at the request of the Phlx as a Governor, committee member or in-house 
legal counsel, officer, director (or person in similar position), 
employee or agent of another corporation or of a partnership (general 
or limited), limited liability company, joint venture, trust or other 
enterprise or business entity, against expenses (including attorneys' 
fees), judgments, fines and amounts paid in settlement actually and 
reasonably incurred by the person in connection with any action, suit 
or proceeding if the person acted in good faith and in a manner the 
person reasonably believed to be in or not opposed to the best 
interests of the Phlx, and, with respect to any criminal action or 
proceeding, had no reasonable cause to believe the person's conduct was 
unlawful. The Phlx may also pay the expenses of indemnified persons 
incurred in defending a suit or proceeding in advance of the final 
disposition of the suit or proceeding. The proposed Certificate of 
Incorporation will also permit the Phlx to secure insurance on behalf 
of any officer, director, employee or other agent for any liability 
arising out of his or her actions in that capacity. The Exchange 
believes that these indemnification provisions are substantially 
similar to those generally employed by other Delaware stock 
corporations and the scope of the persons covered is intended to 
continue to attract and retain qualified personnel.

C. Permits and Trading Rights

Issuance of Permits and Application Process
    Under the proposed Plan of Demutualization, access to the Exchange 
facilities and the right to trade will be conferred by the newly-issued 
permits rather than by ownership or leasing of Seats of the Exchange. 
As discussed above, trading of foreign currency options will continue 
to be allowed through the existing FCO participations, but, after 
Demutualization, will also be permitted through permits, as will be 
provided in proposed Rule 908(c)(i).
    Proposed Rule 971 will provide that all ETPs and ETP use agreements 
will terminate with immediate effect as of the close of trading on the 
day the Merger becomes effective without any further action on the part 
of any party thereto. Similarly, proposed Rule 971 will also provide 
that all leases of Seats and all leases and A-B-C agreements with 
respect to such Seats, will terminate with immediate effect as of the 
close of trading on the day the Merger becomes effective without any 
further action on the part of any party thereto. All provisions in the 
Certificate of Incorporation, By-laws and Rules relating to the 
transfer or lease of a Seat or A-B-C agreement, and all defined terms 
related thereto (such as ``Lessor'' and ``Lessee'') will be amended as 
necessary to reflect that, after the Demutualization, these provisions 
and defined terms will only apply to FCO participations. These 
provisions will no longer be applicable to permits, because permits 
(including the Series A-1 Permits) will not constitute property that 
can be transferred by its holder (except within the same member 
Organization). Similarly, the provisions relating to ETPs, such as Rule 
23, will be deleted.
    To provide an orderly transition from Seats to permits, proposed 
Rule 972 will allow each Member (including, without limitation, each 
holder of an equity trading permit), inactive nominee and Member 
Organization holding that status immediately before the effective time 
of the Merger that, at that time, is not subject to any suspension of 
that status, to maintain that status. All Members and ETP holders who 
fulfill the requirements described in the previous sentence will 
receive Series A-1 Permits immediately upon the Demutualization.
    Proposed Rule 972 will also provide that existing Member 
Organizations will maintain their status for a period of 15 days 
following the Merger. Each Member Organization, however, will have to 
provide to the Admissions Committee and the Exchange, as applicable, 
before the end of the 15-day period, the following:
    [sbull] The security deposit or alternative compliance with 
proposed Rule 909 (the ``security requirement'') (as described below);
    [sbull] The form to be filed by the Member Organization's 
qualifying permit holder; and
    [sbull] The designation of the Member Organization's Member 
Organization Representative in the form prescribed by the Exchange.
    If a Member Organization fails within that period to comply with 
the security requirement and/or to furnish the form to be filed by the 
Member Organization's qualifying Member, the Member Organization's 
status as such will immediately be suspended. If a Member Organization 
fails to designate a Member Organization Representative, the Member 
Organization may not exercise any voting rights with respect to any 
permits held by persons who are associated with the Member 
Organization.
Classes or Series of Trading Permits
    Immediately after the Demutualization, pursuant to Section 12-1 of 
the proposed By-laws and proposed Rule 908, there will be only one 
series of permit, called the ``Series A-1 Permit,'' which will confer 
upon its holder all the rights and privileges of a Member of the 
Exchange. An individual will be allowed to hold a Series A-1 Permit if 
he or she meets the qualification criteria that will be set forth in 
Article XII of the proposed By-laws and Rules 901 and 908 and/or may be 
imposed by the Admissions Committee (which criteria the Exchange 
intends will remain largely the same as they were before the 
Demutualization), including the requirements that a Member be an 
individual at least 21 years of age and be associated with a Member 
Organization.\29\ Pursuant to Sections 12-1 and 12-4 of the proposed 
By-laws and proposed Rule 908(b), Series A-1 Permits will be limited or 
unlimited in number and may be issued from time to time by the 
Exchange, as determined by the Board in its sole discretion.
---------------------------------------------------------------------------

    \29\ Under Sections 12-2 and 12-4 of the proposed By-laws, Stock 
Clearing Corporation of Philadelphia (``SCCP''), as an eligible 
corporation, may hold a permit but will continue not to be subject 
to the qualification criteria applicable to persons seeking a 
permit. SCCP, a subsidiary of the Phlx, is a registered clearing 
agency.

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[[Page 67728]]

    After Demutualization, Section 12-1 of the proposed By-laws will 
empower the Board to:
    [sbull] Authorize the issuance of an unlimited or restricted number 
of additional permits;
    [sbull] Terminate or eliminate any class or series of permits; and
    [sbull] Create additional classes or series of permits.
    Any of these actions, however, will continue to be subject to 
Commission review and/or approval. In accordance with Section 12-3 of 
the proposed By-laws, no person will be allowed to hold more than one 
permit.
    Pursuant to proposed Rule 971, separate equity trading permits 
currently issued and outstanding will be eliminated and be replaced by 
the Series A-1 Permits described above.
Qualifications
    Initially, except to the extent provided in applicable product and/
or activity criteria set forth in the proposed Rules, qualifications 
and other requirements for Members to conduct certain activities (e.g., 
to act as a specialist or a floor broker), to trade certain products 
(e.g., special capital requirements for specialists for certain equity 
securities, allocation of books and Registered Options Trader 
assignments) or to use specific facilities of the Exchange (e.g., 
testing requirements for use of certain Exchange technology) will 
remain largely the same as they were before the Demutualization.
Member Organizations and Member Organization Representatives
    As under the current structure, a Member will continue to be 
permitted to be associated with more than one Member Organization.\30\ 
In accordance with proposed Rule 908(c)(ii), each holder of a permit 
will be obliged, however, to designate only a single eligible 
organization with which the Member is associated as the Member's 
``primary affiliation'' for the purposes of voting, as will be provided 
in Article III of the proposed By-laws. A Member will be allowed to 
qualify as a Member Organization only the entity the Member has 
designated as his or her primary affiliation. Accordingly, every Member 
shall have one primarily-affiliated Member Organization and may have 
more than one associated Member Organization.
---------------------------------------------------------------------------

    \30\ See Rule 793.
---------------------------------------------------------------------------

    Unlike the current Phlx regime, after Demutualization, individual 
Members will not directly be accorded voting rights. Rather, in regard 
to the election and removal of On-Floor Governors, Member Organizations 
will be entitled to exercise voting rights in respect of the permits 
held by those Members who have designated the Member Organization as 
their primary affiliation. Specifically, pursuant to proposed Rule 921 
and Section 12-8 of the proposed By-laws, each Member Organization will 
have to register with the Exchange and designate a single individual as 
its ``Member Organization Representative.'' The concept of a Member 
Organization Representative is designed to facilitate the post-
Demutualization voting process. Permit holders, or Members, themselves 
will not exercise any voting rights. Instead, voting rights associated 
with a permit will be exercised by the Member Organization with which 
the Member is primarily associated and, as noted above, will be 
exercised by the Member Organization's Member Organization 
Representative. The Member Organization Representative will be the only 
person who may exercise the voting rights in respect of the Member 
Organization in respect of matters on which Member Organizations may 
vote. Proposed Rule 921 will also provide that a Member Organization 
Representative will have to accept the designation by filling out a 
registration documentation required by the Exchange.
    Pursuant to proposed Rules 921 and 972, with the exception of 
certain provisions in proposed Rule 921(c) retaining the existing 
concept of ``inactive nominees'' in order to alleviate hardships, 
failure to qualify a Member Organization Representative at any time 
will prevent a Member Organization from exercising any rights in 
connection with the Exchange, including the right to vote for 
designated On-Floor Governors as described below.
    According to proposed Rule 924, Members \31\ will be liable with 
respect to any fees, fines, dues, penalties or other amounts imposed by 
the Exchange in connection with such Member's permit or any activities 
conducted in connection with such permit, whether or not any such 
obligation was incurred on behalf of his account or on behalf of his 
Member Organization. In addition, proposed Rule 924 will provide that 
Member Organizations will be liable with respect to any fees, fines, 
dues, penalties or other amounts imposed by the Exchange in connection 
with such Member Organization and any Member associated with such 
Member Organization in connection with a permit or any activities 
conducted in connection with such permit by such member on behalf or 
for the account of such Member Organization. Under proposed Rule 
924(b), similar to the rule in effect today, Member Organizations will 
have the ability to allocate responsibilities among themselves 
regarding Members associated with more than one Member Organization, 
provided that any such arrangements have been provided to the Exchange 
in the form required by it at least 30 days prior to their desired 
effectiveness.
---------------------------------------------------------------------------

    \31\ This rule also applies to FCO participants and participant 
organizations with respect to FCO participations.
---------------------------------------------------------------------------

Security Requirement
    According to proposed Rule 909, each Member Organization will have 
to provide and maintain security to the Exchange (or alternative 
compliance) for the payment of any claims owed to the Exchange, to 
SCCP, and to Members and/or other Member Organizations. Currently, 
Section 14-5 of the By-laws provides that the Exchange (through the 
Admissions Committee) may dispose of any Seat upon written notice if 
amounts owed to the Exchange exceed a certain threshold amount and have 
been outstanding for at least one year, which possibility will be 
eliminated in connection with the elimination of Seats in the 
Demutualization. Accordingly, the Exchange proposes the security 
requirement to protect itself in the case of non-payment of certain 
amounts owed. The proposed security requirement will consist of:
    (i) Excess net capital of at least the amount required by the 
Exchange, as will be published by the Exchange from time to time; \32\
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    \32\ In accordance with the By-laws and Rules, the Member 
Organization will be subject to monthly reporting obligations to 
evidence the maintenance of that excess net capital requirement.
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    (ii) an acceptable guaranty by a clearing Member Organization that 
is acceptable to the Exchange; or
    (iii) a deposit with the Exchange in an amount not to exceed 
$50,000.
    The amount of the security for a Member Organization will remain 
the same regardless of the number of permits issued to affiliates of 
the Member Organization. If a Member Organization's registration is 
terminated and no Members remain associated with the Member 
Organization, the Exchange will be permitted to apply the proceeds of 
any remaining security to the payment of any amounts owed by or on 
behalf of the Member Organization to, or claimed by, the Exchange, to 
SCCP, and to other Member Organizations, and any balance of the 
security thereafter remaining will be returned to the Member 
Organization or, in the case of

[[Page 67729]]

a guaranty, the guaranty will be returned to the guarantor Member 
Organization.
    The proposed By-laws will also provide in Section 12-9(b) that 
following the Demutualization, Members, Member Organizations and 
holders of FCO participations will have to pledge in writing to abide 
by the proposed Certificate of Incorporation, the proposed By-laws, the 
proposed Rules and any other rules and regulations of the Exchange.
Voting Rights
    After the Demutualization, holders of permits will not have any 
voting rights. Member Organizations will have the right to:
    [sbull] Designate the five On-Floor Governors for election to the 
Board in accordance with Section 3-12 of the proposed By-laws;
    [sbull] Remove the On-Floor Governors in accordance with Sections 
3-2(c) and 3-3 of the proposed By-laws (together with the right to 
designate the On-Floor Governors, the ``Designation Rights''); and
    [sbull] Designate the On-Floor Vice-Chair in a contested election 
as described below.
    Each permit will carry one vote. As discussed above, the vote may 
be exercised only by the qualified Member Organization Representative 
of a Member Organization designated by a holder of a permit as its 
primary affiliation.
    The Designation Rights will be exercised in accordance with the 
following procedure:
    [sbull] Based on input from the membership or others, the 
Nominating and Elections Committee will propose a slate of qualified 
On-Floor Governors;
    [sbull] In addition, the Member Organization Representatives, 
representing at least 50 permits, will be permitted to propose 
qualified alternative candidates;
    [sbull] The Member Organization Representatives, at an annual 
meeting of Members and Member Organizations, will then elect the 
designated On-Floor Governors from among the Nominating and Elections 
Committee's slate and any qualified individuals nominated by Member 
Organization Representatives in accordance with the nomination 
procedures.
    The winners of this election will then be eligible for designation 
as On-Floor Governors. In compliance with Delaware corporate law, the 
designated On-Floor Governors will be formally elected by the Trust 
that holds the single outstanding share of Series A Preferred Stock in 
accordance with Article FOURTH(a)(iii) of the proposed Certificate of 
Incorporation.
Contested Election of the On-Floor Vice Chairman
    With respect to the election of the On-Floor Vice Chairman, Section 
4-2 of proposed By-laws will provide that, if there is a contest for 
the position of On-Floor Vice Chairman of the Board, the On-Floor Vice 
Chairman of the Board may be selected from the On-Floor Governors by a 
vote of the Member Organization Representatives, as promptly as 
possible after the annual meeting of stockholders at a special meeting 
of Members and Member Organizations called for that purpose.
Voting Concentration Limits
    In order to prevent any group of Members of Member Organizations 
from dominating elections of the Member Organization Representatives, 
the proposed By-laws will provide in Section 3-12(c) that if any Member 
Organization, directly or indirectly, possesses the right to vote more 
than 20% of the then outstanding permits, that Member Organization will 
not have any right to vote, or to give any consent or proxy with 
respect to, any permits exceeding the 20%, and the excess permits will 
not be considered present for the purposes of determining whether a 
quorum is present at any meeting or vote of the Members or Member 
Organizations, and will not be entitled to vote in determining the 
number of permits required for a quorum or to be voted for approval of 
or to give consent with respect to any matter presented to the Members 
or the Member Organizations.
Member and Member Organization Meetings and Actions
    Pursuant to Section 3-2 of the proposed By-laws, annual meetings of 
Members and Member Organizations will be held on the second Monday in 
March of each year to designate nominees for On-Floor Governors. Except 
as described above with respect to a special meeting called for the 
purpose of removing an On-Floor Governor, special meetings of Members 
or the Member Organization Representatives may be called at any time 
only by the Chairman of the Board or by a majority of the Board.
    At all meetings of Members and Member Organizations, each Member 
Organization Representative may cast his vote in person or by proxy, 
provided that no action will become effective unless there shall have 
been voted a majority of the number of permits outstanding at such 
time, not including any Excess Permits, as defined in Section 3-12(c) 
of the proposed By-laws. Each Member Organization Representative may 
cast the number of votes equal to the number of permits held by Members 
having designated the Member Organization Representative's Member 
Organization as its primary affiliation (subject to the voting 
restrictions described above).
    Section 3-11 of the proposed By-laws will provide that notice of 
any meeting of Members and Member Organizations must be given to each 
Member Organization Representative entitled to vote at such meeting not 
less than 10 days nor more than 50 days before the date of the meeting.
Term and Termination of Permits
    Pursuant to proposed Rule 908(e), the holder of a permit will be 
allowed to terminate the permit at any time upon written notice to the 
Exchange. The Exchange will be allowed to terminate any individual 
permit in accordance with the By-laws and Rules of the Exchange only 
upon:
    [sbull] The non-payment of any dues, foreign currency options 
users' fees, fees, fines, penalties, other charges, and/or other monies 
due and owed the Exchange;
    [sbull] The insolvency of a Member or Member Organization (or if 
the Business Conduct Committee has determined the Member or Member 
Organization to be financially unsafe to continue trading); or
    [sbull] The Exchange's imposition of a disciplinary sanction.\33\
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    \33\ See Section 14-1 and Articles XVII and XVIII of the 
proposed By-laws.
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    The terminating permit holder and each Member Organization with 
which the holder is associated will remain responsible for all 
obligations of the terminating Member, including, without limitation, 
all applicable dues, fees, charges, fines, penalties and other 
obligations arising from the holding or use of a permit before its 
termination.
    Pursuant to proposed Rule 908(f), the Exchange will be able to 
terminate the entire series of Series A-1 Permits on no less than 60 
days' notice to the permit holders. If, however, within six months 
after any such termination of the entire series of Series A-1 Permits, 
the Exchange issues any other class or series of permit with respect to 
any securities product previously covered by the Series A-1 Permit, any 
permit holder of a terminated Series A-1 Permit, who meets the 
applicable eligibility requirements with respect to such new class or 
series of permit, will be entitled to receive on terms no less 
favorable

[[Page 67730]]

than those applicable to other persons such new class or series of 
permit so long as such permit holder will trade with such new class or 
series of permit such product in the same capacity as he had done with 
a Series A-1 Permit before such termination (but only if he had 
continuously traded such product in such capacity for at least one year 
prior to such termination). In addition, such holder of the terminated 
Series A-1 Permit will be required to apply for such new permit within 
30 days of the later to occur of (i) the termination of the series of 
Series A-1 Permits or (ii) the initial issuance of the new class or 
series of permit.
Transfer of Permits
    Section 12-1(b) of the proposed By-laws, as well as proposed Rule 
908(h) will also provide that, unless the Board resolves otherwise, no 
permit may be sold, transferred (by operation of law or otherwise), 
leased or otherwise encumbered by any person to whom such permit is 
issued by the Exchange. However, proposed Rule 908(h) provides that the 
existing concept of ``inactive nominees'' will be retained to alleviate 
certain administrative hardships for Member Organizations, such that a 
permit can be transferred to and from an inactive nominee.
Disciplinary Actions and Appeal Process
    Enforcement of any disciplinary action and appeals against the same 
will be conducted in the same manner as before the Demutualization.
Fees, Dues and Charges
    Currently, the Board of Phlx has the authority to set fees, dues 
and other charges \34\ in its sole discretion, subject to the 
requirements under the Act, including filing requirements. Pursuant to 
lease agreements, Members who lease Seats from Owners are ordinarily 
required to make lease payments in respect of the lease.
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    \34\ According to the Exchange, the existing and proposed By-
laws and Rules may refer to ``dues, fees and other charges'' to 
cover various types of monies owed to the Exchange, however, no 
substantive difference is intended.
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    After the Demutualization, the Board of the Phlx will continue to 
have the authority to set Member fees, dues and other charges in its 
sole discretion in accordance with Section 14-1 of the proposed By-
laws. However, seat leases and lease payments (other than with respect 
to FCO participations) will no longer exist. All other Exchange charges 
in effect at the time of the Demutualization will continue to apply 
until changed.\35\ Of course, all fees are subject to change, both 
before and after Demutualization, subject to approval by the Board and 
filing with the Commission.
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    \35\ Separately, with the elimination of Seats and leases 
thereof, the Exchange intends to file a proposed rule change to 
adopt fees applicable to Series A-1 Permits and to make conforming 
changes to its fee schedule as a result of the Demutualization.
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    In connection with the Demutualization, the Exchange proposes to 
make certain corresponding changes to the defined terms applicable to 
its By-laws and Rules. These changes, reflected in Section 1-1 of the 
existing and the proposed By-laws, as well as in Rules 1 through 21 of 
the existing Rules and 1 through 22 of the proposed Rules, are 
generally \36\ designed to adapt such defined terms to the proposed 
post-Demutualization structure of the Exchange, as described herein.
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    \36\ See the discussion of the changes to the definitions of 
Member Organization, Member Firm and Member Corporation below.
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ii. Summary of Non-Demutualization-Related Changes
    Certain aspects of the Proposed Rule Change are not directly 
related to the Plan of Demutualization. These changes are principally 
of a clean-up nature, intended to delete obsolete provisions that 
relate mainly to membership, in the interest of clarity and to avoid 
confusion post-Demutualization.
Definition of Member Firm, Member Corporation and Member Organization
    The Exchange proposes to harmonize the use of the defined terms 
Member Firm, Member Corporation and Member Organization throughout its 
By-laws and Rules by eliminating the separate defined terms ``Member 
Firm'' (Rule 3 of the existing Rules) and ``Member Corporation'' (Rule 
4 of the existing Rules) and amending the defined term ``Member 
Organization'' (Rule 6 of the existing Rules and Rule 3 of the proposed 
Rules) to include any Member Firm and Member Corporation, as they were 
previously defined. Wherever such defined terms appear in either the 
By-laws or the Rules, the Exchange proposes to make the corresponding 
change to Member Organization. The Exchange believes that these changes 
eliminate certain definitional inconsistencies.
Convertible Memberships
    The Exchange proposes to delete the parts of Article XII of the 
existing By-laws that relate to ``convertible memberships'' on the 
Exchange, together with any references to any classes of memberships 
that existed in connection with the Exchange's pre-1975 status as an 
unincorporated entity. No such convertible membership has been 
outstanding at any time and any transitional rules relating to the 
Exchange's previous unincorporated status are obviously no longer 
required.
Commissions
    The Exchange proposes to delete Article XIX of the existing By-laws 
in its entirety, which relates to certain requirements for fixed rates 
of commissions for transactions effected on or by the use of the 
facilities of the Exchange. The Exchange believes these provisions do 
not comport with Section 6(e) of the Act.\37\ To avoid confusion, they 
should, therefore, be deleted without replacement. The Exchange also 
proposes to delete the related Rule 248.
---------------------------------------------------------------------------

    \37\ 15 U.S.C. 78f(e).
---------------------------------------------------------------------------

Market-Maker Membership
    The Exchange proposes to delete Article XXIII of the existing By-
laws, relating to Market-Maker Memberships, in its entirety. No such 
Market-Maker Membership has been issued since the 1970s and none is 
currently outstanding. Following the Demutualization, the Exchange is 
not initially proposing to create a specific permit for market-makers; 
any rights and privileges required to engage in market making on the 
Exchange will initially be granted through the proposed Series A-1 
Permit. The Exchange also proposes to delete the related Rules 456-459. 
These deletions are intended to avoid confusion with respect to these 
unused membership-related provisions.
Exchange Options Trading
    The Exchange proposes to delete Article XXVI of the existing By-
laws, relating to Exchange options trading through a classification of 
membership named ``Options Membership'' in its entirety. No such 
Options Membership has at any time been issued and outstanding. 
Following the Demutualization, the Exchange is not initially proposing 
to create a specific permit to trade options on the Exchange; any 
rights and privileges required to engage in trading options on the 
Exchange will initially be granted through the proposed Series A-1 
Permit. Accordingly, this deletion is also intended to avoid confusion.
References to the Exchange's Constitution
    The Exchange proposes to delete references to the ``Constitution of 
the Exchange'' from the Rules 111, 201A

[[Page 67731]]

and 960.2 as well as from the commentary to Rule 803. Where applicable, 
the references will be either deleted in their entirety or will be 
replaced by references to the Certificate of Incorporation. The 
Exchange has not had a constitution since its incorporation in 1972 
and, since that time, has been governed exclusively by its Certificate 
of Incorporation and By-laws.
References to the Exchange's President
    The Exchange proposes to delete references to the Exchange's 
``President'' from the Rules and replace such references with 
``Chairman of the Board of Governors.'' The Exchange has not 
established the position of a President and has no immediate plans to 
establish such a position after the Demutualization.
Participation in Mandatory Decimalization Testing
    The Exchange proposes to delete Rule 650 in its entirety which 
relates to the mandatory participation of Members in certain programs 
concerning the testing of the Exchange's system in connection with 
decimalization. Such tests have been performed, and, therefore, Rule 
650 has become obsolete.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act \38\ in general and, in particular, 
furthers the objectives of Sections 6(b)(2),\39\ 6(b)(3),\40\ 6(b)(5) 
\41\ and 11(A)(a)(1) \42\ of the Act. Specifically, after careful 
consideration, the Exchange believes that the proposed permit structure 
to be established in connection with the Plan of Demutualization should 
further general access for any registered broker or dealer or natural 
person associated with a registered broker or dealer to become a member 
of the Phlx in accordance with Section 6(b)(2) of the Act.\43\ Under 
its current structure, Seats on the Exchange, to which the right to be 
a member of the Exchange is linked, are limited in number to 505.\44\ 
Under Section 12-1 of the proposed By-laws, the Exchange will be 
entitled to issue a potentially unlimited number of permits \45\ to 
qualified individuals. Consequently, the potential availability of a 
number of permits greater than 505 would allow more qualified brokers 
and dealers to become Phlx Members.
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    \38\ 15 U.S.C. 78f(b).
    \39\ 15 U.S.C. 78f(b)(2).
    \40\ 15 U.S.C. 78f(b)(3).
    \41\ 15 U.S.C. 78f(b)(5).
    \42\ 15 U.S.C. 78kA(a)(1).
    \43\ 15 U.S.C. 78f(b)(2).
    \44\ One of the 505 Seats is held by SCCP pursuant to Section 
12-3 of the existing By-laws and, therefore, is not otherwise 
available.
    \45\ Each series of permits issued by the Exchange may either be 
restricted or unlimited in number, as determined by the Exchange.
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    The Exchange further believes that the proposed provisions of the 
Certificate of Incorporation, the By-laws and the corresponding 
provisions of the Trust Agreement should assure the fair representation 
of its Members and Member Organizations in the selection of its 
Governors and the administration of its affairs by providing that the 
On-Floor Governors shall be elected by the Trust as a holder of the 
share of Series A Preferred Stock at the direction of the Member 
Organization Representatives who represent both the Member Organization 
that designated them, and, indirectly, the Member Organization's 
primarily affiliated Member(s). This election process, together with 
the composition of the Board and the various standing committees of the 
Board, should ensure fair representation by both upstairs Member 
Organizations and the Exchange floor in accordance with Section 6(b)(3) 
of the Act.\46\ Article SIXTH of the proposed Certificate of 
Incorporation, together with Section 4-1 of the proposed By-laws, will 
continue to provide for five Governors of the Exchange to be ``On-
Floor'' Governors, which will consist of:
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    \46\ 15 U.S.C. 78f(b)(3).
---------------------------------------------------------------------------

    [sbull] Two Governors who are industry Governors and are members 
\47\ primarily engaged in business on the Exchange's equity floor;
---------------------------------------------------------------------------

    \47\ Solely in connection with these composition requirements, 
``members'' in each case includes general partners, executive 
officers (vice president and above) or Members associated with 
Member Organizations primarily engaged in the relevant business on 
the Exchange.
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    [sbull] One Governor who is an industry Governor and is a Member 
primarily engaged in business as a specialist on the Exchange's equity 
options floor;
    [sbull] One Governor who is an industry Governor and is a Member 
primarily engaged in business as a Registered Options Trader on the 
Exchange's equity options floor; and
    [sbull] One Governor who is an industry Governor and is a Member 
primarily engaged in business on the Exchange's equity options floor as 
a floor broker.
    There will also be five ``Off-Floor'' Governors who are industry 
Governors and are general partners, executive officers (vice president 
or above), or Members (or participants) associated with Member (or 
participant) Organizations which conduct a non-member or non-
participant public customer business and shall individually not be 
primarily engaged in business activities on the Exchange Floor. These 
Off-Floor Governors will be elected by the owners of the common stock 
of the Exchange. In addition, pursuant to the proposed By-laws, at 
least half of the members \48\ of the Admissions Committee and the 
Foreign Currency Options Committee will be required to be Members, 
participants or persons affiliated with Member Organizations or 
participant organizations, and at least half of the members of the 
Options Committee and the Floor Procedure Committee will be required to 
be Members or persons affiliated with Member Organizations, which 
should ensure Member participation and influence over core governance 
decisions of the Exchange in areas of importance to the Members and 
Member Organizations. The Exchange also believes that the proposal is 
consistent with Section 6(b)(5) of the Act,\49\ in that the Exchange 
will continue to offer a marketplace for the trading of securities that 
is designed to promote just and equitable principles of trade, prevent 
fraudulent and manipulative acts and practices, remove impediments to 
and perfect the mechanism for a free and open market and a national 
market system, as well as to protect investors and the public interest.
---------------------------------------------------------------------------

    \48\ Here, the term ``member'' is used merely to refer to 
persons serving on a committee.
    \49\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    In general, the Exchange believes that the Plan of Demutualization 
is consistent with the findings of Congress expressed in Section 11A of 
the Act \50\ that, inter alia, the securities markets are an important 
national asset which must be preserved and strengthened and that it is 
in the public interest and appropriate for the protection of investors 
and the maintenance of fair and orderly markets to assure economically 
efficient execution of securities transactions. Under its current 
mutual structure, the Exchange will be severely hindered in its ability 
to address the financial and competitive challenges it is facing today. 
To keep pace with technological and other market changes, develop new 
products, react swiftly to competitors while continuing to comply with 
its statutory requirements as a self-regulatory organization, the 
Exchange believes that it will depend on both internal and external 
sources of capital. The Plan of Demutualization removes obstacles to 
third-party investments by creating a

[[Page 67732]]

``currency'' (common stock or preferred stock in a for-profit 
corporation) for the investments, subject to the control and approval 
of the Commission in the case of preferred stock and if certain 
ownership or voting thresholds are exceeded. On the other hand, the 
Plan of Demutualization and the new permit structure also facilitate 
the fair and reasoned assessment of Members and Member Organizations 
through a targeted permit fee structure and a potentially unlimited 
number of Permits.
---------------------------------------------------------------------------

    \50\ 15 U.S.C. 78k(A).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change would 
impose any inappropriate burden on competition.

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

    First, on September 29, 2003, a letter addressed to the Exchange's 
Board questioned the motives and necessity to demutualize.\51\ 
Thereafter, on October 22, the same persons requested the 
``demutualization package'' and criticized the scheduling of multiple 
(as opposed to a single) Member and Owner meetings.\52\ The Exchange's 
response letter explained that the materials would be distributed by 
the next day and that multiple meetings were intended as a scheduling 
convenience to permit more Members and Owners to attend.\53\ Lastly, 
although not a comment to the Exchange directly, a letter dated October 
30, 2003, addressed to Members/Owners of the Phlx, was circulated, 
stating, among other things, that the Plan of Demutualization is not 
fair, did not involve Member or Owner input, and urges Members and 
Owners to vote against it.\54\ It also criticizes the elimination of 
the ability of Members to propose By-law changes and states that the 
Plan rewards management with up to 10% of the outstanding stock. The 
Exchange determined to respond to the letter, explaining, among other 
things, that the reason for the elimination of the Members' right to 
petition changes to the By-laws is that Delaware law requires that 
stockholders amend the By-laws. Furthermore, the Exchange's response 
explains that the 10% limitation is a ceiling, and not a guarantee.
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    \51\ See letter from Joseph D. Carapico, Andrew W. Snyder and 
Richard B. Feinberg, Penn Mont Securities, to the Board, dated 
September 29, 2003.
    \52\ See letter from Joseph D. Carapico, Andrew W. Snyder and 
Richard B. Feinberg, Penn Mont Securities, to Murray L. Ross, 
Secretary, Phlx, dated October 22, 2003.
    \53\ See letter from Murray L. Ross, Secretary, Phlx, to Joseph 
D. Carapico, Andrew W. Snyder and Richard B. Feinberg, Penn Mont 
Securities, dated October 22, 2003.
    \54\ See letter from Richard B. Feinberg, dated October 30, 
2003.
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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 the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Phlx. All submissions should refer to file 
number SR-Phlx-2003-73 and should be submitted by December 24, 2003.
    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\55\
---------------------------------------------------------------------------

    \55\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-30062 Filed 12-2-03; 8:45 am]
BILLING CODE 8010-01-P