[Federal Register Volume 69, Number 100 (Monday, May 24, 2004)]
[Notices]
[Pages 29611-29626]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-11651]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49718; File No. SR-PCX-2004-08]


Self-Regulatory Organizations; Pacific Exchange, Inc.; Order 
Approving Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval of Amendment No. 1 Thereto Relating to the 
Demutualization of the Pacific Exchange, Inc.

May 17, 2004.

I. Introduction

    On February 10, 2004, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to convert the ownership of the existing Exchange 
from a non-stock, not-for-profit membership corporation into a for-
profit stock corporation, and to convert the options trading rights of 
current PCX seats to Option Trading Permits. On March 29, 2004, the 
proposed rule change was published for comment in the Federal 
Register.\3\ The Commission received one comment letter in response to 
the proposed rule change.\4\ On May 14, 2004, PCX filed Amendment No. 1 
to the proposed rule change.\5\ This order approves the proposed rule 
change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 49451 (March 19, 
2004), 69 FR 16305 (``Notice'').
    \4\ See Letter from John A. Brown, Pacific Exchange Member, to 
Jonathan G. Katz, Secretary, Commission, dated April 7, 2004 
(``Brown Letter'').
    \5\ See Letter from Steven B. Matlin, Regulatory Policy, PCX, to 
Nancy J. Sanow, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated May 13, 2004 (``Amendment No. 
1''). See Section IV infra for a description of Amendment No. 1.
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II. Description of Proposed Rule Change

    The current PCX, a Delaware non-stock, not-for-profit corporation, 
proposes a plan to ``demutualize,'' whereby it will be reorganized as a 
subsidiary (the ``reorganized PCX'' or ``reorganized Exchange'') \6\ of 
a for-profit stock corporation, the stockholders of which initially 
will be the current owners of the outstanding authorized memberships of 
the current Exchange.\7\ To effect the demutualization, a newly-formed 
Delaware stock corporation, PCX Holdings, Inc. (``PCX Holdings''), will 
become a holding company for the reorganized Exchange and its other 
operating subsidiaries. PCX Holdings has formed a wholly-owned 
subsidiary solely for the purpose of completing the merger, which will 
merge with and into the current PCX. This surviving entity, the 
reorganized Exchange, will be a wholly-owned subsidiary of PCX 
Holdings. The reorganized PCX, a non-stock corporation, will operate 
the options business of the current PCX and will have a separate Board 
of Directors. The reorganized PCX will retain the self-regulatory 
organization function for the options business as well as for its 
equities business subsidiary, PCX Equities, Inc. (``PCX Equities'' or 
``PCXE''). According to the Exchange, the proposed demutualization will 
not affect PCXE's operations, governance structure, or rules.
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    \6\ In this Order, where the context requires differentiation 
between the PCX prior to the demutualization and the PCX after the 
demutualization, the existing membership organization is referred to 
as the ``current PCX'' or ``current Exchange,'' and the new entity, 
which will be a wholly-owned subsidiary of PCX Holdings, is referred 
to as the ``reorganized PCX'' or the ``reorganized Exchange.''
    \7\ The proposed rule change, as amended, includes: the Rules 
for the reorganized Exchange; the Certificate of Incorporation for 
PCX Holdings; the Bylaws for PCX Holdings; the Certificate of 
Incorporation for the reorganized Exchange; the Bylaws for the 
reorganized Exchange; and the deletion of the Constitution and the 
Certificate of Incorporation of the current Exchange.
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    Prior to the merger, the current Exchange will undergo a 
recapitalization whereby it will convert each of its 552 outstanding 
authorized memberships into two separate components: (1) A Class A 
membership interest representing each member's ownership interest in 
the current Exchange; and (2) a Class B membership interest 
representing options trading privileges on the current Exchange. As a 
result of the demutualization, current PCX members will receive one 
thousand (1,000) shares of voting common stock

[[Page 29612]]

in PCX Holdings in exchange for their Class A membership interest and, 
in addition, will receive an Options Trading Permit (``OTP'') \8\ in 
the reorganized PCX in place of the Class B membership interest.
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    \8\ See PCX Rule 1.1(p) (definition of ``OTP''; see also PCX 
Rule 1.1(q) (definition of ``OTP Holder'') and PCX Rule 1.1(r) 
(definition of ``OTP Firm'').
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    The common stock of PCX Holdings will represent an equity interest 
in the company and will have the traditional features of common stock, 
including dividend, voting, and liquidation rights.\9\ Holders of 
common stock will be entitled to vote on all matters submitted to the 
stockholders for a vote, including the election of the Board of 
Directors of PCX Holdings, extraordinary transactions such as a merger, 
consolidation, dissolution or sale of all or substantially all of the 
assets of PCX Holdings, and certain changes to the Bylaws of PCX 
Holdings.
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    \9\ According to the Exchange, it does not currently anticipate 
that PCX Holdings will pay dividends on its common stock in the 
immediate future. The Exchange represents that, in the event that a 
dividend is declared, any revenues received by the reorganized PCX 
from regulatory fees or regulatory penalties will be applied only to 
fund the legal, regulatory, and surveillance operations of the 
reorganized PCX, and will not be used to pay dividends to the 
holders of PCX Holdings common stock.
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    According to the Exchange, by restructuring its business as a stock 
corporation with business control and management vested in a Board of 
Directors, the entity will have greater flexibility to develop and 
execute strategies designed to improve its competitive position than it 
has under the current membership-cooperative structure. Further, the 
Exchange anticipates that by restructuring as a stock corporation, PCX 
management will be better able to respond quickly to competitive 
pressures and to make changes to its operations as market conditions 
warrant, without diminishing the integrity of its regulatory programs. 
Following the completion of the demutualization, PCX believes that the 
holders of common stock of PCX Holdings will retain, through their 
ownership of stock, their economic interest in its operating 
subsidiaries and ultimately will benefit from any improvement in the 
financial health of these entities resulting from the demutualization.

A. Corporate Structure

1. PCX Holdings, Inc.
    Following the completion of the demutualization, PCX Holdings will 
be a for-profit stock corporation and will act as a holding company for 
the reorganized Exchange and its operating subsidiaries. PCX Holdings 
will provide management and corporate support to its subsidiaries. PCX 
Holdings, as the sole member of the reorganized PCX, will have the 
right to elect the Board of Directors of the reorganized PCX \10\ and 
will have the right to vote on any proposal to merge the reorganized 
PCX with a third party, to sell a significant amount of the reorganized 
Exchange's assets to a third party, or to dissolve or liquidate the 
reorganized PCX. The Certificate of Incorporation and Bylaws of PCX 
Holdings will govern the activities of PCX Holdings.
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    \10\ This right is subject to Trading Permit Holders' right to 
nominate their candidates.
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a. Board of Directors
    The Board of Directors of PCX Holdings shall consist of not less 
than seven (7) nor more than twelve (12) members, with the Board of 
Directors currently contemplated initially to consist of nine (9) 
members, including the Chief Executive Officer (``CEO'') of PCX 
Holdings and at least five (5) persons who shall not have any material 
business relationship with PCX Holdings or its affiliates, other than 
as an OTP Holder on the reorganized PCX. The authorized number of 
Directors shall be as determined from time to time upon the majority 
approval of the full Board of Directors. The CEO of PCX Holdings may be 
designated Chairman of the Board.
    The current PCX Nominating Committee has consulted with the CEO of 
the current PCX and proposed a slate of Directors for the initial 
Board. This slate was part of the demutualization package sent to the 
members for a vote and will be put in place once the demutualization 
becomes effective. The PCX Holdings Nominating Committee will nominate 
subsequent Directors to the Board of Directors. The Nominating 
Committee shall nominate Directors for election at the annual meeting 
of stockholders. Such nominations shall comply with the Bylaws of PCX 
Holdings. The Chairman of the Board of Directors of PCX Holdings shall 
appoint the members of the PCX Holdings Nominating Committee.
    The Board of Directors of PCX Holdings shall appoint the Chairman 
of the Board by majority vote. The Board of Directors shall be divided 
into three classes and serve in staggered terms of three years, as set 
forth in the Certificate of Incorporation. Each Director shall hold 
office until the expiration of the Director's term. If, however, there 
remains a vacancy on the Board of Directors (for example, the Director 
is not re-elected and the Director's successor is not elected or 
qualified), the Director shall continue to serve until his or her 
successor is elected and qualified or until his or her earlier death, 
resignation or removal. A Director may serve for any number of terms, 
consecutive or otherwise. Directors need not be stockholders of PCX 
Holdings.
b. Committees of PCX Holdings Board of Directors
    PCX Holdings shall have a Board Audit Committee, Compensation 
Committee, and Nominating Committee. The Board of Directors of PCX 
Holdings may, by resolution passed by a majority of the Directors in 
office, establish one or more additional committees (``PCX Holdings 
Board Committees''). Any such PCX Holdings Board Committee, to the 
extent provided in the resolution of the Board, shall have and may 
exercise all the power and authority of the Board of Directors for 
direction and supervision of the management of the business and affairs 
of PCX Holdings. No such PCX Holdings Board Committee, however, shall 
have power or authority to amend the Certificate of Incorporation or 
the Bylaws, adopt an agreement of merger or consolidation, recommend to 
the stockholders the sale, lease, or exchange of all or substantially 
all of PCX Holdings' property and assets, recommend to the stockholders 
a dissolution of PCX Holdings or a revocation of a dissolution, elect a 
Director or elect or remove an officer, and, unless the resolution 
expressly so provides, no such committee shall have the power or 
authority to declare a dividend or to authorize the issuance of stock.
c. Management
    The officers of PCX Holdings shall include the Chairman of the 
Board of Directors, CEO, Secretary, and such other officers as are 
desirable for the conduct of the business of the corporation in the 
opinion of the CEO. The Chairman of the Board of Directors shall 
appoint officers of PCX Holdings, other than the Chairman of the Board 
of Directors and the CEO. The same person may hold any two or more 
offices. The officers of PCX Holdings will manage the business and 
affairs of PCX Holdings, subject to the oversight of the Board of 
Directors.
d. Shareholder Restrictions
    The Certificate of Incorporation and Bylaws of PCX Holdings place 
certain restrictions on the ability to transfer and own the stock of 
PCX Holdings. For a period of 30 days following the effective date of 
the demutualization, PCX

[[Page 29613]]

Holdings stockholders will not be permitted to sell their shares unless 
the Board of Directors of PCX Holdings waives the transfer restriction. 
Regardless of whether such transfer restriction is waived, PCX Holdings 
stockholders will remain subject to the ownership and voting 
concentration limits and minimum lot transfer provisions described 
below.
    No person (``Person''), either alone or together with its related 
persons (``Related Persons''),\11\ may own shares constituting more 
than forty percent (40%) of the outstanding shares of capital stock of 
PCX Holdings.\12\ This provision can be waived by an amendment to the 
Bylaws of PCX Holdings approved by the Board, subject to the Board 
having determined that such Person is not subject to any applicable 
``statutory disqualification'' (within the meaning of Section 3(a)(39) 
of the Act),\13\ and the amendment being approved by the Commission. No 
trading permit holder of the reorganized PCX or equities trading permit 
holder of PCX Equities, either alone or together with its Related 
Persons, may own shares constituting more than twenty percent (20%) of 
the outstanding shares of common stock of PCX Holdings.\14\ Any Person, 
either alone or together with its Related Persons, that at any time 
owns of record or beneficially, whether directly or indirectly, five 
percent (5%) or more of then outstanding shares of capital stock, who 
has the right to vote in the election of the Board of Directors of PCX 
Holdings, shall, immediately upon so owning five percent (5%) or more 
of the then outstanding shares of such stock, give the Board of 
Directors of PCX Holdings written notice of such ownership.\15\
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    \11\ See PCX Holdings Certificate of Incorporation, Article 9, 
Section 1(b)(iv) for definitions of the terms ``Person'' and 
``Related Persons.''
    \12\ PCX Holdings Certificate of Incorporation, Article 9, 
Section 1(b)(i).
    \13\ 15 U.S.C. 78c(a)(39).
    \14\ PCX Holdings Certificate of Incorporation, Article 9, 
Section 1(b)(ii).
    \15\ PCX Holdings Certificate of Incorporation, Article 9, 
Section 1(b)(iii).
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    No Person, either alone or together with its Related Persons, may 
vote, possess the right to vote or cause the voting of shares 
representing more than twenty percent (20%) of the issued and 
outstanding capital stock of PCX Holdings.\16\ This provision can be 
waived by an amendment to the Bylaws of PCX Holdings approved by the 
Board of Directors, subject to the Board of Directors having determined 
that such person is not subject to any applicable ``statutory 
disqualification'' (within the meaning of Section 3(a)(39) of the Act), 
and the amendment being approved by the Commission.
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    \16\ PCX Holdings Certificate of Incorporation, Article 9, 
Section 1(c).
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    If any stockholder purports to vote, or sell, transfer, assign or 
pledge any shares to any person other than PCX Holdings in a 
transaction that would violate the transfer restrictions and voting and 
ownership concentration limits, then PCX Holdings shall record on its 
books the transfer of only that number of shares that would not violate 
these provisions and shall treat the remaining shares as owned by the 
purported transferor for all purposes, including, without limitation, 
voting, payment of dividends, and distributions.\17\ In addition, if 
any stockholder purports to vote, or sell, transfer, assign or pledge 
any shares to any person in a transaction that would violate the 
transfer restrictions and voting and ownership concentration limits, 
then PCX Holdings shall have the right to redeem such shares at a price 
equal to the par value thereof, upon the approval of the PCX Holdings 
Board of Directors.\18\
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    \17\ PCX Holdings Certificate of Incorporation, Article 9, 
Section 2.
    \18\ PCX Holdings Certificate of Incorporation, Article 9, 
Section 3.
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    Unless otherwise approved by the CEO of PCX Holdings, transfers of 
shares of the capital stock of PCX Holdings may be made only in minimum 
lots of 1,000 shares for a period of one year after the demutualization 
and thereafter in minimum lots of 100 shares.\19\ Holders of PCX 
Holdings capital stock will have no redemption or preemptive rights. 
However, PCX Holdings may redeem shares of its capital stock acquired 
in violation of the transfer restrictions and ownership and voting 
concentration limits contained in its Certificate of Incorporation for 
a price per share equal to the par value thereof, upon the approval of 
the PCX Holdings Board of Directors.
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    \19\ PCX Holdings Bylaws, Article 6, Section 6.07.
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    In the case of transactions relating to PCX Holdings, a merger, 
consolidation, sale of all or substantially all of the assets, or 
dissolution must be approved by an affirmative vote of at least a 
majority of the outstanding shares.\20\
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    \20\ PCX Holdings Bylaws, Article 2, Section 2.06(b). PCX 
represents, however, that under Delaware law this provision would 
not be applicable if such interested stockholder owned at least 85% 
of the voting stock of PCX Holdings outstanding at the time the 
transaction commences, excluding certain shares. Telephone 
conversation between Mai Shiver, Acting Director and Senior Counsel, 
PCX, and Frank N. Genco, Attorney, Division, Commission, on March 3, 
2004.
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    A merger, asset sale, or other business combination with a person 
who, together with affiliates and associates, owns or controls fifteen 
percent (15%) or more of the voting stock of PCX Holdings (``interested 
stockholder'') during the three-year period after the date that the 
person became an interested stockholder will require approval by at 
least two-thirds of the outstanding voting stock of PCX Holdings, which 
is not owned by the interested stockholder, and the prior approval of 
the Board of Directors of PCX Holdings.\21\
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    \21\ PCX Holdings Bylaws, Article 2, Section 2.06(b).
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e. Self-Regulatory Functions and Oversight
    There are various provisions in the Bylaws of PCX Holding that are 
designed to protect the independence of the self-regulatory function of 
the reorganized Exchange or to clarify the Commission's oversight 
responsibilities.
    Under the Bylaws of PCX Holdings, PCX Holdings must give due regard 
to the preservation of the independence of the self-regulatory function 
of the reorganized PCX and to its obligations to investors and the 
general public and shall not take any actions which would interfere 
with the effectuation of any decisions by the Board of Directors of the 
reorganized PCX relating to its regulatory functions or the structure 
of the market which it regulates or which would interfere with the 
ability of the reorganized PCX to carry out its responsibilities under 
the Act.\22\ Moreover, all books and records and the information 
contained therein of the reorganized PCX reflecting confidential 
information pertaining to the self-regulatory function of the 
reorganized PCX, which shall come into the possession of PCX Holdings, 
shall be retained in confidence by PCX Holdings and its Board of 
Directors, officers, employees, and agents, and shall not be used for 
any non-regulatory purposes.\23\
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    \22\ PCX Holdings Bylaws, Article 3, Section 3.15.
    \23\ Id.
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    PCX Holdings Bylaws provide that, to the extent that they are 
related to the activities of the reorganized Exchange, the books, 
records, premises, officers, directors, agents and employees of PCX 
Holdings are deemed to be the books, records, premises, officers, 
directors, agents, and employees of the reorganized Exchange for 
purposes of and subject to oversight pursuant to the Act.\24\
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    \24\ PCX Holdings Bylaws, Article 7, Section 7.03.
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    In addition, pursuant to PCX Holdings Bylaws, PCX Holdings and its 
officers,

[[Page 29614]]

directors, employees and agents, by virtue of their acceptance of such 
position, are deemed to irrevocably submit to the exclusive 
jurisdiction of the U.S. federal courts, the Commission, and the 
Exchange for the purposes of any suit, action or proceedings pursuant 
to the U.S. federal securities laws and the rules and regulations 
thereunder, arising out of, or relating to, the activities of the 
reorganized Exchange.\25\ Further, PCX Holdings and its officers, 
directors, employees and agents, by virtue of their acceptance of any 
such position, are deemed to waive and agree not to assert by way of 
motion, as a defense or otherwise in any such suit, action or 
proceeding, any claims that it or they are not personally subject to 
the jurisdiction of the Commission, that the suit, action or proceeding 
is an inconvenient forum or that the venue of the suit, action or 
proceeding is improper, or that the subject matter thereof may not be 
enforced in or by such courts or agency.\26\ Moreover, PCX Holdings 
Bylaws provide that the officers, directors, employees and agents of 
PCX Holdings, by virtue of their acceptance of such position, are 
deemed to agree to cooperate with the Commission and the reorganized 
Exchange in respect of the Commission's oversight responsibilities with 
respect to the Exchange and the self-regulatory functions and 
responsibilities of the Exchange.\27\
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    \25\ PCX Holdings Bylaws, Article 7, Section 7.04.
    \26\ Id.
    \27\ PCX Holdings Bylaws, Article 7, Section 7.05. The 
Commission notes that the staff of the Exchange has indicated that 
it would present to the Board of Directors of PCX Holdings for its 
approval a proposed new Bylaws provision stating that PCX Holdings 
would take such action as is necessary to insure that its officers, 
directors and employees consent to the applicability of Sections 
7.03 and 7.04 of the Bylaws with respect to Exchange-related 
activities. Letter from Kathryn Beck, Senior Vice President, General 
Counsel, Corporate Secretary and Chief Regulatory Officer, PCX, to 
Elizabeth King, Associate Director, Division, Commission, dated May 
13, 2004.
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    Finally, PCX Holdings Certificate of Incorporation and Bylaws 
provide that, before any amendment to or repeal of a provision of the 
Certificate of Incorporation or Bylaws, respectively, shall be 
effective, it must be submitted to the Board of Directors of the 
reorganized Exchange and if that Board determines that the amendment or 
repeal of such provision must be filed with the Commission before it 
may be effective, the amendment or repeal of such provision shall not 
be effective until it is filed with the Commission.\28\
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    \28\ PCX Holdings Certificate of Incorporation, Article 14, and 
PCX Holdings Bylaws, Article 7, Section 7.06.
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2. Reorganized PCX
    The reorganized PCX will be a wholly-owned subsidiary of PCX 
Holdings that will continue to be a non-stock membership corporation 
with its own Board of Directors. PCX Holdings will be the sole member 
of, and, as such, will have one hundred percent (100%) voting control 
over the reorganized PCX (``Holding Member'').\29\ Only the Holding 
Member will have any right to take part in the ownership of the 
Exchange and will be the Exchange's sole Corporate Member.\30\ The 
reorganized PCX will retain the self-regulatory organization function 
with respect to the members of the current Exchange. PCX Equities will 
continue to be a wholly-owned subsidiary of the reorganized PCX. OTP 
Holders (as well as Exchange Trading Permit (``ETP'') Holders of PCX 
Equities) will have the right to representation on the Board of 
Directors of the reorganized PCX. The Board of Directors of the 
reorganized PCX also will have the right to amend the Bylaws of the 
reorganized PCX.
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    \29\ The term ``Holding Member'' is defined in PCX Bylaws, 
Article II, Section 2.01. Pursuant to this provision of the PCX 
Bylaws, the reorganized PCX is a non-stock corporation consisting of 
a sole member, which is PCX Holdings (also referred to as the 
Holding Member).
    \30\ Under the reorganized PCX's Certificate of Incorporation, 
Corporate Member refers to any member of the Exchange within the 
meaning of Section 102(4) of the General Corporation Law of the 
State of Delaware.
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a. Governing Documents and PCX Rules
    The proposed PCX Certificate of Incorporation, PCX Bylaws, and PCX 
Rules will govern the activities of the reorganized PCX. Proposed PCX 
Rules 1 through 3 relate to qualifications for OTPs and corporate 
governance.\31\ The reorganized PCX's Rules and Bylaws will reflect the 
status of the reorganized Exchange as a wholly-owned subsidiary of PCX 
Holdings, under management of the reorganized PCX Board of Directors 
and its designated officers, and with self-regulatory responsibilities 
pursuant to PCX's registration under Section 6 of the Act.\32\
b. Board of Directors
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    \31\ See Section II.C. infra for a description of the Rules of 
the reorganized PCX.
    \32\ 15 U.S.C. 78f.
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    The Board of Directors shall consist of not less than eight (8) or 
more than twelve (12) Directors, with the Board of Directors to consist 
initially of ten (10) Directors, including the CEO of PCX Holdings. The 
authorized number of Directors shall be as determined from time to time 
by the Board of Directors. At least fifty percent (50%) of the 
Directors will be persons from the public and will not be, or be 
affiliated with, a broker-dealer in securities or employed by, or 
involved in any material business relationship with, the reorganized 
PCX or its affiliates (``Public Directors'').\33\ At least twenty 
percent (20%) of the Directors shall consist of individuals nominated 
by the trading permit holders, with at least one Director nominated by 
the ETP Holders \34\ of PCX Equities, Inc. and with at least one 
Director nominated by the OTP Holders of the reorganized PCX 
(collectively the ``Permit Holder Directors''). The exact number of 
Public Directors and Permit Holder Directors shall be determined from 
time to time by the Board of Directors, subject to the percentage 
restrictions described in proposed Article III, Section 3.02(a) of the 
reorganized PCX's Bylaws. The term of office of a Director shall not be 
affected by any decrease in the authorized number of Directors.
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    \33\ PCX Bylaws, Article III, Section 2(a).
    \34\ See PCXE Rule 1.1(n) for a definition of ``ETP Holder''.
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    The initial Directors of the reorganized Exchange shall consist of 
individuals nominated by the Nominating Committee of the current PCX in 
consultation with the CEO and shall be approved by the Board of 
Governors of the current PCX. At the first annual meeting and at each 
subsequent annual meeting of the Holding Member, except as otherwise 
provided by the reorganized PCX's Bylaws, the Holding Member shall 
elect Directors to serve until the next annual meeting or until their 
successors are elected and qualified. The Board of Directors shall 
appoint the Chairman of the Board by majority vote.
    Each Director shall hold office for a term that expires at the 
annual meeting of the Holding Member following his or her election, 
provided that if he or she is not re-elected and his or her successor 
is not elected and qualified at the meeting and there remains a vacancy 
on the Board of Directors, he or she shall continue to serve until his 
or her successor is elected and qualified or until his or her earlier 
death, resignation, or removal. A Director may serve for any number of 
terms, consecutive or otherwise.
c. Committees of the Board of Directors
    The reorganized PCX Board Committees shall consist of the 
following: (1) A Board Appeals Committee; (2) a Regulatory Oversight 
Committee; (3) an Audit Committee; and (4) a Compensation Committee. 
The Board of Directors may, by resolution passed by a majority of the 
Directors in

[[Page 29615]]

office, establish one or more additional committees (``Board 
Committees''), each committee to consist of one or more Directors. Each 
Board Committee shall be composed of at least fifty percent (50%) 
Public Directors. Each Board Committee, to the extent provided in the 
resolution of the Board creating the committee, shall have and may 
exercise all of the power and authority of the Board of Directors for 
direction and supervision of the management of the business and affairs 
of the reorganized Exchange, and may authorize the seal of the Exchange 
to be affixed to all papers that may require it. No Board Committee, 
however, shall have power or authority to amend the Certification of 
Incorporation or the Bylaws, adopt an agreement of merger or 
consolidation, recommend to the Holding Member the sale, lease or 
exchange of all or substantially all of the Exchange's property and 
assets, recommend to the Holding Member a dissolution of the Exchange 
or a revocation of a dissolution, elect a Director, or elect or remove 
an officer; and unless the resolution expressly so provides, no Board 
Committee shall have the power or authority to declare a dividend or to 
authorize the issuance of membership interests.
d. Nominating Committee
    After the formation of the initial Board of Directors, the 
Nominating Committee of the Board of Directors of PCX Holdings will 
nominate Directors for election to the Board of Directors of the 
reorganized PCX at the annual meeting of the Holding Member. Such 
nominations shall comply with the Bylaws and Rules of the reorganized 
PCX. The reorganized PCX Nominating Committee will nominate the OTP 
Holder nominee(s) to the Board of Directors. The selection process for 
the OTP Holder nominee(s) differs from the selection process for the 
ETP Holder nominee.\35\ Specifically, after the nomination by petition 
period has closed, the Board of Directors of PCX Holdings shall have 
ten (10) business days to object to the nomination of any or all of the 
OTP Holder nominee(s). The Board of Directors of PCX Holdings may, in 
its sole discretion, object to the nomination of any or all of the OTP 
Holder nominee(s) if the nominee(s) have been disciplined by any 
securities self-regulatory organization or the nominee would be subject 
to statutory disqualification within the meaning of Section 3(a)(39) of 
the Act. Any nominee who is objected to by the Board of Directors of 
PCX Holdings is not eligible to be considered as a nominee or petition 
candidate until the expiration of the current term of the Board of 
Directors. If the Board of Directors of PCX Holdings objects to all of 
the proposed nominees, the Nominating Committee shall publish the name 
of an eligible alternative nominee by the later of ten (10) business 
days after the Board of Directors of PCX Holdings notifies the 
Secretary of the reorganized Exchange of their objection to the 
proposed nominee(s) or sixty-five days prior to the expiration of the 
term of the Directors. If the Board of Directors of PCX Holdings 
objects to all of the original nominees, the above-noted process shall 
continue with all of the same deadlines until the Nominating Committee 
nominates a nominee that is not objected to by the Board of Directors 
of PCX Holdings.
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    \35\ PCX represents that the ETP Nominee will be appointed to 
the reorganized PCX Board of Directors as required by the PCX/PCXE 
Shareholder Voting Agreement.
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    According to PCX, the purposes for allowing the Board of Directors 
of PCX Holdings to object to an OTP Holder nominee(s) are: (1) To 
accord PCX Holdings, as sole member of the reorganized PCX, the voting 
rights normally provided to a member of a membership organization; and 
(2) to provide the Board of Directors of PCX Holdings the ability to 
object to the nomination of particular individuals that, for various 
reasons, would be inappropriate as a director of a self-regulatory 
organization. PCX represents that, in both of the above circumstances, 
OTP Holders will still be afforded ``fair'' representation as required 
under the Act because, as a result of the process described above, a 
representative nominated by the OTP Holders will be selected.
e. Management
    The Board of Directors shall elect such officers of the reorganized 
PCX, as it deems appropriate, which must include a Secretary, and which 
may include a President, a CEO, and, upon the recommendation of the 
CEO, any other officers as are desirable for the conduct of the 
business of the corporation. Any two or more offices may be held by the 
same person. The officers of the reorganized PCX will manage the 
business and affairs of the Exchange, subject to the oversight of the 
Board of Directors, and, in some cases, the approval of PCX Holdings as 
the sole member.\36\
---------------------------------------------------------------------------

    \36\ According to the Exchange, under Delaware law events such 
as the sale of all or substantially all assets, a merger, or 
liquidation of the reorganized PCX may reuire the approval of the 
Board of Directors of PCX Holdings. Telephone conversation between 
Mai Shiver, Acting Director and Senior Counsel, and Steve Matlin, 
Senior Counsel, PCX, and Nancy J. Sanow, Assistant Director, and 
Frank N. Genco, Attorney, Division, Commission, on March 17, 2004 
(``Telephone Conversation on March 17, 2004'').
---------------------------------------------------------------------------

f. Disciplinary Process
    The reorganized PCX will retain the self-regulatory organization 
function for the options business of the PCX, as well as for its 
equities business subsidiary, PCX Equities. The proposed 
demutualization will not affect PCXE's current disciplinary process. 
The reorganized PCX's disciplinary process will be the same as the 
existing PCX disciplinary process and will be governed by an Ethics and 
Business Conduct Committee (``EBCC''). The reorganized PCX Board of 
Directors or a designee of the reorganized PCX will appoint the EBCC. 
The EBCC shall be made up primarily of OTP Holders and Allied Persons 
\37\ of an OTP Firm. At least one member of the public shall serve on 
the EBCC.\38\
---------------------------------------------------------------------------

    \37\ ``Allied Person''is defined in PCX Rule 1.1(b) as an 
individual, who is: (1) An employee of an OTP Firm who controls such 
firm; (2) an employee of an OTP Firm corporation who is a director 
or principal executive officer of such corporation; (3) an employee 
of an OTP Firm limited liability company who is a manager or a 
principal executive officer of such limited liability company; or 
(4) a general partner in an OTP Firm partnership.
    \38\ PCX represents that committees involved in the disciplinary 
process will remain unaffected by the demutualization.
---------------------------------------------------------------------------

    The Chief Regulatory Officer of the reorganized PCX or his or her 
staff will authorize the initiation of disciplinary actions and 
proceedings. As is presently the case, the EBCC will conduct hearings, 
render decisions, and impose sanctions. Decisions of the EBCC may be 
appealed for review to a Board Appeals Committee, which will be 
appointed by the reorganized PCX's Board of Directors and will include 
public members, the OTP representative(s), and the ETP 
representative(s) of the Board of Directors. Decisions of the Board 
Appeals Committee shall be subject to the review of the reorganized 
PCX's Board of Directors.
g. Other Committees
    The proposed Bylaws and Rules of the reorganized PCX envision three 
Options committees--the Nominating Committee, the Ethics and Business 
Conduct Committee, and the OTP Advisory Committee.\39\ However, the 
Board of Directors may, by resolution passed by a majority of Directors 
in the office, establish other Options committees, if it deems it 
appropriate.

[[Page 29616]]

Except for the Nominating Committee, the Board of Directors of the 
reorganized PCX will appoint the members of all Options Committees for 
terms of one year. The CEO of the reorganized PCX will appoint the 
Chair and Vice Chair of each Options Committee. OTP Holders and public 
representatives may be appointed to serve on Options Committees.
---------------------------------------------------------------------------

    \39\ The OTP Advisory Committee shall act in an advisory 
capacity regarding rule changes related to disciplinary matters and 
trading rules. See PCX Rule 3.2(b)(3).
---------------------------------------------------------------------------

h. Options Listings and Delistings
    The management of the reorganized PCX will make all decisions with 
respect to listing and delisting options and related products in 
accordance with rules and standards comparable to those set forth in 
the current PCX Rules and used by the Option Listing Committee of the 
current PCX.
i. Regulation/Disciplinary Process
    Following the demutualization, the reorganized PCX will operate as 
a national securities exchange registered under Section 6 of the 
Act.\40\ For purposes of the Act, OTP Holders and OTP Firms will be 
deemed ``members'' of the reorganized PCX.
---------------------------------------------------------------------------

    \40\ 15 U.S.C. 78f.
---------------------------------------------------------------------------

    As a registered national securities exchange and self-regulatory 
organization, the reorganized PCX will continue to carry out its 
statutory responsibilities to enforce compliance by OTP Holders and OTP 
Firms (including ETP Holders of its equities business subsidiary, PCX 
Equities) with the provisions of the federal securities laws and the 
applicable Rules of the reorganized PCX and of PCX Equities. As the 
registered self-regulatory organization, the reorganized PCX will 
continue to have ultimate responsibility for the administration and 
enforcement of rules governing the options and equities business 
operations.
    The reorganized PCX will continue to be required to approve any 
changes to the Rules and governing documents of PCX Equities and to 
file any such changes with the Commission pursuant to Section 19(b) of 
the Act \41\ and Rule 19b-4 thereunder.\42\
j. National Market System Plans
---------------------------------------------------------------------------

    \41\ 15 U.S.C. 78s(b).
    \42\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

    PCX currently is a participant in various national market system 
(``NMS'') plans, including the Consolidated Tape Association (``CTA'') 
Plan, the Consolidated Quotation System (``CQS'') Plan, the Intermarket 
Trading System (``ITS'') Plan, the Options Price Reporting Authority 
(``OPRA''), the Options Intermarket Linkage (``Linkage'') Plan, and the 
Reporting Plan for Nasdaq-Listed Securities Traded on Exchanges on an 
Unlisted Trading Privileges Basis (``Nasdaq UTP'') Plan.\43\ These 
plans are joint industry plans entered into by self-regulatory 
organizations for the purpose of addressing last sale reporting, 
quotation reporting, intermarket equities trading, options price 
reporting, and intermarket options trading, respectively. Following the 
completion of the demutualization, the reorganized PCX, in its 
continuing role as the self-regulatory organization, will continue to 
serve as the voting member of these NMS plans. For those plans that 
relate to equity trading (i.e., the CTA Plan, the CQS Plan, the ITS 
Plan, and the Nasdaq UTP Plan) a PCX Equities representative will 
continue to serve as the reorganized PCX's representative with respect 
to dealing with these plans.\44\ Similarly, the reorganized PCX expects 
that a representative of the reorganized PCX will serve as its 
representative with respect to those NMS plans that relate to options 
trading (i.e., OPRA and Linkage).
---------------------------------------------------------------------------

    \43\ Telephone conversation between Mai Shiver, Acting Director 
and Senior Counsel, PCX, and Frank N. Genco, Attorney, Division, 
Commission, on March 3, 2004, confirming that PCX is a participant 
in the Nasdaq UTP Plan.
    \44\ Id.
---------------------------------------------------------------------------

3. PCX Equities
    PCX Equities will be a wholly-owned stock subsidiary of the 
reorganized PCX. The proposed demutualization will not affect PCXE's 
operations, governance structure, or rules.
a. Agreements Between the Current PCX and PCX Equities
    Currently, the PCX options operations and equities operations share 
certain infrastructure and personnel. After the completion of the 
demutualization, these shared assets will continue to be owned by the 
reorganized PCX and the shared personnel will continue to be employed 
by the reorganized PCX. In each case, however, PCX Equities will have 
access to those resources through inter-company agreements with the 
reorganized PCX. In particular, the reorganized PCX will continue to 
provide PCX Equities with certain management and support services and 
staff. The services provided are for administration, membership, 
technology, finance, accounting, human resources, and legal services. 
PCX represents that the agreement between the reorganized PCX and PCX 
Equities will allocate charges for these services and staff between the 
reorganized PCX and PCX Equities.

B. Option Trading Permits

1. Privileges Conferred by OTPs
    The reorganized PCX will be authorized to issue OTPs that will 
entitle holders of the permits to trade options on the options trading 
facilities of the reorganized PCX, including the options trading floor, 
POETS,\45\ PCX Plus,\46\ or any other systems approved by the Board of 
Directors, as a Market Maker, Floor Broker or order-flow firm. OTP 
Holders may engage in trading of options in the same manner as 
currently practiced by PCX Members who trade on the options trading 
facility.\47\
---------------------------------------------------------------------------

    \45\ Currently, PCX operates an electronic order routing and 
execution system called Pacific Options Exchange Trading System 
(``POETS''), and several other peripheral systems including the 
Pacific Options Processing System (``POPS'') and the Floor Broker 
Hand Held trading system, in conjunction with traditional open 
outcry trading with Floor Brokers and competing Market Makers.
    \46\ PCX Plus is the Exchange's electronic order delivery, 
execution, and reporting system for designated option issues through 
which orders and quotes with size of members are consolidated for 
execution and/or display. This trading system includes the 
electronic communications network that enables registered Market 
Makers to enter orders/quotes with size and execute transactions 
from remote locations or the trading floor. See Securities Act 
Release No. 47838 (May 13, 2003), 68 FR 27129 (May 19, 2003) (order 
approving File No. SR-PCX-2002-36).
    \47\ PCX intends to simplify its membership rules by eliminating 
Automated System Access Privileges (``ASAPs''). ASAPs refer to a 
permit issued by the Exchange for effecting option transactions 
principally over an electronic or automated system such as POETS. 
Under current PCX Rule 1.14, an ASAP member that wishes to obtain 
electronic access to the Options Floor must be a registered broker-
dealer and approved by the Membership Committee. To date, the 
Exchange has issued no ASAPs. Because the reorganized PCX proposes 
to issue OTPs, there will no longer be a need for two separate 
membership categories. Therefore, PCX represents that the rules 
related to ASAPs will be rescinded.
---------------------------------------------------------------------------

    An OTP does not grant its holder any right to trade securities on 
PCX Equities. Any OTP Holder that wishes to trade securities on PCX 
Equities must be approved for, and obtain an ETP pursuant to, the 
PCXE's application procedures.
    OTP Holders will have limited voting rights and may nominate, 
through the Nominating Committee or by petition, at least one member to 
the reorganized PCX Board of Directors.
    OTP Holders will hold six of the seven positions on the Nominating 
Committee. Subsequent nominations to the Nominating Committee will be 
made by the sitting Nominating Committee. The seventh position on the 
Nominating Committee will be a person from the public selected by the 
CEO of the reorganized PCX.
    OTP Holders will not have any distribution or other ownership 
rights in

[[Page 29617]]

the reorganized PCX or PCX Holdings by virtue of their status as OTP 
Holders.
2. Number of OTPs
    There will be no limit on the number of OTPs issued by the 
reorganized PCX.
3. Qualification for OTPs
    The reorganized PCX will commence issuing OTPs once the 
demutualization is completed. Persons or entities that are registered 
broker-dealers and are not existing PCX members may be granted trading 
privileges on the reorganized PCX through an application process. OTP 
qualifications will be substantially the same as the current 
requirements for PCX membership.
    The application process for applicants who are not current PCX 
members will be the same as is now required by PCX. The decision to 
grant or deny an application for trading privileges will be made by 
officers of the reorganized PCX (there will be no Membership Committee) 
and the denial of an application will be appealable to the reorganized 
PCX Board Appeals Committee.
4. Non-transferability of OTPs
    OTPs will not be transferable by sale or lease, but they may be 
transferred by a firm holding an OTP between individuals within the 
same firm in accordance with the Rules of the reorganized PCX.
5. Cost of OTPs
    Pursuant to the requirements of Section 19 of the Act,\48\ PCX 
intends to set forth in a separate rule filing the fees for an OTP that 
will be assessed.
---------------------------------------------------------------------------

    \48\ 15 U.S.C. 78s.
---------------------------------------------------------------------------

C. Rules of the Reorganized PCX

    PCX represents that the majority of the Rules proposed to regulate 
the business conduct and practices of its OTP Holders, OTP Firms, and 
associated persons are closely patterned on PCX's existing Rules (with 
the exception of proposed PCX Rules 1 through 3). The reorganized 
Exchange's Rules contain changes to reflect the new structure whereby 
trading permits will be issued to persons or entities conducting 
business on the reorganized PCX. The discussion below indicates those 
Rules that reflect a significant departure from the current PCX Rules 
and, for those Rules that are closely patterned after existing PCX 
Rules, notes which current PCX Rules were used as a model and whether 
only minor conforming word changes and clean-up corrections were made.
1. Summary of Rules of the Reorganized PCX
    Following the demutualization, the reorganized PCX will implement, 
subject to certain revisions, the applicable trading rules and 
standards of the current PCX as they relate to the current options 
trading business. Rules 1 through 3 of the reorganized PCX, which 
relate to definitions, qualifications for OTPs, and corporate 
governance, reflect significant departures from existing PCX Rules. The 
remaining rules are substantially similar to the current Rules, unless 
noted otherwise. The following section discusses the Rules of the 
reorganized Exchange that are contained in the proposed rule change, as 
amended, and that will be implemented by the reorganized Exchange in 
conjunction with the demutualization.
a. PCX Rule 1--Definitions
    PCX Rule 1 defines certain terms and references (e.g., OTP Holder) 
used throughout the Rules, and is intended to ensure uniformity in the 
use of such terms. In conjunction with the demutualization and the 
issuance of the OTPs, the PCX has developed the following new terms and 
proposes to incorporate them into PCX Rule 1.
    PCX Rule 1.1(h)--The term ``Exchange'' means the reorganized PCX, a 
Delaware corporation as described in the company's Certificate of 
Incorporation and Bylaws. The reorganized Exchange is a national 
securities exchange as that term is defined in Section 6 of the 
Act.\49\
---------------------------------------------------------------------------

    \49\ 15 U.S.C. 78f.
---------------------------------------------------------------------------

    PCX Rule 1.1(n)--The term ``Nominee'' means an individual who is 
authorized by an OTP Firm, in accordance with PCX Rule 2.4, to conduct 
business on the Exchange's Trading Facilities (as defined below) and to 
represent such OTP Firm in all matters relating to the Exchange. As 
long as a Nominee remains effective, the Nominee will have status as a 
``member'' of the Pacific Exchange, as that term is defined in Section 
3 of the Act.\50\ A Nominee must agree to be bound by the Bylaws and 
Rules of the Exchange, and by all applicable rules and regulations of 
the Commission.
---------------------------------------------------------------------------

    \50\ 15 U.S.C. 78c.
---------------------------------------------------------------------------

    PCX Rule 1.1(p)--The term ``OTP'' refers to an Options Trading 
Permit issued by the Exchange for effecting approved securities 
transactions on the Exchange's Trading Facilities. An OTP may be issued 
to a sole proprietor, partnership, corporation, limited liability 
company, or other organization which is a registered broker or dealer 
pursuant to Section 15 of the Act,\51\ and which has been approved by 
the Exchange.
---------------------------------------------------------------------------

    \51\ 15 U.S.C. 78o.
---------------------------------------------------------------------------

    PCX Rule 1.1(q)--The term ``OTP Holder'' refers to a natural 
person, in good standing, who has been issued an OTP, or has been named 
as a Nominee. An OTP Holder must be a registered broker or dealer 
pursuant to Section 15 of the Act,\52\ or a Nominee or an associated 
person of a registered broker or dealer that has been approved by the 
Exchange to conduct business on the Exchange's Trading Facilities. An 
OTP Holder shall agree to be bound by the Bylaws and Rules of the 
Exchange, and by all applicable rules and regulations of the 
Commission. An OTP Holder shall not have ownership or distribution 
rights in the Exchange. An OTP Holder will have limited voting rights 
to nominate an OTP Holder to the Exchange's Board of Directors pursuant 
to proposed PCX Rule 3.2(b)(2)(C). An OTP Holder will have status as a 
``member'' of the Pacific Exchange, as that term is defined in Section 
3 of the Act.\53\
---------------------------------------------------------------------------

    \52\ 15 U.S.C. 78o.
    \53\ 15 U.S.C. 78c.
---------------------------------------------------------------------------

    PCX Rule 1.1(r)--The term ``OTP Firm'' refers to a sole 
proprietorship, partnership, corporation, limited liability company, or 
other organization in good standing who holds an OTP or upon whom an 
individual OTP Holder has conferred trading privileges on the 
Exchange's Trading Facilities pursuant to and in compliance with these 
rules. An OTP Firm must be a registered broker or dealer pursuant to 
Section 15 of the Act.\54\ An OTP Firm shall agree to be bound by the 
Certificate of Incorporation, Bylaws, and PCX Rules of the Exchange, 
and by all applicable rules and regulations of the Commission. An OTP 
Firm shall not have ownership or distribution rights in the Exchange. 
An OTP Firm will have limited voting rights to nominate an OTP Holder 
to the Exchange's Board of Directors pursuant to PCX Rule 3.2(b)(2)(C). 
An OTP Firm will have status as a ``member'' of the current PCX, as 
that term is defined in Section 3 of the Act.\55\
---------------------------------------------------------------------------

    \54\ 15 U.S.C. 78o.
    \55\ 15 U.S.C. 78c.
---------------------------------------------------------------------------

    PCX Rule 1.1(y)--The terms ``self-regulatory organization'' and 
``SRO'' has the same meaning as set forth in the provisions of the Act 
relating to national securities exchanges.
    PCX Rule 1.1(aa)--The term ``Trading Facilities'' refers to the 
Exchange's facilities for the trading of options, office space provided 
by the Exchange

[[Page 29618]]

to OTP Holders and OTP Firms in connection with their floor trading 
activities, and any and all electronic or automated order execution 
systems and reporting services provided by the Exchange to OTP Holders 
and OTP Firms.
b. PCX Rule 2--Option Trading Permits
    PCX Rule 2, which describes the application process, the 
qualification requirements and other requirements for holding an OTP, 
is similar to the requirements and procedures now described in PCX Rule 
1 of the current Exchange and certain sections of the Constitution of 
the current Exchange. However, as described below, certain substantive 
changes have been made to reflect the characteristics of the new OTPs. 
These substantive changes include the following:
    PCX Rule 2.2--In accordance with PCX Rule 2.2, an OTP may be issued 
to an individual, partnership, corporation, limited liability company, 
or other organization that is a registered broker-dealer. As discussed 
under Section 1.1(p) of PCX Rule 1, an OTP will authorize its holder to 
trade options on any facility of the reorganized PCX, including the 
options trading floor, POETS, or PCX Plus, as a registered Market 
Maker, Floor Broker, or order flow firm. An OTP will not confer any 
rights to trade on the Archipelago Exchange, i.e., the equities trading 
facility of PCX Equities. Any OTP Holder that wishes to trade 
securities on the Archipelago Exchange must be approved for and obtain 
a PCXE ETP pursuant to PCXE's standard application procedures.
    PCX Rule 2.3--To be consistent with the approach taken with respect 
to seat ownership, under PCX Rule 2.3(b), all firms that directly own 
OTPs are required to designate a natural person to hold their OTPs 
(i.e., the OTP Holder). Accordingly, whenever an OTP confers the right 
to vote (e.g., election of the Nominating Committee, as discussed 
below), it is the OTP Holder, rather than the OTP Firm, who casts the 
vote. However, pursuant to PCX Rule 2.21(c) (as discussed below), the 
OTP Firm retains the right to replace the OTP Holder with another 
qualified Nominee employed by the OTP Firm at any time. Therefore, 
since the reorganized PCX will use revocable proxies to conduct its 
votes, OTP Firms will be able to effectively control the voting process 
with respect to the OTPs that they own in the same manner as PCX member 
firms control the voting process with respect to Nominees today.
    PCX Rules 2.4, 2.5, and 2.6--PCX Rules 2.4, 2.5, and 2.6 would 
alter PCX's existing member approval process by authorizing the 
reorganized PCX management--in place of a Membership Committee--to 
approve or reject OTP applicants. As described in PCX Rule 2.4(g), in 
the event that the Exchange rejects an application, the applicant will 
have the opportunity to appeal the decision to the Exchange's Board 
Appeals Committee pursuant to proposed PCX Rule 10. Minor changes in 
terminology have been made to conform to the demutualization.
    PCX Rule 2.21--As described in PCX Rule 2.21(a) and (b), unlike 
current PCX memberships, OTPs may not be purchased, sold, or leased. 
Therefore, the current Exchange's Rules 1.21 and 1.24 and sections of 
Rules 1.22 and 1.23 relating to the purchase, sale, or lease of 
memberships have been deleted from the reorganized PCX Rules. Under PCX 
Rule 2.21(c) of the reorganized Exchange, the only permissible 
transfers of OTPs are intra-firm transfers involving Nominees employed 
by the same firm. A new Nominee, unless he or she is a previously 
approved person or approved Allied Person \56\ of the OTP Firm, shall 
provide all information required for the Exchange to conduct an 
investigation of the Nominee prior to his or her approval as a Nominee.
---------------------------------------------------------------------------

    \56\ See note 37 supra for a definition of Allied Person.
---------------------------------------------------------------------------

    PCX Rule 2.22--Pursuant to PCX Rule 2.22, an OTP will terminate 
upon the occurrence of the permit holder's expulsion, suspension 
without reinstatement, death, declaration of incompetence, dissolution, 
winding up, or other cessation of business. An OTP Holder whose trading 
privileges are terminated must be current in all filings and payments 
of dues, fees, and charges. If the OTP Holder fails to be current as 
required, the Exchange retains jurisdiction over the permit holder 
until such time as the permit holder is current. In addition, an OTP 
that confers trading privileges on an OTP Firm will terminate when the 
named OTP Holder ceases to be an employee of the OTP Firm. In that 
event, the OTP Firm may nominate another employee as its Nominee OTP 
Holder. An OTP Firm upon which trading privileges are conferred shall 
continue to be responsible for all obligations, including, without 
limitation, dues, fees, and charges imposed by or due to the Exchange.
    The Exchange represents that, other than the substantive changes 
discussed above and minor conforming word changes that reflect the 
demutualization, each section of PCX Rule 2 (except PCX Rule 2.21 and 
PCX Rule 2.22) is substantially the same as a relevant corresponding 
PCX Rule or Article of the Constitution.
c. PCX Rule 3--Organization and Administration
    PCX Rule 3 sets forth the organization and governance structure of 
the reorganized PCX. PCX Rules 3.1 through 3.3 regarding Options and 
Board Committees were drafted using PCX and PCXE Rules of the current 
Exchange as a starting point.\57\ Under the rules of the reorganized 
Exchange, the use of a ``member'' committee structure will be reduced 
substantially.
---------------------------------------------------------------------------

    \57\ See Rules 11.1(a)-(b), 11.2(a)-(b), 11.3-11.5, 11.6(b); and 
11.8(d) of the current Exchange; Articles II-IV of the current 
Exchange's Constitution; and PCXE Rule 3.
---------------------------------------------------------------------------

    PCX Rule 3.1--PCX Rule 3.1 states that the Board of Directors may 
establish: (1) One or more Board committees consisting of one or more 
Directors of the Exchange; and (2) one or more Options committees 
consisting of people other than Directors. As discussed in more detail 
below, although the reorganized PCX's Board may establish additional 
Options Committees under this rule, the Bylaws and Rules of the 
reorganized PCX currently envision solely a Nominating Committee, an 
Ethics and Business Conduct Committee, and an OTP Advisory Committee. 
Similarly, although the Board may establish additional Board 
Committees, the Rules currently envision only a Board Appeals 
Committee, a Regulatory Oversight Committee, an Audit Committee, and a 
Compensation Committee.
    PCX Rule 3.2(a)--PCX Rule 3.2(a) establishes the substantive and 
procedural rules for an Options Committee conducting meetings and 
exercising its authority. In particular, PCX Rule 3.2(a), which is 
similar to rules and procedures of the current PCX and of PCXE, 
discusses quorums, voting, conference call meetings, vacancies, the 
removal and resignation of committee members, and eligibility for and 
appointment to Options Committees, interested persons and 
subcommittees.
    Under this rule, OTP Holders and Allied Persons \58\ of OTP Firms 
as well as public representatives may be appointed to serve on Options 
Committees. No more than one person affiliated with the same OTP Firm 
will be eligible for service on the same Options Committee. PCX Rule 
3.2(a) vests authority in the Board of Directors or such other designee 
of the reorganized PCX to appoint the members of Options Committees 
(other

[[Page 29619]]

than the Nominating Committee). The CEO or such other designee of the 
reorganized PCX will appoint the Chair and Vice Chair of each Options 
Committee (other than the Nominating Committee).
---------------------------------------------------------------------------

    \58\ See note 37 supra.
---------------------------------------------------------------------------

    PCX Rule 3.2(b)(1)--PCX Rule 3.2(b)(1) describes the functions and 
authority of the Ethics and Business Conduct Committee (``EBCC''). The 
reorganized PCX's disciplinary process will be similar to the existing 
PCX disciplinary process and will be governed by the EBCC. Pursuant to 
the proposed rule, the EBCC would have the following functions and 
authority: (1) Examine the business conduct and financial condition of 
OTP Holders, OTP Firms, and associated persons; (2) conduct hearings 
and render decisions in summary disciplinary actions and proceedings; 
(3) impose appropriate sanctions of expulsion, suspension, fine, 
censure, or any other fitting sanctions where the Committee finds that 
a violation within the disciplinary jurisdiction of the Exchange has 
been committed; and (4) require the production of detailed financial 
reports of an OTP Holder or OTP Firm and such other operational reports 
as it may deem relevant.
    In addition, under this rule, the EBCC will have the authority to 
examine and subsequently suspend an OTP Firm or OTP Holder if the 
person or entity is in violation of PCX Rule 4. Any such suspension is 
subject to review by the Board Appeals Committee. Such review shall not 
operate as a stay of the suspension unless specifically allowed by the 
Board. A person or firm that experiences a reversal of the suspension 
imposed by the Committee shall be prohibited from instituting a lawsuit 
against the Exchange or the Committee members.
    Finally, decisions of the EBCC or sanctions imposed by the 
regulatory staff relating to disciplinary proceedings may be appealed 
to the Board Appeals Committee in accordance with PCX Rule 10.
    PCX Rule 3.2(b)(2)--PCX Rule 3.2(b)(2) describes the 
characteristics and function of the Nominating Committee. Specifically, 
the Nominating Committee shall have seven members consisting of six OTP 
Holders and one public representative. Members of the Nominating 
Committee will be nominated in accordance with the procedures set forth 
in proposed PCX Rule 3.2(b)(2). This Rule states that, prior to the 
expiration of its term, the Nominating Committee shall publish a slate 
of six eligible nominees for the committee. OTP Holders may submit a 
petition to the Exchange in writing to nominate additional eligible 
candidates to fill the OTP positions. Upon written petition of the 
lesser of thirty-five or ten percent (10%) of the OTP Holders in good 
standing, the additional candidates shall also be nominated by the 
Nominating Committee. The CEO shall appoint a person from the public to 
fill the public position on the Nominating Committee.
    If there are more than six nominees to fill the OTP Holder 
positions on the Nominating Committee, the Nominating Committee shall 
submit the nominees to the OTP Holders for election. Each OTP Holder in 
good standing shall be permitted to vote for up to six nominees and the 
six nominees receiving the most votes shall fill the OTP positions. Tie 
votes shall be decided by the Board of Directors at its first meeting 
following the election. If there are only six nominees to fill the OTP 
Holder positions, those six nominees shall be deemed elected to the 
Nominating Committee.
    This Nominating Committee will nominate at least one nominee for 
the reorganized PCX Board. Such nominee may be an OTP Holder or Allied 
Person of an OTP Firm. OTP Holders may submit a written petition to the 
Exchange to nominate additional eligible candidates to fill the OTP 
Holder position and, upon written petition of the lesser of thirty-five 
(35) or ten percent (10%) of OTP Holders in good standing, the 
additional person(s) shall also be nominated by the Nominating 
Committee.
    After the nomination by petition period has closed, the Board of 
Directors of PCX Holdings shall have ten (10) business days to object 
to the nomination of any or all of the OTP Holder nominee(s). The Board 
of Directors of PCX Holdings may in its sole discretion object to the 
nomination of any or all of the OTP Holder nominee(s) if the nominee(s) 
have been disciplined by any securities SRO or the nominee would be 
subject to statutory disqualification within the meaning of Section 
3(a)(39) of the Act. Any nominee who is objected to by the Board of 
Directors of PCX Holdings is not eligible to be considered as a nominee 
or petition candidate until the expiration of the current term of the 
Board of Directors. If the Board of Directors of PCX Holdings objects 
to all of the proposed nominees, the Nominating Committee shall publish 
the name of an eligible alternative nominee by the later of ten (10) 
business days after the Board of Directors of PCX Holdings notifies the 
Secretary of the reorganized Exchange of their objection to the 
proposed nominee(s) or sixty-five (65) days prior to the expiration of 
the term of the Directors. If the Board of Directors of PCX Holdings 
objects to all of the original nominees, the above-noted process will 
continue with all of the same deadlines, until the Nominating Committee 
nominates a nominee that is not objected to by the Board of Directors 
of PCX Holdings.
    If there are two or more OTP Holder nominees for the Board of 
Directors of the reorganized PCX, the Nominating Committee shall submit 
the contested nomination to the OTP Holders for selection. Each OTP 
Holder may select one nominee for the contested seat on the Board of 
Directors. With respect to the contested positions, the nominee for the 
Board of Directors selected by the OTP Holders, shall be submitted by 
the Nominating Committee to the Board of Directors. Similarly, the 
Nominating Committee shall submit an uncontested nominee to the Board 
of Directors. Tie votes shall be decided by the Board of Directors at 
its first meeting following the election.
    PCX Rule 3.2(b)(3)--OTP Advisory Committee will be responsible for 
advising the management of the reorganized PCX regarding rule changes 
relating to disciplinary matters and trading rules. The OTP Advisory 
Committee will be made up of OTP Holders. According to PCX, attempts 
shall be made to have diverse OTP Holder representation of different 
constituencies on the Committee.
    PCX Rule 3.2(c)--Under this Rule, each Options Committee will have 
such other powers and duties as delegated to it by the Board of 
Directors. Each Options Committee is subject to the control, review, 
and supervision of the Board of Directors.
    PCX Rule 3.3(a)(1)--PCX Rule 3.3(a)(1) describes the functions and 
authority of the Board Appeals Committee. The Board Appeals Committee 
will be composed of the OTP Director(s), the ETP Director(s), and all 
of the Public Directors of the reorganized PCX. Board Appeals Committee 
Panels (``Appeals Panels'') will be composed of members of the Board 
Appeals Committee. An Appeals Panel will be composed of no less than 
three (3), but no more than five (5) individuals.\59\ The Appeals Panel 
will conduct reviews of matters subject to the applicable provisions of 
proposed PCX Rule 3.2(b)(1)(C) or 10. Each Appeals Panel will contain 
at least one Public Director and at least one Director

[[Page 29620]]

that is an OTP Holder or Allied Person of an OTP Firm. Subject to PCX 
Rule 10, decisions of the Board Appeals Committee will be subject to 
the review of the Board of Directors. The decision of the Board of 
Directors will constitute the final action of the Exchange, unless the 
Board remands the proceedings.
---------------------------------------------------------------------------

    \59\ The body conducting the review, either the Board Appeals 
Committee itself or the Appeals Panel, is also referred to in the 
PCX Rules as the Review Board.
---------------------------------------------------------------------------

    PCX Rule 3.3(a)(2)--PCX Rule 3.3(a)(2) describes the functions and 
authority of the Regulatory Oversight Committee (``ROC''). The ROC 
shall ensure: (1) the independence of Exchange regulation; (2) that the 
Exchange provides adequate resources to properly fulfill its SRO 
regulatory obligations; and (3) that Exchange management fully supports 
the execution of the regulatory process. The ROC shall be composed of 
all of the Public Directors of the reorganized PCX.
    PCX Rule 3.3(a)(3)--PCX Rule 3.3(a)(3) describes the functions and 
authority of the Audit Committee. The Audit Committee shall be made up 
of at least three (3) Directors of the reorganized PCX. All members of 
the Audit Committee shall be Public Directors and at least one member 
of the Audit Committee shall have accounting or related financial 
management expertise, as the reorganized PCX Board of Directors 
interprets such qualification in its business judgment. The Audit 
Committee shall conduct an annual review with the independent auditors 
to determine the scope of their examination and the cost thereof. The 
Audit Committee shall periodically review with the independent auditors 
and the internal auditor, the Exchange's internal controls and the 
adequacy of the internal audit program. The Audit Committee shall 
review the annual reports submitted both internally and externally, and 
take such action with respect thereto as it may deem appropriate. The 
Audit Committee shall also recommend independent public accountants as 
auditors of the Exchange and its subsidiaries to the reorganized PCX 
Board of Directors.
    PCX Rule 3.3(a)(4)--PCX Rule 3.3(a)(4) describes the functions and 
authority of the Compensation Committee. The Compensation Committee 
shall be made up of at least three (3) Directors of the reorganized PCX 
Board of Directors. Only one (1) non-Public Director may serve on the 
committee. The Compensation Committee shall review and approve 
corporate goals and objectives relevant to the CEO's Compensation, 
evaluate the CEO's performance in light of those goals and objectives, 
and set the CEO's compensation level based on this evaluation. The 
Compensation Committee also shall make recommendations to the Board of 
Directors of the reorganized PCX with respect to the design of 
incentive compensation and equity-based plans.
    PCX Rule 3.6--Subject to minor word changes, PCX Rule 3.6 regarding 
surveillance agreements is the same as PCX Rule 14.1 of the current 
Exchange.
    PCX Rules 3.7--3.9--Other than minor conforming word changes, PCX 
Rules 3.7 through 3.9 are the same as Article XIV, Section 1 of the 
current Exchange's Constitution. Under these Rules, the reorganized PCX 
Board may impose reasonable fees, assessments, charges, or fines to be 
paid by OTP Holders or OTP Firms. The Exchange represents that, prior 
to implementing the demutualization, it will file with the Commission a 
rule proposal to change its Schedule of Fees and Charges for services 
provided by the reorganized PCX.
d. PCX Rule 4--Capital Requirements, Financial Reports, and Margins
    PCX Rule 4, which sets forth the net capital, financial reporting, 
and margin requirements for OTP Holders and OTP Firms, has been adapted 
from PCX Rule 2 of the current Exchange. Only minor conforming changes 
in terminology and clean-up corrections have been made to the Rules of 
the current Exchange.
e. PCX Rule 5--Listings
    PCX Rule 5 is comprised of the General Provisions and Definitions, 
Underlying Securities, Stock Index Options, Flexible Exchange Options, 
Buy-Write Option Unitary Derivatives (BOUNDs), and Portfolio Depositary 
Receipts. This Rule has been adapted from Rules 3, 7, and 8 of the 
current PCX. Only minor conforming changes in terminology and clean-up 
corrections have been made to the Rules of the current Exchange.
f. PCX Rule 6--Options Trading
    Other than the substantive changes discussed below and minor 
conforming word changes that reflect the demutualization, PCX Rule 6 is 
unchanged from Rule 6 of the current Exchange, which governs options 
trading. There are two notable modifications to the Exchange's options 
trading rules. First, the Exchange seeks to confer jurisdiction 
currently held by the Options Floor Trading Committee to the Exchange. 
Second, the Exchange proposes to confer jurisdiction currently held by 
Floor Officials to either Trading Officials or the Exchange.\60\
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    \60\ Initially, Trading Officials will be acting as officials of 
the Exchange as opposed to members of the Options Floor Trading 
Committee. Over time, the Exchange expects that the PCX's regulatory 
staff will be primarily responsible for the general supervision of 
the conduct and dealings of OTP Holders, OTP Firms, and Associated 
Persons on the options trading facility.
---------------------------------------------------------------------------

g. PCX Rule 7--General Trading PCX Rules
    PCX Rule 7, which pertains to general trading rules that address 
matters such as trading hours and access to trading facilities has been 
adapted from Rule 4 of the current Exchange. Only minor conforming 
changes in terminology have been made to the provisions of Rule 4 of 
the current Exchange.
h. PCX Rule 9--Conducting Business With the Public
    PCX Rule 9, which governs how OTP Holders and OTP Firms must 
conduct business with the public, is patterned after Rule 9 of the 
current PCX. Except for minor changes in terminology and clean-up 
corrections, this Rule is substantially the same as Rule 9 of the 
current Exchange.
i. PCX Rule 10--Disciplinary Proceedings, Other Hearings, and Appeals
    PCX Rule 10 describes the disciplinary process for the reorganized 
PCX. The reorganized PCX's disciplinary process will be similar to the 
current PCX's disciplinary process (including summary sanction 
procedures under the Minor Rule Plan) and will be governed by the EBCC. 
Therefore, aside from conforming word changes and the substantive 
changes discussed below, PCX Rule 10 will be closely modeled after Rule 
10 of the current Exchange.
    PCX Rules 10.8(a)--This rule defines and clarifies the procedures 
and timetables for the respondent to follow when requesting the review 
of a decision by the Conduct Panel appointed by the EBCC.\61\ The 
respondent may appeal to the Board at any time within fifteen (15) 
calendar days after the decision has been served.
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    \61\ The Exchange is proposing to make certain technical changes 
throughout the text of the PCX Rule 10 for clarification purposes, 
e.g., adding references to calendar days.
---------------------------------------------------------------------------

    PCX Rule 10.8(b)--This rule provides that the Board Appeals 
Committee may appoint an Appeals Panel to review the decision rendered 
by the Conduct Panel. The composition of the Appeals Panel will be 
determined by the Board Appeals Committee in accordance with proposed 
PCX Rule 3.3(a)(1)(A). Unless the Review Board shall decide to open the 
record for the introduction of new evidence or to hear argument, such 
review shall be based solely upon the record and the written exceptions 
filed

[[Page 29621]]

by the parties. The standard of review shall be de novo.
    PCX Rules 10.14(a)-(m)--Rules 11.7(a)-(m) of the current Exchange, 
which pertain to appeals for non-disciplinary matters, will be 
incorporated into PCX Rule 10.14. PCX Rule 10.14 provides the 
procedures for persons aggrieved by any of the following actions taken 
by the reorganized Exchange to apply for an opportunity to be heard and 
to have the action reviewed. These actions are: (1) Denial of an OTP; 
(2) the barring of any person from becoming associated with an OTP 
Firm; (3) the suspension or cancellation of OTP trading privileges; (4) 
the prohibition or limitation with respect to access to services 
provided by the Exchange, or the access to services of any OTP Firm 
taken pursuant to the Bylaws, or Rules or procedures of the Exchange; 
(5) actions taken pursuant to PCX Rules 6.37 (Obligations of Market 
Makers), 6.82(e) or (f) (regarding allocation or reallocation of option 
issues), and 6.82(g) (regarding qualification or disqualification of an 
LMM); or (6) the denial of an applicant for registration as a Market 
Maker, Lead Market Maker, or Floor Broker (PCX Rules 6.33, 6.44 and 
6.82(b)(1)). The provisions of this Rule shall not apply to reviews of 
disciplinary action, for which review is already provided within 
proposed PCX Rule 10, and actions in Arbitration.
j. PCX Rule 11--Business Conduct
    PCX Rule 11 consolidates various options-related rules that address 
business practices, ethical standards, and prohibited acts contained in 
Rules 2 and 4 and the Constitution of the current Exchange. Other than 
minor conforming word changes that reflect the demutualization, each 
section of PCX Rule 11 is substantially the same as the relevant 
corresponding rule or Article of the current PCX.
k. Rule 12--Arbitration
    PCX Rule 12, the arbitration rule, has been patterned closely after 
Rule 12 of the current Exchange. Only minor changes in terminology have 
been made to conform this rule to the circumstances of the 
demutualization.
l. PCX Rule 13--Expulsion, Suspension, and Reinstatement
    PCX Rule 13 clarifies, restates, and reorganizes rules and 
procedures of the current Exchange regarding certain suspensions, 
cancellations, bars, and prohibitions on access to the reorganized 
PCX's services and facilities. The following describes provisions of 
Rule 13 and how they differ from Rule 13 of the current Exchange, where 
applicable.
    PCX Rules 13.1(a)-(b)--PCX Rules 13.1(a)-(b) incorporate a modified 
version of Article X, Sections 1(a) and (b) of the current Exchange's 
Constitution. This rule requires an OTP Holder or OTP Firm to give 
prompt written notice to the Exchange if it is expelled or suspended 
from any SRO, encounters financial difficulty or operating 
inadequacies, fails to perform contracts or becomes insolvent, or if 
any associated person of such OTP Firm is similarly expelled or 
suspended by an SRO.
    PCX Rules 13.2(a)-(b)--PCX has reorganized and simplified its rules 
relating to summary and non-summary disciplinary proceedings. Rule 
13.2(a)-(b) has been adapted from the NASD Rule 9510 Series and Article 
X, Section 2 and Article XI, Section 3(c) of the current Exchange's 
Constitution. Rule 13.2(a)-(b) is intended to eliminate any potential 
ambiguities in the procedures relating to summary and non-summary 
suspensions by expressly identifying the grounds for imposing such 
suspensions.
    PCX Rule 13.2(c)--PCX Rule 13.2(c) provides that action taken 
pursuant to PCX Rule 13.2(a) also shall be subject to the applicable 
provisions of PCX Rule 10.14. Furthermore, under Commentary .01, the 
Exchange will be required to notify the Commission in the event that it 
determines to take summary action pursuant to PCX Rule 13.2.
    PCX Rule 13.3--PCX Rule 13.3 states that an OTP Holder, OTP Firm, 
or Associated Person \62\ thereof loses all rights and trading 
privileges when those privileges are suspended or canceled by the 
Exchange. However, such person or organization shall remain subject to 
the disciplinary power of the Exchange.
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    \62\ ``Associated Person'' is defined in PCX Rule 1.1(d).
---------------------------------------------------------------------------

    PCX Rule 13.4--PCX Rule 13.4 states that an OTP Holder, OTP Firm, 
or Associated Person thereof whose trading privileges are suspended may 
be disciplined by the Exchange for any offense committed either before 
or after the announcement of the suspension.
    PCX Rule 13.5--Other than minor word changes, PCX Rule 13.5 is 
modeled closely after Article X, Section 3 of the current PCX's 
Constitution. PCX Rule 13.5 states that a person or organization whose 
trading privileges have been suspended must immediately afford every 
resource required by the Exchange for the investigation of its affairs.
    PCX Rule 13.6--Other than minor word changes, PCX Rule 13.6 is 
modeled closely after Article X, Section 4 of the current PCX's 
Constitution. PCX Rule 13.6 describes the grounds for canceling trading 
privileges.
    PCX Rule 13.7--Other than minor word changes, PCX Rule 13.7 is 
modeled closely after Article X, Section 5 of the current Exchange's 
Constitution. PCX Rule 13.7 describes the reinstatement process after 
trading privileges have been suspended.
    PCX Rule 13.8--PCX Rule 13.8 provides that if any OTP Holder, OTP 
Firm, or any Associated Person is suspended and fails or is unable to 
apply for reinstatement or fails to obtain reinstatement, trading 
privileges conferred by an OTP will terminate.
m. PCX Rule 14--Liability of Directors and Exchange
    PCX Rule 14 has been adapted from Rule 13 of the current Exchange. 
Only minor changes in terminology have been made to conform the rule to 
the proposed demutualization.
n. Option Floor Procedure Advices (``OFPA'')
    The proposed rule change also contains revisions to various options 
floor procedures and policies that have been adopted over time. These 
revised OFPA have been adapted from existing ones, which were 
previously approved by the Commission. These OFPA will apply to OTP 
Holders, OTP Firms, or Associated Persons thereof that conduct business 
on the options trading facilities. Minor conforming changes in 
terminology have been made to the existing floor procedures and 
policies. In addition, the Exchange proposes to delete OFPA B-4 (Market 
Maker Trading on PCX Equity Floors) and OFPA D-8a (Marking Orders to 
Reflect Split Transactions) because, according to PCX, they are 
obsolete and no longer applicable to the current trading environment.

III. Summary of Comments

    The Commission received one comment letter in response to the 
proposed rule change.\63\ The Brown Letter requested that the Exchange 
undertake several actions prior to Commission approval of the 
demutualization proposal. First, the Brown Letter suggested that the 
Exchange hold another vote on the proposal. The commenter argued that 
the Exchange's $750 monthly seat assessment has reduced the value of 
Exchange seats and allegedly was

[[Page 29622]]

undertaken to force out a group of dissident seat holders. The 
commenter urged that the assessment be stopped. Second, the commenter 
stated that the current PCX Chairman would receive ten percent (10%) of 
the stock in the reorganized Exchange and the Compensation Committee 
will award him stock options with a strike price based on the value of 
$20,000 per seat. The commenter urged that PCX be required to rewrite 
the option plan both as to the amount of shares and strike price. 
Finally, the Brown Letter suggested that a new vote be scheduled after 
the above-mentioned remedies are in place.
---------------------------------------------------------------------------

    \63\ See Brown Letter, note 4 supra. The Brown Letter included 
as an attachment a letter from this commenter to Phil DeFeo, 
Chairman, PCX, dated October 29, 2003, which also raised issues 
regarding the Exchange's demutualization proposal.
---------------------------------------------------------------------------

    In responding to the Brown Letter, the Exchange noted that the 
allegation suggesting that its management levied the $750 monthly per 
seat charge for reasons that were not legitimate to the Exchange's 
business purpose is baseless.\64\ The Exchange pointed out that this 
monthly charge was increased to its current level in February 1999, 
which it noted was months before current top senior management was in 
place. The PCX also noted that it temporarily waived the assessment for 
over a year to reduce the cost to carry an unassigned membership as a 
means to lessen the impact of the closure of the PCX's equities 
business and the migration of those seats to the options business.
---------------------------------------------------------------------------

    \64\ Letter from Kathryn L. Beck, Senior Vice President, General 
Counsel, Corporate Secretary and Chief Regulatory Officer, PCX, to 
Jonathan G. Katz, Secretary, Commission, dated April 29, 2004.
---------------------------------------------------------------------------

    Regarding the Brown Letter's statement that the current Chairman of 
PCX would unfairly receive 10% of the stock in the reorganized 
Exchange, the Exchange asserted that the statement is incorrect. 
According to the Exchange, there is no guarantee the Chairman, or any 
other employee, would receive any stock in PCX Holdings. While the 
stock incentive plan does reserve certain shares for the CEO of the 
reorganized Exchange, the PCX noted that PCX Holdings' Compensation 
Committee will administer the stock incentive plan, that the Committee 
will have the sole and absolute discretion to determine the terms, 
conditions, restrictions, and limitations of any awards issued pursuant 
to the plan,\65\ and that, therefore, there is no guarantee that any of 
the reserved shares would be awarded to the CEO. Finally, the Exchange 
pointed out that terms and conditions of the stock incentive plan were 
fully disclosed to Exchange members prior to their vote on the 
demutualization proposal.
---------------------------------------------------------------------------

    \65\ The PCX noted that the plan reserves 40,500 shares (50% of 
the eligible shares) for the CEO, which is far less than the 10% of 
the 1,000,000 authorized shares that the Brown Letter claimed would 
be awarded to the CEO.
---------------------------------------------------------------------------

IV. Amendment No. 1 to the Proposed Rule Change

    In Amendment No. 1 to the proposed rule change, the Exchange 
proposed revisions to various aspects of its proposal. The proposed 
revisions in Amendment No. 1 would:
     Add PCX Rule 2.4(h) to specify the required activation 
time period for approved applications for an OTP;
     Amend the employee registration procedure in PCX Rule 
2.23(a)-(c) to reflect a rule amendment previously approved by the 
Commission;
     Clarify the Nominating Committee's role in PCX Rule 
3.2(b)(2)(C)(ii) in that if the Board of Directors is made up of more 
than 10 individuals, the Public Directors, after consulting with the 
CEO, will determine whether the additional permit holder representative 
is an OTP Holder or an Equity Trading Permit Holder of PCX Equities, 
Inc., and if the additional representative is an OTP Holder, then the 
Nominating Committee shall nominate additional nominees so that at 
least twenty percent (20%) of the Directors consist of individuals 
nominated by trading permit holders;
     Amend the text of PCX Rule 5.3(f)(1)-(4) regarding the 
listings of options on the securities of restructured companies;
     Amend the description of securities in PCX Rule 
5.3(g)(2)(A)-(C) in order to allow for trading of options on fixed-
income exchange traded funds;
     Amend PCX Rule 5.6(d) to add a missing cross-reference to 
PCX Rule 5.6(c);
     Amend the index options rules set forth in PCX Rules 5.10-
5.29 in order to reflect a rule amendment previously approved by the 
Commission;
     Amend PCX Rule 6.8, Commentary .04, to reflect a rule 
amendment previously approved by the Commission;
     Amend PCX Rule 6.11(a) to reflect a rule amendment 
previously approved by the Commission;
     Amend PCX Rule 6.23 to add a reference to Article VII, 
Section 4 of the Bylaws for claims made pursuant to this rule;
     Amend Rule PCX Rule 6.37(f) to remove the reference to the 
term ``OFTC'' and replace it with ``two Trading Officials;''
     Amend PCX Rule 6.37(b)(1)(F) to reflect a rule amendment 
previously approved by the Commission;
     Amend PCX Rule 6.37(f)(2) to reflect a rule amendment 
previously approved by the Commission;
     Amend PCX Rule 6.62 to reflect a rule amendment previously 
approved by the Commission;
     Amend PCX Rules 6.82, 6.87(b)(6)-(7), and 6.90 to replace 
references to the term ``Option Allocation Committee'' with 
``Exchange;''
     Clarify in Rule 7.1, Commentary .02, the trading hours for 
options on exchange traded funds;
     Amend PCX Rules 9.2 and 9.11 to replace references to 
``Member'' with ``OTP Holder;''
     Amend PCX Rule 9.18(d) to replace the cross-reference to 
PCX Rule 9.1(b) with PCX Rule 9.1(c);
     Amend PCX Rule 10.1(a) to include associated persons of an 
OTP Holder to the group of individuals that are subject to PCX 
jurisdiction for disciplinary matters;
     Amend PCX Rule 10.5(a) to change the minimum number of 
required Conduct Panel members from one to three;
     Amend PCX Rule 10.14(a)(5) to add a cross-reference to PCX 
Rule 6.82(e);
     Delete PCX Rule 10.14(m);
     Delete PCX Rule 10.15(d);
     Amend PCX Rule 11.9 to expand the provisions of prohibited 
discretionary transactions to include transactions executed through ITS 
or any other Application of the System;
     Amend PCX Rules 12.1(e)(3)&(4) to add Allied Persons of 
OTP Holders and OTP Firms to the list of individuals covered under the 
provisions for class action arbitration claims;
     Amend PCX Rule 12.8, Commentary .01 to reinsert Los 
Angeles as an acceptable forum for arbitrations;
     Amend PCX Rule 13.2(a)(1)(C) to delete a section and 
remove the Board's ability to suspend the trading privileges of an OTP 
Holder, OTP Firm, or any Associated Person of an OTP Firm who is found 
in violation of any of the prohibited acts as specified in Rule 
11.2(a)-(f); and
     Delete the former PCX Constitution and Certificate of 
Incorporation.

V. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\66\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(1) of the Act,\67\ which 
requires a national securities exchange to be so

[[Page 29623]]

organized and have the capacity to carry out the purposes of the Act 
and to enforce compliance by its members and persons associated with 
its members with the provisions of the Act. The Commission also finds 
that the proposed rule change is consistent with Section 6(b)(3) of the 
Act,\68\ which requires that the rules of a national securities 
exchange assure the fair representation of its members in the selection 
of its directors and administration of its affairs, and provide that 
one or more directors shall be representative of issuers and investors 
and not be associated with a member of the exchange, broker, or dealer. 
Further, the Commission finds that the proposed rule change is 
consistent with Section 6(b)(5) of the Act,\69\ in that it is designed, 
among other things, to prevent fraudulent and manipulative acts and 
practices; to promote just and equitable principles of trade; to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system; and, in general, to protect investors and the 
public interest.
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    \66\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \67\ 15 U.S.C. 78f(b)(1).
    \68\ 15 U.S.C. 78f(b)(3).
    \69\ 15 U.S.C. 78f(b)(5).
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A. PCX Holdings as Sole Member

    Following completion of the demutualization of PCX, PCX Holdings 
will be the sole member of the reorganized PCX, which is a non-stock 
membership corporation. Section 19(b) of the Act \70\ and Rule 19b-4 
thereunder \71\ require a self-regulatory organization (``SRO'') to 
file proposed rule changes with the Commission. Although PCX Holdings 
is not an SRO, certain provisions of its Certificate of Incorporation 
and Bylaws may be rules of an exchange \72\ if they are the stated 
policies, practices, or interpretations, as defined in Rule 19b-4 of 
the Act,\73\ of the reorganized PCX. Any proposed rule or any proposed 
rule change in, addition to, or deletion from the rules of an exchange 
must be filed pursuant to Section 19(b) of the Act and Rule 19b-4 
thereunder.\74\ Accordingly, PCX has filed the Certificate of 
Incorporation and Bylaws of PCX Holdings with the Commission.\75\
---------------------------------------------------------------------------

    \70\ 15 U.S.C. 78s.
    \71\ 17 CFR 240.19b-4.
    \72\ Section 3(a)(27) of the Act defines the rules of an 
exchange to be the constitution, articles of incorporation, bylaws, 
and rules, or instruments corresponding to the foregoing, of an 
exchange, and such stated policies, practices, or interpretations of 
such exchange as the Commission, by rule, may determine to be 
necessary or appropriate in the public interest or for the 
protection of investors to be deemed to be rules of such exchange. 
15 U.S.C. 78c(a)(27).
    \73\ 17 CFR 240.19b-4. The term ``stated policy, practice, or 
interpretation'' includes any material aspect of the operation of an 
SRO.
    \74\ PCX Holdings Certificate of Incorporation and Bylaws 
provide that, before any amendment to or repeal of a provision of 
the Certificate of Incorporation or Bylaws, respectively, shall be 
effective, it must be submitted to the Board of Directors of the 
reorganized Exchange and if that Board determines that the amendment 
or repeal of such provision must be filed with the Commission before 
it may be effective, the amendment or repeal of such provision shall 
not be effective until it is filed with the Commission. PCX Holdings 
Certificate of Incorporation, Article 14, and PCX Holdings Bylaws, 
Article 7, Section 7.06.
    \75\ See PCX Holdings Certificate of Incorporation, Article 14, 
and PCX Holdings Bylaws, Article 7, Section 7.06.
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B. Changes in Control of PCX

    The Commission believes that the restrictions in PCX Holdings 
Certificate of Incorporation on direct and indirect changes in control 
of PCX Holdings are sufficient to enable the PCX to carry out its self-
regulatory responsibilities and to enable the Commission to fulfill its 
responsibilities under the Act.
    The reorganized PCX will continue to be a non-stock membership 
corporation. Its Bylaws establish PCX Holdings as the sole member.\76\ 
Accordingly, PCX Holdings will have 100% voting control over the 
reorganized PCX.\77\ The Certificate of Incorporation of PCX Holdings 
imposes limitations on direct and indirect changes in control of PCX 
Holdings through voting and ownership limitations placed on PCX 
Holdings' capital stock (whether common stock or preferred stock), and 
allow the Board of Directors of PCX Holdings to monitor potential 
changes in control through a notification requirement once a threshold 
percentage of ownership of capital stock is reached.\78\
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    \76\ PCX Bylaws, Article II, Section 2.01.
    \77\ The Commission has not formally established the standards 
for control persons of shareholder-owned national securities 
exchanges. It expects, however, to consider providing guidance on 
this issue in the future.
    \78\ The Certificate of Incorporation for PCX Holdings requires 
that any Person, either alone or together with its Related Persons, 
who at any time owns five percent (5%) or more of then outstanding 
shares of capital stock and who has the right to vote in the 
election of the Board of Directors of PCX Holdings, shall, 
immediately upon so owning five percent (5%) or more of the then 
outstanding shares of such stock, give the Board of Directors of PCX 
Holdings written notice of such ownership and update that notice 
promptly after an ownership change of a specified percentage. PCX 
Holdings Certificate of Incorporation, Article 9, Section 1(b)(iii) 
and (iv).
---------------------------------------------------------------------------

    Specifically, the Certificate of Incorporation of PCX Holdings 
provides that no Person, either alone or together with its Related 
Persons, may vote or cause the voting of shares of capital stock or 
give any proxy or consent with respect to shares representing more than 
twenty percent (20%) of the voting power of the issued and outstanding 
capital stock of PCX Holdings.\79\ Furthermore, PCX Holdings 
Certificate of Incorporation places limitations on the right of any 
Person, either alone or together with its Related Persons, to enter 
into any agreement with respect to the withholding of any vote or 
proxy.
---------------------------------------------------------------------------

    \79\ The terms ``Person'' and ``Related Persons'' are defined in 
Article 9 of PCX Holdings Certificate of Incorporation.
---------------------------------------------------------------------------

    PCX Holdings Certificate of Incorporation also provides that no 
Person, either alone or together with its Related Persons may own, 
directly or indirectly, shares constituting more than forty percent 
(40%) of the outstanding shares of capital stock of PCX Holdings. PCX 
Holdings Certificate of Incorporation also provides that if any 
stockholder votes, sells, transfers, assigns or pledges any shares in 
violation of the transfer restrictions and voting and ownership 
concentration limits, then those shares shall be treated as owned by 
the transferor for all purposes, including, without limitation, voting, 
payment of dividends, and distributions.\80\ In addition, if any 
stockholder votes, sells, transfers, assigns or pledges any shares in 
violation of the transfer restrictions and voting and ownership 
concentration limits, PCX Holdings has the right to redeem those shares 
at a price equal to the par value thereof, upon the approval of the 
Board of Directors. These voting and ownership limitations, however, 
can be waived by an amendment to the Bylaws of PCX Holdings adopted by 
its Board of Directors, subject to the Board having determined that 
such person is not subject to any applicable ``statutory 
disqualification'' (within the meaning of Section 3(a)(39) of the 
Act),\81\ and the amendment being approved by the Commission. Any such 
amendment to PCX Holdings Bylaws would be a proposed rule change that 
would need to be filed with the Commission. The proposed rule change 
would present the Commission with an opportunity to determine what 
additional measures, if any, might be necessary to provide sufficient 
regulatory jurisdiction over the proposed controlling person.
---------------------------------------------------------------------------

    \80\ PCX Holdings Certificate of Incorporation, Article 9, 
Section 2.
    \81\ 15 U.S.C. 78c(a)(39).
---------------------------------------------------------------------------

    In addition, PCX Holdings Certificate of Incorporation provides 
that no Person, either alone or together with its Related Persons, who 
is a trading permit holder of the reorganized PCX, or an equities 
trading permit holder of PCX Equities, may own, directly or indirectly, 
shares constituting more than twenty percent (20%) of an class of 
capital stock of PCX Holdings.

[[Page 29624]]

    The Commission finds that the limitation on ownership of PCX 
Holdings by trading permit holders is consistent with the Act. Under 
the member-owned exchange model, a member who trades securities through 
the facilities of an exchange can have an ownership interest in the 
exchange. However, a member's interest could become so large as to cast 
doubt on whether the exchange can fairly and objectively exercise its 
self-regulatory responsibilities with respect to that member. A member 
that also directly or indirectly controls an exchange might be tempted 
to exercise that controlling influence by directing the exchange to 
refrain from diligently surveiling the member's conduct or from 
punishing any conduct that violates the rules of the exchange or the 
federal securities laws. An exchange also might be reluctant to surveil 
and enforce its rules zealously against a member that the exchange 
relies on as its largest source of capital.\82\
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    \82\ The Commission notes, however, that PCX Holdings should 
disclose periodically, or otherwise make available upon request, 
information regarding the number of outstanding shares of capital 
stock, so that persons with a stake in the capital stock can 
determine whether they are reaching or have reached any of the 
thresholds that restrict that person's ability to vote or own the 
shares or require that person to provide written notice under the 
Article 9 of the PCX Holdings Certificate of Incorporation.
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C. Regulatory Jurisdiction Over PCX Holdings

    The Commission believes that the terms of PCX Holdings Bylaws 
provides the Commission with sufficient regulatory jurisdiction over 
the controlling parties to carry out its oversight responsibilities 
under the Act. PCX Holdings Bylaws provide that, to the extent that 
they are related to the activities of the reorganized Exchange, the 
books, records, premises, officers, directors, agents and employees of 
PCX Holdings are deemed to be the books, records, premises, officers, 
directors, agents, and employees of the reorganized Exchange for 
purposes of and subject to oversight pursuant to the Act.\83\ This 
provision would enable the Commission to exercise its authority under 
Section 19(h)(4) of the Act \84\ with respect to officers and directors 
of PCX Holdings, because all such officers and directors, to the extent 
that they are acting in matters related to Exchange activities, would 
be deemed to be officers and directors of the reorganized Exchange 
itself. Furthermore, the books and records of PCX Holdings, to the 
extent that they are related to the activities of the reorganized PCX, 
are subject to the Commission's examination authority under Section 
17(b)(1) of the Act,\85\ as these records would be deemed to be the 
records of the Exchange itself.
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    \83\ PCX Holdings Bylaws, Article 7, Section 7.03.
    \84\ 15 U.S.C. 78s(h)(4). Section 19(h)(4) authorizes the 
Commission, by order, to remove from office or censure any officer 
or director of a national securities exchange if it finds, after 
notice and an opportunity for hearing, that such officer or 
director: (1) Has willfully violated any provision of the Act or the 
rules and regulations thereunder, or the rules of a national 
securities exchange; (2) willfully abused his or her authority; or 
(3) without reasonable justification or excuse, has failed to 
enforce compliance with any such provision by a member or person 
associated with a member of the national securities exchange.
    \85\ 15 U.S.C. 78q(b)(1).
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    In addition, pursuant to PCX Holdings Bylaws, PCX Holdings and its 
officers, directors, employees and agents, by virtue of their 
acceptance of such position, are deemed to irrevocably submit to the 
exclusive jurisdiction of the U.S. federal courts, the Commission, and 
the Exchange for the purposes of any suit, action or proceedings 
pursuant to the U.S. federal securities laws and the rules and 
regulations thereunder, arising out of, or relating to, the activities 
of the reorganized Exchange.\86\ Moreover, PCX Holdings and such 
officers, directors, employees and agents, by virtue of their 
acceptance of any such position, are deemed to waive and agree not to 
assert by way of motion, as a defense or otherwise in any such suit, 
action or proceeding, any claims that it or they are not personally 
subject to the jurisdiction of the Commission, that the suit, action or 
proceeding is an inconvenient forum or that the venue of the suit, 
action or proceeding is improper, or that the subject matter thereof 
may not be enforced in or by such courts or agency. Moreover, PCX 
Holdings Bylaws provide that the officers, directors, employees and 
agents of PCX Holdings, by virtue of their acceptance of such position, 
are deemed to agree to cooperate with the Commission and the 
reorganized Exchange in respect of the Commission's oversight 
responsibilities with respect to the Exchange and the self-regulatory 
functions and responsibilities of the Exchange.\87\
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    \86\ PCX Holdings Bylaws, Article 7, Section 7.04.
    \87\ PCX Holdings Bylaws, Article 7, Section 7.05. The 
Commission notes that the staff of the Exchange has indicated that 
it would present to the Board of Directors of PCX Holdings for its 
approval a proposed new Bylaws provision stating that PCX Holdings 
would take such action as is necessary to insure that its officers, 
directors and employees consent to the applicability of Sections 
7.03 and 7.04 of the Bylaws with respect to Exchange-related 
activities. Letter from Kathryn Beck, Senior Vice President, General 
Counsel, Corporate Secretary and Chief Regulatory Officer, PCX, to 
Elizabeth King, Associate Director, Division, Commission, dated May 
13, 2004.
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    The Commission also notes that, even in the absence of these 
provisions of PCX Holdings Bylaws, Section 20(a) of the Act \88\ 
provides that any person with a controlling interest in PCX Holdings 
would be jointly and severally liable with and to the same extent that 
PCX Holdings is liable under any provision of the Act, unless the 
controlling person acted in good faith and did not directly or 
indirectly induce the act or acts constituting the violation or cause 
of action. The Commission believes that, taken together, these 
provisions grant the Commission sufficient jurisdictional authority 
over the controlling persons of PCX Holdings. Moreover, the reorganized 
Exchange is required to enforce compliance with these provisions 
because they are ``rules of the exchange'' within the meaning of 
Section 3(a)(27) of the Act.\89\ A failure on the part of the 
reorganized Exchange to enforce its rules could result in suspension or 
revocation of registration under Section 19(h)(1) of the Act.\90\
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    \88\ 15 U.S.C. 78t(a).
    \89\ 15 U.S.C. 78c(a)(27).
    \90\ 15 U.S.C. 78s(h)(1).
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D. Self-Regulatory Function of the Reorganized Exchange

    The Rules and Bylaws of the reorganized Exchange reflect its status 
as a wholly-owned subsidiary of PCX Holdings, under management of the 
reorganized Exchange's Board of Directors and its designated officers 
and with self-regulation pursuant to PCX's registration as a national 
securities exchange under Section 6 of the Act.\91\ As a result, the 
reorganized PCX will retain the self-regulatory organization function 
for its options business as well as for its subsidiary, PCX Equities.
---------------------------------------------------------------------------

    \91\ 15 U.S.C. 78f.
---------------------------------------------------------------------------

    As the sole owner of PCX, the Commission believes that PCX 
Holdings' activities with respect to its ownership of PCX must be 
consistent with PCX's obligations under the Act. Under PCX Holdings 
Bylaws, PCX Holdings' Board, officers, employees and agents must give 
due regard to the preservation of the independence of the self-
regulatory function of the reorganized PCX and to its obligations to 
investors and the general public and shall not take any actions that 
would interfere with the effectuation of any decisions by the Board of 
Directors of the reorganized PCX relating to its regulatory functions 
or the structure of the market which it regulates or which would 
interfere with the ability of the reorganized PCX to carry out its 
responsibilities under the Act.\92\ In

[[Page 29625]]

addition, all books and records of the reorganized Exchange reflecting 
confidential information pertaining to its self-regulatory function 
(including but not limited to disciplinary matters, trading data, 
trading practices, and audit information) which come into the 
possession of PCX Holdings, and the information contained therein, must 
be retained in confidence by PCX Holdings and the members of its Board 
and its officers, employees, and agents and shall not be used for any 
non-regulatory purposes. The Commission believes that these provisions, 
which are designed to acknowledge the need to maintain the independence 
of the reorganized Exchange's self-regulatory role and protect from 
improper use information pertaining to the self-regulatory function of 
the reorganized Exchange, are appropriate.
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    \92\ PCX Holdings Bylaws, Article 3, Section 3.15.
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    Further, the Commission notes that the Certificate of Incorporation 
for the reorganized Exchange expressly requires that the Board of 
Directors of the reorganized PCX to consider applicable requirements 
for registration as a national securities exchange under Section 6(b) 
of the Act,\93\ including the requirement that the rules of the 
reorganized PCX be designed to protect investors and the public 
interest, and the requirement that the reorganized PCX shall be so 
organized and have the capacity to carry out the purposes of the Act 
and to enforce compliance by its members and persons associated with 
its members with the provisions of the Act, the rules and regulations 
thereunder, and with the rules of the reorganized Exchange. In the 
Commission's view, this provision should serve to remind the Board of 
Directors that they must consider the interests of all Exchange 
constituents and the requirements of the Act when taking actions on 
behalf of the reorganized PCX.
---------------------------------------------------------------------------

    \93\ 15 U.S.C. 78f.
---------------------------------------------------------------------------

E. Fair Representation

    Section 6(b)(3) of the Act \94\ requires that the rules of an 
exchange assure fair representation of its members in the selection of 
its directors and administration of its affairs and provide that one or 
more directors be representative of issuers and investors and not be 
associated with a member of the exchange, or with a broker or dealer. 
In addition, Section 6(b)(1) of the Act requires that an exchange be so 
organized and have the capacity to be able to carry out the purposes of 
the Act.
---------------------------------------------------------------------------

    \94\ 15 U.S.C. 78f(b)(3).
---------------------------------------------------------------------------

    Under the Bylaws of the reorganized PCX, the reorganized Exchange 
will have not less than eight (8) or more than twelve (12) Directors, 
with the Board of Directors to consist initially of ten (10) Directors, 
including the CEO of PCX Holdings. The authorized number of Directors 
will be as determined from time to time by the Board of Directors of 
the reorganized PCX. At least fifty percent 50% of the Directors shall 
be Public Directors.\95\ At least twenty percent 20% of the Directors 
will consist of individuals nominated by the trading permit holders, 
with at least one Director nominated by the ETP Holders \96\ of PCX 
Equities, Inc. and with at least one Director nominated by the OTP 
Holders of the reorganized PCX (``Permit Holder Directors''). The exact 
number of Public Directors and Permit Holder Directors will be 
determined from time to time by the Board of Directors, subject to the 
percentage restrictions described in proposed Article III, Section 
3.02(a) of the reorganized PCX's Bylaws.
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    \95\ PCX Bylaws, Article III, Section 2(a).
    \96\ See PCXE Rule 1.1(n) (definition of ``ETP Holder'').
---------------------------------------------------------------------------

    The initial Directors of the reorganized Exchange will consist of 
individuals nominated by the Nominating Committee of the current PCX in 
consultation with the CEO and will be approved by the Exchange's Board 
of Directors. After the formation of the initial Board of Directors, 
the Nominating Committee of the Board of Directors of PCX Holdings will 
nominate Directors for election to the Board of Directors of the 
reorganized PCX. The reorganized PCX Nominating Committee will nominate 
the OTP Holder nominee(s) to the Board of Directors.\97\ At the first 
annual meeting and at each subsequent annual meeting of the Holding 
Member,\98\ except as otherwise provided by the reorganized PCX's 
Bylaws, the Holding Member will elect Directors to serve until the next 
annual meeting or until their successors are elected and qualified. The 
reorganized PCX Board of Directors will appoint the Chairman of the 
Board of the reorganized Exchange by majority vote.
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    \97\ The Commission notes that the selection process for the OTP 
Holder nominee(s) differs from the selection process for the ETP 
Holder nominee. PCX represents that the ETP Nominee will be 
appointed to the reorganized PCX Board of Directors as required by 
the PCX/PCXE Shareholder Voting Agreement.
    \98\ The reorganized PCX is a non-stock corporation consisting 
of a sole member, PCX Holdings. See Bylaws of the reorganized PCX, 
Article II, Section 2.01 for a definition of Holding Member. Only 
the Holding Member has any right to take part in the ownership of 
the Exchange and will be the sole ``Corporate Member'' of the 
Exchange, as that term is defined in Article 5 of the reorganized 
PCX's Certificate of Incorporation.
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    In addition, pursuant to the proposed Bylaws of the reorganized 
PCX, each Board Committee will be comprised of at least fifty percent 
50% Public Directors. The Board Appeals Committee will be made up of 
the OTP Director(s), the ETP Director(s), and all of the Public 
Directors. The Regulatory Oversight Committee will be made up of all of 
the Public Directors of the reorganized Exchange. The Audit Committee 
will be made up of at least three Directors and all must be Public 
Directors with one at least one having accounting or related financial 
management expertise. The Compensation Committee will be made up of at 
least three Directors, but only one non-Public Director may serve on 
that Committee.
    Further, various Options Committees will have representatives of 
OTP Holders, as well as Public Directors. The Nominating Committee will 
have seven members consisting of six OTP Holders and one person from 
the public. The EBCC will be made up primarily of OTP Holders and 
Allied Persons of an OTP Firm and at least one member of the public 
will serve on the EBCC.\99\ The OTP Advisory Committee will be made up 
of OTP Holders and the reorganized Exchange will attempt to have 
diverse OTP Holder representation of different constituencies on that 
Committee.
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    \99\ The EBCC may, among other things, impose appropriate 
sanctions including suspension and expulsion where it finds that a 
violation within the disciplinary jurisdiction of the reorganized 
Exchange has been committed. See PCX Rule 3.2(b)(1)(B)(iii).
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    The Commission finds that the requirement that the Board be 
composed of at least 50% Public Directors is consistent with Sections 
6(b)(1) and 6(b)(3) of the Act,\100\ which requires that one or more 
directors be representative of issuers and investors. The Commission 
also finds that the requirement that the Board of Directors be composed 
of at least 20% Permit Holder Directors and the manner in which such 
Directors will be nominated and elected, together with the 
representation of Permit Holders on key Board and Options Committees, 
satisfies the fair representation requirements in Section 6(b)(3) of 
the Act.\101\ The Commission notes, however, that trading privileges 
will be separated from corporate ownership of the reorganized Exchange 
and will be available exclusively through trading permits following the 
completion of the demutualization. The Commission

[[Page 29626]]

therefore expects that trading permits will not be issued in a manner 
that would undermine or circumvent the requirement in Section 6(b)(3) 
of the Act for fair representation of members.\102\ The Commission also 
notes that OTP Holders and OTP Firms will retain a voice in the 
administration of the affairs of the reorganized Exchange, including 
rulemaking and the disciplinary process, through OTP Holder 
participation on various Board and Options Committees.
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    \100\ 15 U.S.C. 78f(b)(3).
    \101\ Id.
    \102\ Id.
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    Finally, the Commission notes that the proposed rule change 
includes revisions to the reorganized Exchange's governance structure 
to reflect the demutualization. The Commission is in the process of 
reviewing a range of governance issues relating to self-regulatory 
organizations and, depending on the results of that review, may 
determine that further steps designed to strengthen the governance of 
SROs, including the reorganized Exchange, are necessary.

F. Dividends

    With the demutualization, the holders of capital stock will have 
the dividend and other distribution rights of a stockholder in a 
Delaware stock corporation. The Bylaws of the reorganized Exchange 
entitles the Holding Member (i.e., PCX Holdings) to receive, at the 
discretion of the Board of Directors, dividend distributions. The 
Bylaws further provide that any revenues received by the Exchange from 
regulatory fees or regulatory penalties will be applied to fund the 
legal, regulatory, and surveillance operations of the Exchange and will 
not be used to pay dividends.\103\ This limitation would preclude the 
reorganized Exchange from providing dividends derived from regulatory 
fees or penalties to the sole Holding Member of the reorganized 
Exchange, i.e., PCX Holdings. As a result, PCX Holdings would not be 
able to provide dividends derived from regulatory fees or penalties 
belonging to the Exchange to its stockholders. The Commission finds 
that the prohibition on the use of regulatory fees or penalties to fund 
dividends is consistent with Section 6(b)(3) of the Act \104\ because 
it will ensure that the regulatory authority of the Exchange is not 
used improperly to benefit PCX Holdings and its stockholders.
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    \103\ For purposes of this provision, regulatory penalties 
include restitution and disgorgement of funds intended for 
customers.
    \104\ 15 U.S.C. 78f(b)(3).
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VI. Accelerated Approval of Amendment No. 1

    The Commission finds good cause exists for approving Amendment No. 
1 to the proposed rule change prior to the thirtieth day after the 
amendment is published for comment in the Federal Register, pursuant to 
Section 19(b)(2) of the Act.\105\ In Amendment No. 1, PCX clarified 
rule text, including the usage of terms such as ``OTP Holder'' and 
``OTP Firm;'' amended rule text to reflect changes to rules approved by 
the Commission subsequent to the filing of the proposed rule change; 
revised rule text to comport more closely with the Rules of the current 
Exchange; added cross-references to provisions of rules, as 
appropriate; corrected erroneous references; deleted extraneous 
provisions; and clarified that the Constitution and Articles of 
Incorporation of the current Exchange would be deleted.
---------------------------------------------------------------------------

    \105\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    The Commission notes that generally the revisions to the Rules 
contained in Amendment No. 1 clarify the Rules as initially proposed; 
reflect changes to Rules as a result of subsequent Commission action 
and thus previously were published for comment by the Commission; or 
amend the Rules in insignificant ways to comport with the 
demutualization process. As a result, the Commission believes that 
Amendment No. 1 raises no new issues and that acceleration of the 
amendment is appropriate.

VII. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the Amendment No. 
1 is consistent with the Act. Comments may be submitted by any of the 
following methods:
    Electronic comments:
     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-PCX-2004-08 on the subject line.
    Paper comments:
     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609. All submissions should refer to File Number 
SR-PCX-2004-08. This file number should be included on the subject line 
if e-mail is used. To help the Commission process and review your 
comments more efficiently, please use only one method. The Commission 
will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 450 Fifth Street, NW., Washington, DC 20549. Copies 
of such filing also will be available for inspection and copying at the 
principal office of PCX. All comments received will be posted without 
change; the Commission does not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly. All submissions should refer to File Number 
SR-PCX-2004-08 and should be submitted on or before June 14, 2004.

VIII. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\106\ that the proposed rule change (SR-PCX-2004-08) be and hereby 
is approved, and Amendment No. 1 is approved on an accelerated basis.
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    \106\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\107\
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    \107\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-11651 Filed 5-21-04; 8:45 am]
BILLING CODE 8010-01-P