[Federal Register Volume 69, Number 114 (Tuesday, June 15, 2004)]
[Notices]
[Pages 33442-33453]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-13403]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49832; File No. SR-Phlx-2003-59]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendments No. 1, 2, 3, 4, and 5 by the Philadelphia Stock 
Exchange, Inc. Relating to the Exchange's New Electronic Trading 
Platform, ``Phlx XL''

June 8, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on October 3, 2003, the Philadelphia Stock Exchange, Inc. 
(``Phlx'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the 
Exchange. On December 9, 2003, December 11, 2003, January 28, 2004, and 
May 11, 2004, the Exchange filed Amendments No. 1, 2, 3, and 4, 
respectively, to the proposed rule change.\3\ On June 4, 2004, the 
Exchange filed Amendment No. 5 to the proposed rule change.\4\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letters from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division of Market 
Regulation (``Division''), Commission, dated December 9, 2004 
(``Amendment No. 1''); December 11, 2003 (``Amendment No. 2''); 
January 28, 2004 (``Amendment No. 3''); and May 10, 2004, replacing 
Form 19b-4 in its entirety (``Amendment No. 4'').
    \4\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Deborah Lassman Flynn, Assistant Director, Division, 
Commission, dated June 3, 2004 (``Amendment No. 5''). In Amendment 
No. 5, the Exchange (i) amended certain proposed rules, (ii) removed 
a sentence from the purpose section of the notice, and (iii) 
committed to: (A) correct any technical drafting and/or typographic 
errors or omissions contained in the proposed rule change, and (B) 
provide a more detailed description of the procedures by which the 
opening price on Phlx XL would be established.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx proposes to adopt new rules for the implementation of its 
new electronic trading platform for options known as ``Phlx XL.'' The 
text of the proposed rule change, as amended, is available at the 
Office of the Secretary, the Phlx, at the Commission, and on the 
Commission's Web site, http://www.sec.gov.

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

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

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

1. Purpose
    The purpose of the proposed rule change is to adopt rules regarding 
the Exchange's new electronic trading platform, Phlx XL. The proposal 
would permit certain on-floor Exchange members, as described below, to 
submit streaming electronic option quotations via electronic interface 
with the Exchange's Automated Options Market (``AUTOM'') System.\5\
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    \5\ AUTOM is the Exchange's electronic order delivery, routing, 
execution and reporting system, which provides for the automatic 
entry and routing of equity option and index option orders to the 
Exchange trading floor. Orders delivered through AUTOM may be 
executed manually, or certain orders are eligible for AUTOM's 
automatic execution features, AUTO-X, Book Sweep and Book Match. 
Equity option and index option specialists are required by the 
Exchange to participate in AUTOM and its features and enhancements. 
Option orders entered by Exchange members into AUTOM are routed to 
the appropriate specialist unit on the Exchange trading floor. See 
Phlx Rule 1080.
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Implementation and Deployment
    The Exchange represents that it will begin the initial rollout of 
Phlx XL on an issue-by-issue basis, beginning with the first of 
approximately 10 issues included in the initial rollout not later than 
10 days following the Commission's approval of the proposed rules 
applicable to Phlx XL. The Exchange plans to expand the deployment of 
Phlx XL to include the Top 120 equity options within 8 months of the 
initial deployment, and the Exchange expects to roll out Phlx XL for 
all options floor wide not later than December 31, 2005.\6\
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    \6\ In January 2004, the Exchange submitted a proposal to modify 
the timing of the deployment of the ROT Access feature of its 
Automated Options Market (AUTOM) system in light of the Exchange's 
proposal to introduce Phlx XL. See Securities Exchange Act Release 
No. 49151 (January 29, 2004), 69 FR 6010 (February 9, 2004) (SR-
Phlx-2004-01). Specifically, if Phlx XL is not deployed floor-wide 
for all options by April 30, 2005, the Exchange has committed to 
ensure that, as of that date, the AUTOM system automatically 
executes eligible incoming orders in options that are not then 
Streaming Quote Options (as defined below) against Phlx Price 
Improving ROT and specialist price improving orders and orders 
matching such price-improving orders entered via the electronic 
interface with AUTOM, as described in Commentary .04 to Phlx Rule 
1080.
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Streaming Quote Options
    Proposed Phlx Rule 1080(k) would provide that the Exchange's 
Options Committee \7\ may, on an issue-by-issue basis, determine the 
specific issues in which Streaming Quote Traders (``SQTs''), as defined 
in Phlx Rule 1014(b)(ii), may generate and submit option quotations 
electronically through an electronic interface with AUTOM via an 
Exchange approved proprietary electronic quoting device. Such issues 
would be known as ``Streaming Quote Options.''
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    \7\ The Options Committee has general supervision of the 
dealings of members on the equity and index options trading floor, 
and of the premises of the exchange facility immediately adjacent 
thereto. It is responsible to make or recommend for adoption, and 
administer such rules as it may deem necessary for the convenient 
and orderly transaction of business upon the equity and index 
options trading floor. The Committee has supervision of the 
activities on the equity and index options trading floor of 
specialists, assistant specialists, registered option traders, floor 
brokers, and other types of market-makers. See Exchange By-Law 
Article X, Section 10-19.
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Streaming Quote Traders and Quoting Requirements
    The proposed rules would provide that the term Registered Options 
Trader (``ROT'') would include an SQT. An SQT would be defined in 
proposed Phlx Rule 1014(b)(ii) as an ROT who has received permission 
from the Exchange to generate and submit option quotations 
electronically through an electronic interface with AUTOM via an 
Exchange approved proprietary electronic quoting device in eligible 
options to which such SQT is assigned. With respect to Streaming Quote 
Options (defined below) to which an SQT is assigned, such SQT would be 
responsible to quote continuous, two-

[[Page 33443]]

sided markets in not less than 60% of the series in each Streaming 
Quote Option (as defined in proposed Phlx Rule 1080(k)) in which such 
SQT is assigned. The specialist assigned in a Streaming Quote Option, 
however, would be required to quote continuous, two-sided markets in 
100% of the series in each assigned option.\8\ ROTs who are not SQTs 
would continue to be responsible to fulfill all of the requirements for 
ROTs set forth in Phlx Rule 1014.
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    \8\ For example, if an SQT is assigned in one Streaming Quote 
Option that includes five series (A, B, C, D, and E), such SQT would 
be required to quote continuous, two-sided markets in three of those 
series in order to fulfill the 60% quoting requirement. If such an 
SQT initially submits quotations in series A, B, and C, and the size 
associated with the quotation in Series A is exhausted, such SQT 
would be required either to refresh its quotation in Series A while 
continuing to submit quotations in Series B and C, or to submit new 
quotations in any three of the five series, in order to fulfill the 
60% quoting requirement.
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    Proposed Phlx Rule 1014(b)(ii)(B) would set forth the minimum 
quotation size for specialists and SQTs in Streaming Quote Options 
traded on Phlx XL. Specifically, the proposed rule would provide that, 
during a six-month period commencing on the date of the initial 
deployment of Phlx XL (the ``initial six-month period''), the 
specialist and any SQT assigned in a Streaming Quote Option would be 
permitted temporarily to submit electronic quotations with a size of 
fewer than 10 contracts for a period of 60 days after such option 
begins trading as a Streaming Quote Option. Beginning on the sixty-
first day after such option begins trading as a Streaming Quote Option, 
SQTs and the specialist assigned in such Streaming Quote Option would 
be required to submit electronic quotations with a size of not less 
than 10 contracts.
    Subsequently, during a six-month period commencing on the first day 
following the expiration of the initial six-month period, the 
specialist and any SQT assigned in a Streaming Quote Option would be 
permitted to submit electronic quotations with a size of fewer than 10 
contracts for a period of 30 days after such option begins trading as a 
Streaming Quote Option. Beginning on the thirty-first day after such 
option begins trading as a Streaming Quote Option, SQTs and the 
specialist assigned in such Streaming Quote Option would be required to 
submit electronic quotations with a size of not less than 10 contracts.
    Thereafter, the specialist and any SQT assigned in a Streaming 
Quote Option that is newly listed and deployed on Phlx XL would be 
required to submit electronic quotations with a size of not less than 
10 contracts beginning on the date on which such Streaming Quote Option 
begins trading on Phlx XL. The purpose of this provision is to enable 
SQTs and the specialist in a Streaming Quote Option, during the initial 
stages of deployment of Phlx XL, to quote with a size of less than ten 
contracts so that such SQTs and specialists may determine over this 
period of time that their quotation systems and models function 
properly and reliably, and to make necessary changes, if any, during 
this time in order to manage their risk while providing fair and 
orderly markets in the Streaming Quote Option. The ten-contract minimum 
quotation size obligation would apply only to an SQT or specialist's 
undecremented quote.\9\ An SQT would be permitted to submit electronic 
quotations only while such SQT is physically present on the floor of 
the Exchange.
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    \9\ For example, if a specialist or SQT electronically submits a 
quotation with a size of 10 contracts, and three of those contracts 
are executed (leaving a disseminated quotation size of seven 
contracts), such specialist or SQT would be permitted continue to 
disseminate that electronic quotation with a size representing the 
remaining 7 contracts. If, however, such specialist electronically 
submits a revised quotation, such revised quotation would be 
required to be for a size of 10 contracts.
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    Under Phlx XL, SQTs and the specialist would be able to quote 
verbally in open outcry in response to a request for a market, or to 
quote electronically (or submit orders electronically) by use of an 
Exchange-approved quoting device.
    Non-SQT ROTs trading Streaming Quote Options would be required to 
quote verbally in response to a request for a market, and would 
continue to have the ability to place limit orders electronically 
directly onto the limit order book through electronic interface with 
AUTOM.\10\ A non-SQT ROT would not, however, have the same continuous, 
electronic quoting requirements as an SQT trading the same Streaming 
Quote Option, unless such non-SQT ROT would trade in excess of a 
specified number of contracts electronically (i.e., by way of placing 
limit orders on the book that are executed via Book Match or Book 
Sweep, as described more fully below) in a given calendar quarter.
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    \10\ See Phlx Rule 1080, Commentary .04.
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    With respect to non-SQT ROTs in Streaming Quote Options, the 
proposed rule would require that, during the initial six-month period, 
for a period of sixty days commencing immediately after an option 
begins trading as a Streaming Quote Option, such non-SQT ROTs may 
provide such quotations with a size of fewer than 10 contracts. 
Beginning on the sixty-first day after such option begins trading as a 
Streaming Quote Option, such quotations would be required to be for a 
size of at least 10 contracts. During a six month period commencing on 
the first day following the expiration of the initial six-month period, 
such non-SQT ROTs may provide such quotations with a size of fewer than 
10 contracts for a period of thirty days after such option begins 
trading as a Streaming Quote Option. Beginning on the thirty-first day 
after such option begins trading as a Streaming Quote Option, such 
quotations would be required to be for a size of at least 10 contracts. 
Thereafter, such non-SQT ROTs would be required to provide such 
quotations with a size of not less than 10 contracts beginning on the 
date on which such Streaming Quote Option begins trading on Phlx XL.
    The same size requirements set forth for non-SQT ROTs in open 
outcry (as set forth in the preceding paragraph) would apply to non-SQT 
ROTs who are required to submit electronic quotations in a Streaming 
Quote Option for which a non-SQT ROT transacts more than 20% of his/her 
contract volume in a Streaming Quote Option electronically (i.e., by 
way of placing limit orders on the limit order book that are executed 
electronically and allocated automatically in accordance with proposed 
Phlx Rule 1014(g)(vii)) versus in open outcry during any calendar 
quarter.
    The Exchange proposes to establish additional obligations for non-
SQT ROTs trading Streaming Quote Options who do not apply to become 
SQTs but nonetheless would be required to submit electronic quotations 
because of the percentage of contracts in Streaming Quote Options they 
trade electronically. Specifically, if a non-SQT ROT trading a 
Streaming Quote Option transacts more than 20% of its contract volume 
electronically in an assigned option that is a Streaming Quote Option 
during any calendar quarter, such non-SQT ROT would be required to 
submit continuous two-sided electronic quotations in a designated 
percentage of series within the Streaming Quote Option (depending on 
the total Exchange volume traded electronically in such Streaming Quote 
Option), beginning with the commencement of the following calendar 
quarter. The following schedule would apply:

[[Page 33444]]



------------------------------------------------------------------------
                                                            Electronic
    Percent of overall streaming quote option volume          quoting
 transacted on the exchange during the previous quarter   percent  (% of
           that was transacted electronically                 series)
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50 or Below.............................................              20
51-75...................................................              40
Above 75................................................              60
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    For example, if 83% of the total volume on the Exchange in a 
particular Streaming Quote Option is transacted electronically, non-SQT 
ROTs in such Streaming Quote Option would be required to maintain 
continuous quotations in 60% of the series. The Exchange will monitor 
on a calendar quarter basis the percentage of contracts transacted 
electronically on the Exchange in each particular Streaming Quote 
Option for the purpose of adjusting the applicable electronic quoting 
percentage during the next succeeding calendar quarter.
    Proposed Phlx Rule 1014(b)(ii)((C)(1)(d) would clarify that any 
volume transacted electronically by a non-SQT ROT (i.e., limit orders 
placed on the limit order book that are executed via Book Match or Book 
Sweep) would not count towards the ROT's in-person requirement 
contained in Phlx Rule 1014, Commentary .01.\11\
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    \11\ Phlx Rule 1014, Commentary .01 provides that, in order for 
an ROT to receive specialist margin treatment for off-floor orders 
in any calendar quarter, the ROT must execute the greater of 1,000 
contracts or 80% of his total contracts that quarter in person.
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SQT Participation in Openings
    In order to clarify the interaction of SQT quotations with opening 
orders, the Exchange proposes to adopt Phlx Rule 1017(g), which would 
provide that, with respect to Streaming Quote Options, SQTs may 
participate in opening transactions by submitting electronic quotations 
to interact with opening orders.
    Exchange openings and re-openings in options are currently 
conducted by way of rotation procedures \12\ or by way of Series 
Opening Request Ticket (``SORT'') procedures, as provided in Phlx Rule 
1047. \13\ Rotation procedures allow a brief period of auction pricing 
for each option series during which bids and offers and transactions 
for that option class may normally only occur in that series. Proposed 
Phlx Rule 1017(g) would clarify that such an auction would include, 
with respect to Streaming Quote Options, bids and offers submitted 
electronically by SQTs and/or the specialist.
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    \12\ A trading rotation is a series of very brief time periods 
during each of which bids, offers and transactions in only a single, 
specified option contract can be made. Opening rotations, currently 
conducted by the specialist assigned in the particular option, are 
held promptly following the opening of the underlying security on 
the primary market where it is traded. An underlying security shall 
be deemed to have opened on the primary market where it is traded if 
such market has (i) reported a transaction in the underlying 
security or (ii) disseminated opening quotations for the underlying 
security and not given an indication of a delayed opening. The 
Specialist generally first opens the one or more series of options 
of a given class having the nearest expiration, then proceeds to a 
series of options having the next most distant expiration, and so 
forth, until all series have been opened. The Specialist determines 
which type of option should open first, and may alternate the 
opening of put series and call series or may open all series of one 
type before opening any series of the other type, depending on 
current market conditions except in the case of a modified rotation.
    Modified rotations include ``reverse'' and ``shotgun'' 
rotations. A ``reverse rotation'' is an opening rotation where the 
Specialist first opens the one or more series of options of a given 
class having the most distant expiration, then proceed to the next 
nearest expiration, and so forth, ending with the nearest 
expiration, until all series have been opened. A ``shotgun 
rotation'' is an opening rotation in which each option series opens 
in the same manner and sequence as during a regular trading rotation 
but is permitted to freely trade once all option series with the 
same expiration month have been opened. See Phlx Rule 1047, 
Commentary .01(a) and (b).
    \13\ A SORT opening is one where the specialist opens all series 
in an options class simultaneously after rotating only those series 
for which a SORT was received. The SORT is a form submitted by a 
member with interest in a particular series to the specialist, at 
least five minutes prior to the opening of trading, and signals the 
specialist to rotate that series. Prior to conducting a SORT 
procedure, the specialist must announce to the crowd that such a 
procedure will be utilized, and in which series, if any, a SORT has 
been received. See Phlx Rule 1047, Commentary .01(c).
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    The opening auction in Streaming Quote Options traded on Phlx XL 
will continue to be managed by the specialist, principally using the X-
Station.\14\ Using the X-Station the specialist will be able to see and 
ascertain the best bid and offer, including limit orders and, with 
respect to Streaming Quote Options traded on Phlx XL, electronic 
quotations submitted by SQTs. The specialist will also continue to take 
into account bids, offers or orders voiced in the trading crowd during 
the opening auction when determining the opening price.
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    \14\ The X-Station is a component of AUTOM used by the 
specialist as an on-floor display of the electronic limit order 
book, and as a tool for, among other things, the manual execution of 
orders that are due for execution.
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    Proposed Phlx Rule 1017(b)(ii) would provide that, in connection 
with an opening in a Streaming Quote Option (as defined in Phlx Rule 
1080(k)), a bid submitted electronically by the specialist or an SQT in 
such Streaming Quote Option which is at a higher price than the price 
at which the option is to be opened and an offer submitted 
electronically by the specialist or an SQT in such Streaming Quote 
Option which is at a lower price than the price at which the option is 
to be opened, are to be executed at the opening price. The purpose of 
this provision is to ensure that an SQT would receive the best 
execution at the opening when such SQT's quotation is higher (lower) 
than the bid (offer).\15\
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    \15\ The Exchange is not proposing a completely automated 
opening process at this time.
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Assignment in Streaming Quote Options
    The Options Allocation, Evaluation and Securities Committee 
(``OAESC'') \16\ would assign SQTs in one or more eligible options in a 
similar fashion to the current practice of allocation of trading 
privileges to specialists. Proposed Phlx Rule 507 would set forth the 
solicitation, application and review process to be followed by the 
OAESC.
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    \16\ The Options Allocation, Evaluation and Securities Committee 
has jurisdiction over the allocation, retention and transfer of the 
privileges to deal in all options to, by and among members on the 
options and foreign currency options trading floors. See Exchange 
By-Law Article X, Section 10-7. See also, Phlx Rule 500.
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    Proposed Phlx Rule 507 would also provide that an application for 
assignment in Streaming Quote Options would be submitted in writing to 
the Exchange's designated staff and would be required to include, at a 
minimum, the name of the SQT applicant and written verification from 
the Exchange's Membership Services Department that such SQT applicant 
is qualified as a ROT.
    In order to ensure an SQT applicant's technological readiness to 
submit electronic quotes, proposed Phlx Rule 507(b)(ii) would mandate 
that no application for assignment in Streaming Quote Options would be 
approved by the OAESC without written certification signed by an 
officer (Vice President or above) of the Exchange's Financial 
Automation Department \17\ indicating that the SQT applicant has 
sufficient technological ability to support his/her continuous quoting 
requirements as set forth in Phlx Rule 1014(b)(ii), and the SQT 
applicant has successfully completed, or is scheduled to complete, 
testing of its quoting system with the Exchange.
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    \17\ The Exchange's Financial Automation Department is 
responsible for the design, development, implementation, testing and 
maintenance of the Exchange's automated trading systems, 
surveillance systems, and back office systems, and for monitoring 
the quality of performance and operational readiness of such 
systems, in addition to user training and validation of user 
technology as it pertains to such users' interface with the 
Exchange's systems.
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    In order to clarify that proposed Phlx Rule 507 is not intended to 
function as a barrier to entry to the Exchange's marketplace while 
still taking into

[[Page 33445]]

account the possibility that, initially, quote capacity may become an 
issue surrounding the number of SQTs who could begin trading as such, 
the Exchange proposes to add Phlx Rule 507(b)(iii) in order to provide 
that (i) Phlx Rule 507 places no limit on the number of qualifying ROTs 
that may become SQTs and (ii) any applicant that is qualified as an ROT 
in good standing and that satisfies the technological readiness and 
testing requirements described in sub-paragraph (b)(ii), must be 
approved as an SQT. However, based on system constraints, capacity 
restrictions or other factors relevant to the maintenance of a fair and 
orderly market, the Board may defer, for a period to be determined in 
the Board's discretion, approval of qualifying applications for SQT 
status pending any action required to address the issue of concern to 
the Board. The Board may not defer a determination of the approval of 
the application of any SQT applicant or place any limitation(s) on 
access to Phlx XL on any SQT applicant unless the basis for such 
limitation(s) or deferral have been objectively determined by the 
Board, subject to Commission approval or effectiveness pursuant to a 
rule change filing under section 19(b) of the Act. The Committee must 
provide written notification to any SQT applicant whose application is 
the subject of such limitation(s) or deferral, describing the objective 
basis for such limitation(s) or deferral.
    The proposed rule also includes a provision that, during the first 
six months of the deployment of Phlx XL, an SQT applicant member or 
member organization that has, for at least the immediately preceding 
twelve months: (i) Been a member of the Exchange and (ii) maintained a 
continuous presence as an ROT in the trading crowd associated with the 
Streaming Quote Option(s) that are the subject of the application, must 
be guaranteed an assignment in the Streaming Quote Option, provided 
that such member organization has received the written certification 
concerning technological readiness as set forth in proposed Phlx Rule 
507(b)(ii).
    Proposed Phlx Rule 507(g) would clarify that an appeal to the Board 
of Governors from a decision of the Committee may be taken by a member 
or member organization interested therein by filing with the Secretary 
of the Exchange written notice of appeal within ten (10) days after the 
decision has been rendered, in accordance with Exchange By-Law Article 
XI, Section 11-1.
Trade Allocation in Streaming Quote Options
    The proposed rules would codify the trade allocation algorithm that 
would apply to orders or electronic quotes in Streaming Quote Options 
that result in automatic executions\18\ via the AUTOM System.\19\ In 
the case of trades stemming from orders that are not automatically 
executed and instead handled manually by the specialist or represented 
in the trading crowd by a Floor Broker, current Exchange rules 
concerning allocation of non-automatically executed trades would 
apply.\20\
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    \18\ Trades in Streaming Quote Options involving inbound orders 
and specialist and SQT quotes delivered via AUTOM would be 
automatically executed by the Book Sweep function (described below); 
and by the Book Match function (described below). Eligible orders 
for non-Streaming Quote Options delivered via AUTOM would be 
automatically executed via AUTO-X, an automatic execution feature of 
AUTOM (see Phlx Rule 1080(c)), or against contra-side orders resting 
on the limit order book by Book Match under Phlx Rule 1080(g)(ii).
    \19\ The proposed trade allocation rules would only apply to 
trades in Streaming Quote Options that are automatically executed 
via Book Match pursuant to Phlx Rule 1080(g)(ii) and via Book Sweep 
pursuant to Phlx Rule 1080(c)(ii). Currently, trades that are 
automatically executed via AUTO-X are allocated among the specialist 
and ROTs participating on the ``Wheel.'' The ``Wheel'' is a feature 
of AUTOM that provides an automated mechanism for assigning 
specialists and ROTs signed on the Wheel for a given listed option, 
on a rotating basis, as contra-side participants to trades executed 
via AUTO-X. See Phlx Rule 1080(g) and Option Floor Procedure Advice 
(``OFPA'') F-24. Under the instant proposal, trades in Streaming 
Quote Options that are automatically executed via Book Match 
pursuant to the proposed amendments to Phlx Rule 1080(g)(ii) would 
be allocated automatically according to the algorithm set forth in 
proposed Phlx Rule 1014(g)(vii) and proposed OFPA B-6, Section F. 
Trades in non-Streaming Quote Options that are automatically 
executed via AUTO-X would continue to be allocated on the Wheel or 
by Book Match.
    \20\ In April 2003, the Commission approved the Exchange's 
proposal to adopt Phlx Rule 1014(g)(v) and OFPA B-6 concerning the 
allocation of non-automatically executed orders in options. See 
Securities Exchange Act Release No. 47739 (April 25, 2003), 68 FR 
23354 (May 1, 2003) (SR-Phlx-2001-39). That proposal was filed in 
response to Order Instituting Public Administrative Proceedings 
Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, 
Making Findings and Imposing Sanctions, Securities Exchange Act 
Release No. 43268 (September 11, 2000) and Administrative Proceeding 
File 3-10282 (the ``Order''). While the instant proposal is not 
filed in direct response to the Order, the Exchange believes that 
the proposed rules concerning the allocation of trades in Streaming 
Quote Options are consistent with the requirements of the Order.
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    The proposed rules would require that automatically executed trades 
in Streaming Quote Options would be allocated among the specialist and 
crowd participants with orders or quotations at the Exchange's 
disseminated price after public customer market and marketable limit 
orders have been executed. This aspect of the proposed rule change is 
consistent with current Exchange rules concerning the priority of 
customer orders.\21\
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    \21\ Phlx Rule 1014(g)(i)(A) requires that orders of controlled 
accounts must yield priority to customer orders. A ``controlled 
account'' includes any account controlled by or under common control 
with a broker-dealer (such as a specialist or an SQT). Customer 
accounts are all other accounts.
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    Quoting alone at the Exchange's best bid/offer. The proposed rules 
would provide that, if one Phlx XL participant is quoting alone at the 
disseminated price and its quote is not matched by another Phlx XL 
participant prior to execution, such Phlx XL participant would be 
entitled to receive a number of contracts up to the size associated 
with his/her quote.
    Parity. The proposed rules would codify the automatic allocation 
algorithm that would apply to orders or electronic quotes in Streaming 
Quote Options that result in automatic executions when two or more Phlx 
XL participants have quotes or booked limit orders at the Exchange's 
disseminated price.\22\
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    \22\ Phlx Rules 119, 120, and 1014(g) are the general rules 
concerning establishment of parity and priority in the execution of 
orders on the options floor. The trade allocation algorithm in 
proposed Phlx Rule 1014(g)(vii) generally does not contemplate that 
price-time priority would apply to quotes and orders in Streaming 
Quote Options. Proposed Phlx Rule 1014(g)(vii)(B)(3) thus would 
state that, notwithstanding the first sentence of Phlx Rule 
1014(g)(i), neither Phlx Rule 119(a)-(d) and (f), nor Phlx Rule 120 
(insofar as it incorporates those provisions by reference) would 
apply to the allocation of automatically executed trades in 
Streaming Quote Options.
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    Quotations entered electronically by the specialist or an SQT that 
do not cause an order resting on the limit order book to become due for 
execution may be matched, or joined, at any time by quotations entered 
electronically by the specialist and/or other SQTs, and by ROT limit 
orders placed on the limit order book via electronic interface, and 
would be deemed to be on parity, subject to the requirement that orders 
of controlled accounts must yield priority to customer orders as set 
forth in Phlx Rule 1014(g)(i)(A). This means specifically that if a 
customer limit order represents all or a portion of the Exchange's 
disseminated size, such customer limit order would be executed first up 
to its disseminated size, before the specialist or any SQT, non-SQT 
ROT, or off-floor broker-dealer would be entitled to receive any 
contracts.
    Quotations entered electronically by the specialist or an SQT that 
cause the specialist's quote, an SQT's quote, or an order resting on 
the limit order book to become due for execution would be subject to 
execution under the proposed

[[Page 33446]]

amended rules concerning the Exchange's Book Match or Book Sweep 
functions, described more fully below.
    Specialist on parity. If the specialist is quoting at the 
Exchange's best bid/offer, after public customer market and marketable 
limit orders have been executed, the specialist would initially be 
entitled to receive the entire allocation in orders for five contracts 
or fewer provided, however, that on a quarterly basis, the Exchange 
will evaluate what percentage of the volume executed on the Exchange is 
comprised of orders for five contracts or fewer executed by 
specialists, and will reduce the size of the orders included in this 
provision if such percentage is over 25%.
    Respecting orders for greater than five contracts, the specialist 
would be entitled to receive the greater of the proportion of the total 
disseminated size at the disseminated price represented by the size of 
the specialist's quote; or:
     60% of the contracts to be allocated if the specialist is 
on parity with one SQT or one non-SQT ROT that has placed a limit order 
on the book at the Exchange's disseminated price;
     40% of the contracts to be allocated if the specialist is 
on parity with two SQTs or non-SQT ROTs that have placed a limit order 
on the book at the Exchange's disseminated price; and
     30% of the contracts to be allocated if the specialist is 
on parity with three or more SQTs or non-SQT ROTs that have placed a 
limit order on the book at the Exchange's disseminated price.
    In order to be entitled to receive the specified percentages, and 
the five contract or fewer order preference, the specialist must be 
quoting at the Exchange's disseminated price. The specialist would not 
be entitled to receive a number of contracts that is greater than the 
size associated with the specialist's quote.
    The Exchange believes that the specialist's entitlement under this 
algorithm should enable the Exchange to attract and retain highly 
capitalized specialist units who can capture order flow for the 
Exchange. According to the Exchange, because the specialist unit is 
currently a key Exchange member organization engaged in aggressive and 
often expensive marketing efforts to attract order flow in particular 
options, the Exchange seeks to provide the appropriate encouragement to 
specialists to plan, invest in, and effect marketing strategies. 
Therefore, the Exchange believes that these programs provide 
specialists with the appropriate incentive to create more depth and 
liquidity. Moreover, the Exchange believes that the specialist's 
entitlement in the proposed algorithm reasonably rewards specialists 
for their additional obligations, such as the proposed requirement to 
quote 100% of the series in all Streaming Quote Options in which they 
are assigned (whereas SQTs would be required by proposed Phlx Rule 
1014(b)(ii) to quote in 60% of the series in Streaming Quote Options in 
which they are assigned); the obligation to handle limit orders on the 
book; the obligation under the Plan for the Purpose of Creating and 
Operating an Intermarket Options Linkage (the ``Linkage Plan'')\23\ to 
handle all inbound Linkage Orders and to send Satisfaction Orders on 
behalf of customer limit orders on the specialist's book; and the 
obligation, under certain circumstances, to allocate manually executed 
trades.\24\
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    \23\ See Securities Exchange Act Release Nos. 43573 (November 
16, 2000), 65 FR 70851 (November 28, 2000) (Notice of Phlx Joining 
the Plan) and 43086 (July 28, 2000), 65 FR 48023 (August 4, 2000) 
(Approval of the Plan).
    \24\ See Phlx Rule 1014(g)(vi) and OFPA F-2.
---------------------------------------------------------------------------

    After public customer limit orders have been executed and the 
specialist has received its entitlement, SQTs quoting at the 
disseminated price and non-SQT ROTs that have placed limit orders on 
the limit order book which represent the Exchange's disseminated price 
would be entitled to receive a number of contracts that is the 
proportion of the aggregate size associated with SQT quotes and non-SQT 
ROT limit orders on the book at the disseminated price represented by 
the size of the SQT's quote or, in the case of a non-SQT ROT, by the 
size of the limit order they have placed on the limit order book. Such 
SQT(s) and non-SQT ROTs would not be entitled to receive a number of 
contracts that is greater than the size associated with their quotation 
or limit order.
    With respect to contracts relating to off-floor broker-dealer limit 
orders resting on the limit order book that are executed and allocated 
automatically, if any contracts remain to be allocated after the 
specialist, SQTs and non-SQT ROTs with limit orders on the limit order 
book have received their respective allocations, off-floor broker-
dealers that have placed limit orders on the limit order book which 
represent the Exchange's disseminated price would be entitled to 
receive a number of contracts that is the proportion of the aggregate 
size associated with off-floor broker-dealer limit orders on the limit 
order book at the disseminated price represented by the size of the 
limit order they have placed on the limit order book. Such off-floor 
broker-dealers would not be entitled to receive a number of contracts 
that is greater than the size that is associated with its quote.
    However, when an off-floor broker-dealer order is resting on the 
limit order book at the Exchange's disseminated bid or offer, an order 
executed manually by the specialist would be required to be allocated 
first to customer orders, and next to off-floor broker-dealer limit 
orders, before the specialist and SQTs with quotations at the same 
price and non-SQT ROTs that have placed limit orders via electronic 
interface at the same price would be entitled to receive their 
respective allocations under proposed Phlx Rule 1014(g)(vii).
    Currently, Phlx Rule 1014(g)(i)(A) provides that orders of 
controlled accounts\25\ must yield priority to customer orders, but 
that orders of controlled accounts are not required to yield priority 
to other controlled account orders. The Exchange proposes to amend Phlx 
Rule 1014(g)(i)(A) to require the specialist, SQTs and non-SQT ROTs to 
yield priority to off-floor broker-dealer limit orders in Streaming 
Quote Options resting on the limit order book solely in the limited 
circumstance where the specialist executes such an order manually, and 
not in the circumstance where such an order is executed and allocated 
automatically under Phlx XL. The purpose of this provision is to ensure 
that the specialist complies with the fiduciary obligation that 
devolves upon the specialist when acting as agent for such a limit 
order.
---------------------------------------------------------------------------

    \25\ Phlx Rule 1014(g)(i)(A) defines a controlled account as any 
account controlled by or under common control with a broker-dealer. 
Customer accounts are all other accounts.
---------------------------------------------------------------------------

    In the situation where the off-floor broker-dealer limit order 
resting on the limit order book is executed and allocated 
automatically, the Exchange believes that the operation of the proposed 
automatic trade allocation algorithm contained in proposed Phlx Rule 
1014(g)(vii), which would allocate contracts to off-floor broker-dealer 
limit orders resting on the limit order book after customers, the 
specialist, SQTs and non-SQT ROTs have received their respective 
allocations is appropriate since the specialist is not acting as 
``agent'' for such an order in such a circumstance.
Off-Floor Broker-Dealer Orders and section 11(a) of the Act
    Exchange rules do not currently distinguish between members or non-
members respecting ``off-floor broker-dealer'' orders. The Exchange 
believes that its definition of ``off-floor broker-dealer,''\26\ which 
does not make this

[[Page 33447]]

distinction, is consistent with section 11(a) of the Act\27\ and the 
rules thereunder.
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    \26\ The term ``off-floor broker-dealer'' means a broker-dealer 
that delivers orders from off the floor of the Exchange for the 
proprietary account(s) of such broker-dealer, including a market 
maker located on an exchange or trading floor other than the 
Exchange's trading floor who elects to deliver orders via AUTOM for 
the proprietary account(s) of such market maker. See Phlx Rule 
1080(b)(i)(C).
    \27\ 15 U.S.C. 78k(a).
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    Section 11(a) prohibits a member of a national securities exchange 
from effecting transactions on the exchange for its own account, the 
account of an associated person, or an account in which it or an 
associated person exercises investment discretion, unless certain 
exceptions apply. One such exception is Rule 11a2-2(T) under the 
Act,\28\ known as the ``Effect Versus Execute Rule,'' permits an 
exchange member, subject to certain conditions, to effect a transaction 
for such accounts, utilizing an unaffiliated member to execute 
transactions on an exchange floor. The Rule requires that: (i) The 
order must be transmitted from off the exchange floor; (ii) once the 
order has been transmitted, the exchange member that transmitted the 
order may not participate in the execution; (iii) the transmitting 
member may not be affiliated with the executing member; and (iv) 
neither nor the member nor the associated person may retain any 
compensation in connection with effecting such a transaction respecting 
accounts over which either has investment discretion without the 
express written consent of the person authorized to transact business 
in the account. When the Exchange received Commission approval to allow 
off-floor broker dealers to deliver proprietary orders to the limit 
order book over AUTOM,\29\ the Commission provided the Exchange with 
interpretive guidance based on the Exchange's representations that the 
Effect vs. Execute Rule was applicable to off-floor broker-dealer 
orders that are delivered via AUTOM.\30\
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    \28\ 17 CFR 240.11a2-2T.
    \29\ See Securities Exchange Act Release No. 45758 (April 15, 
2002), 67 FR 19610 (April 22, 2002) (SR-Phlx-2001-40) (Order 
approving the establishment of a six-month pilot program relating to 
broker-dealer access to AUTOM); see also Securities Exchange Act 
Release No. 46660 (October 15, 2002), 67 FR 64951 (October 22, 2002) 
(SR-Phlx-2002-50) (Order granting permanent approval of the pilot 
program providing broker-dealer access to AUTOM).
    \30\ See letter from Paula R. Jenson, Deputy Chief Counsel, 
Division of Market Regulation, Commission, to Richard S. Rudolph, 
Counsel, Phlx, dated April 15, 2002.
---------------------------------------------------------------------------

    The instant proposal, which includes proposed rules relating to the 
priority and trade allocation of off-floor broker-dealer limit orders 
handled manually, may affect the yielding of priority by member and 
non-member off-floor broker-dealer limit orders in certain instances. 
Specifically, Section 11(a)(1)(G) of the Act\31\ provides an exemption 
from the prohibition against a member of a national securities exchange 
from effecting transactions on the exchange for its own account, the 
account of an associated person, or an account in which it or an 
associated person exercises investment discretion for any transaction 
for a member's own account for a member who engages in a specific 
securities business, but requires such member to yield priority, 
parity, and precedence in execution to orders for the account of 
persons who are not members or associated with members of the 
exchange.\32\
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    \31\ 15 U.S.C 78k(a)(1)(G).
    \32\ Section 11(a)(1)(G) of the Act provides that it shall not 
make unlawful any other transaction for a member's own account, 
provided that (i) such member is primarily engaged in the business 
of underwriting and distributing securities issued by other persons, 
selling securities to customers, and acting as broker, or any one or 
more of such activities, and whose gross income normally is derived 
principally from such business and related activities and (ii) such 
transaction is effected in compliance with rules of the Commission 
which, at a minimum, assure that the transaction is not inconsistent 
with the maintenance of fair and orderly markets and yields 
priority, parity and precedence in execution to orders for the 
account of persons who are not members or associated with members of 
the exchange.
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    As stated above, proposed Phlx Rule 1014(g)(i)(A) currently 
provides that orders of controlled accounts must yield priority to 
customer orders, and that orders of controlled accounts are not 
required to yield priority to other controlled account orders, except 
when the specialist manually executes an off-floor broker-dealer limit 
order on the limit order book as provided in proposed Phlx Rule 
1014(g)(i)(A). The Exchange believes that the only potential issue 
raised by including both member and non-member off-floor broker-dealers 
is the issue of manual allocation of contracts by specialists among 
such member and non-member off-floor broker-dealers, and the 
requirement that member broker-dealers who satisfy a ``business mix 
test,'' \33\ and who therefore rely on the section 11(a)(1)(G) 
exemption, yield priority to non-member broker-dealers.
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    \33\ Rule 11a1-1T under the Act provides that a transaction 
effected on a national securities exchange for the account of a 
member which meets the requirements of Section 11(a)(1)(G)(i) of the 
Act shall be deemed, in accordance with the requirements of Section 
11(a)(1)(G)(ii), to be not inconsistent with the maintenance of fair 
and orderly markets and to yield priority, parity, and precedence in 
execution to orders for the account of persons who are not members 
or associated with members of the exchange if such transaction is 
effected in compliance with each of the following requirements:
    A member shall disclose that a bid or offer for its account is 
for its account to any member with whom such bid or offer is placed 
or to whom it is communicated, and any member through whom that bid 
or offer is communicated shall disclose to others participating in 
effecting the order that it is for the account of a member.
    Immediately before executing the order, a member (other than the 
specialist in such security) presenting any order for the account of 
a member on the exchange shall clearly announce or otherwise 
indicate to the specialist and to other members then present for the 
trading in such security on the exchange that he is presenting an 
order for the account of a member.
    Notwithstanding rules of priority, parity, and precedence 
otherwise applicable, any member presenting for execution a bid or 
offer for its own account or for the account of another member shall 
grant priority to any bid or offer at the same price for the account 
of a person who is not, or is not associated with, a member, 
irrespective of the size of any such bid or offer or the time when 
entered.
    A member shall be deemed to meet the requirements of Section 
11(a)(1)(G)(i) of the Act if during its preceding fiscal year more 
than 50 percent of its gross revenues was derived from one or more 
of the sources specified in that section. In addition to any revenue 
which independently meets the requirements of Section 
11(a)(1)(G)(i), revenue derived from any transaction specified in 
paragraph (A), (B), or (D) of Section 11(a)(1) of the Act or 
specified in Rule 11a1-4(T) shall be deemed to be revenue derived 
from one or more of the sources specified in Section 11(a)(1)(G)(i). 
A member may rely on a list of members which are stated to meet the 
requirements of Section 11(a)(1)(G)(i) if such list is prepared, and 
updated at least annually, by the exchange. In preparing any such 
list, an exchange may rely on a report which sets forth a statement 
of gross revenues of a member if covered by a report of independent 
accountants for such member to the effect that such report has been 
prepared in accordance with generally accepted accounting 
principles.
    17 CFR 240.11a1-1T.
---------------------------------------------------------------------------

    The Exchange believes that its proposal to include member and non-
member off-floor broker-dealers together in proposed Phlx Rule 
1014(g)(i)(A) relating to the manual trade allocation rules is 
consistent with Section 11(a) of the Act and Rule 11a1-1(T) thereunder 
because Exchange rules require any order to which the yielding 
requirement of Section 11(a)(1)(G)(i) applies is required to be marked 
with the requirement to yield priority, including such orders placed on 
the limit order book by Floor Brokers.\34\ Thus, specialists manually 
allocating such orders to off-floor broker-dealers would know from the 
notation on the order which member off-floor broker-dealer limit orders 
must yield to non-member off-floor broker-dealer orders.
---------------------------------------------------------------------------

    \34\ Phlx Rule 1014(g)(i)(A) and OFPA B-6 require that orders of 
controlled accounts, other than ROTs and Specialists market making 
in-person, must be (1) verbally communicated as for a controlled 
account when placed on the floor and when represented to the trading 
crowd and (2) recorded as for a controlled account by appropriately 
circling the ``yield'' field on the floor ticket of any such order 
(except market maker tickets) or, in the case of trades involving a 
Floor Broker, by making the appropriate notation the Options Floor 
Broker Management System.
---------------------------------------------------------------------------

    Specialist not on parity. If the specialist is not quoting at the

[[Page 33448]]

Exchange's disseminated price, SQTs quoting at the disseminated price 
and non-SQT ROTs that have placed limit orders on the limit order book 
which represent the Exchange's disseminated price would be entitled to 
receive a number of contracts that is the proportion of the total 
remaining disseminated size at the disseminated price represented by 
the size of the SQT's quote or, in the case of a non-SQT ROT, by the 
size of the limit order they have placed on the limit order book. 
Thereafter, off-floor broker-dealers that have placed limit orders on 
the limit order book which represent the Exchange's disseminated price 
would be entitled to receive a number of contracts that is the 
proportion of the aggregate size associated with off-floor broker-
dealer limit orders on the limit order book at the disseminated price 
represented by the size of the limit order they have placed on the 
limit order book, not to exceed the size of their limit orders.
    Split price executions. Proposed Phlx Rule 1014(g)(vii)(B)(3) would 
provide that there would be no automatic split-price executions in 
Streaming Quote Options. Therefore, if a market order or an electronic 
quotation to be executed in a Streaming Quote Option is received for a 
greater number of contracts than the Exchange's disseminated size, the 
portion of such an order or quotation executed via Book Match at the 
Exchange's disseminated size would be allocated in accordance with 
proposed Phlx Rule 1014(g)(vii). Contracts remaining in such an order 
would be represented by the specialist and handled in accordance with 
Exchange rules.
    The Exchange believes that, respecting Streaming Quote Options in 
which specialists and SQTs submit independent electronic quotations, it 
is inappropriate for the Exchange to establish the next price at which 
the remaining contracts in a market order should be executed after the 
Exchange's disseminated size is exhausted. To ensure that the remaining 
contracts in such an order are executed at the best price available 
from Exchange specialists and SQTs, the Exchange would not 
automatically execute the remaining portion of such an order. Instead, 
the Exchange believes that the specialist, SQTs and ROTs should re-
establish their bids and offers upon exhaustion of the Exchange's 
disseminated size and execute the remaining contracts manually.
    Participation in non-electronic orders. An SQT participating in a 
crowd (together with the specialist and non-SQT ROTs in the crowd) 
would be permitted to participate in manual trades initiated by Floor 
Brokers or the specialist in such a crowd.
    Accordingly, an SQT generally must be present in the trading crowd 
to participate in non-electronic trades, with one exception. While the 
proposed rules generally require in-crowd presence to participate in 
non-electronic trades, proposed Phlx Rule 1014, Commentary .05(c) would 
provide that, where a non-electronic trade is initiated by a Floor 
Broker or specialist, an SQT assigned in a Streaming Quote Option who 
is located in the SQT Zone (as described below) for the Streaming Quote 
Option, but who is not participating in the crowd trading the Streaming 
Quote Option, would be able to participate in such a manual trade only 
if the non-electronic order is executed at the price quoted by the non-
crowd participant SQT at the time of execution. For purposes of trade 
allocation, such an SQT would be entitled to receive contracts under 
existing Phlx Rule 1014(g)(v), which applies to the allocation of 
contracts for orders handled manually by the specialist or represented 
in the crowd by a floor broker.
    The proposed rule would permit the specialist and/or SQTs 
participating in a crowd, in response to a verbal request for a market 
by a floor broker, to state a bid or offer that is different than their 
electronically submitted bid or offer, provided that such stated bid or 
offer is not inferior to such electronically submitted bid or offer, 
with one exception.
    Specifically, Commentary .05(c) would provide that the requirement 
that a specialist or SQT state a bid or offer that is not inferior to 
their electronically submitted quotation would not apply if such 
response is to a floor broker's solicitation of a single bid or offer 
as set forth in Phlx Rule 1033(a)(ii). In such a situation, Phlx Rule 
1033(a)(ii) permits the members of a trading crowd to discuss, 
negotiate and agree upon the price or prices at which an order of a 
size greater than the Exchange's disseminated size can be executed at 
that time, or the number of contracts that could be executed at a given 
price or prices.\35\ This is especially true of extremely large sized 
orders where the trading crowd may determine by agreement to quote a 
single price that could be inferior to an electronic quotation 
submitted by a specialist or an SQT.\36\
---------------------------------------------------------------------------

    \35\ Phlx Rule 1033(a)(ii) and Options Floor Procedure Advice 
(``Advice'') F-32, Solicitation of Quotations, provide that, in 
response to a floor broker's solicitation of a single bid or offer, 
the members of a trading crowd (including the specialist and ROTs) 
may discuss, negotiate and agree upon the price or prices at which 
an order of a size greater than the AUTO-X guarantee can be executed 
at that time, or the number of contracts that could be executed at a 
given price or prices. Notwithstanding the foregoing, a single crowd 
participant may voice a bid or offer independently from, and 
differently from, the members of a trading crowd (including the 
specialist and ROTs). See Securities Exchange Act Release No. 45573 
(March 15, 2002), 67 FR 13674 (March 25, 2003) (SR-Phlx-2001-33) 
(filed in response to Section IV.B.j. of the Order, which requires 
the Exchange (as well as the other respondent options exchanges) to 
implement certain undertakings. One such undertaking to adopt new, 
or amend existing, rules to include any practice or procedure 
whereby market makers trading any particular option class determine 
by agreement the spreads or option prices at which they will trade 
any option class, or the allocation of orders in that option class).
    \36\ As stated in the Exchange's proposal to adopt Phlx Rule 
1033(a)(ii),
    ``Ordinarily, in meeting their obligation to make fair and 
orderly markets, Phlx specialists and ROTs would be expected to make 
independent business decisions concerning what market to quote at a 
particular point in time, in lieu of discussing or agreeing with 
other members of the trading crowd on what should be the market for 
a particular option. In order to make fair and orderly markets and 
to respond efficiently to the needs of investors, however, the Phlx 
believes that there are circumstances where some coordination among 
ROTs and specialists is both necessary and beneficial.
    For example, when a request for a market to buy or sell a large 
number of options contracts is presented by the floor broker to the 
trading crowd, the customer on whose behalf the request is made 
typically wants to know promptly at what single price all of the 
options represented by the request may be bought or sold. However, 
such large trades typically require more liquidity than any single 
ROT or the specialist is able to provide. Coordinated efforts of the 
trading crowd are, thus, necessary to respond to such a request and 
to fill any resulting order to buy or sell the option at a single 
price. In this regard, borrowing a phrase from corporate principles, 
the Phlx believes that the trading crowd is properly viewed as a 
``joint venture,'' in which the resources of the individual crowd 
members are combined to produce the necessary liquidity to respond 
to the needs of investors and to compete effectively with other 
options exchanges.
    When an options order exceeds the size that individual trading 
crowd members can execute, the Phlx believes that the trading crowd 
must act as a joint venture or single economic unit. In this 
situation, the trading crowd must reach agreement on the price they 
will offer because the customer desires a single price. 
Significantly, in the Exchange's view, the antitrust laws permit 
competitors to collaborate to produce and sell a product that they 
could not otherwise offer individually. In fact, such activity is 
pro-competitive because it increases output and increases the number 
of competitors.''
    See Securities Exchange Act Release No. 45391 (February 4, 
2002), 67 FR 6570 (February 12, 2002) (SR-Phlx-2001-33).
---------------------------------------------------------------------------

    In order to remain consistent with the Linkage Plan, the Exchange 
proposes to amend Phlx Rule 1033(a)(ii) and Advice F-32 to provide that 
orders executed under the Rule and Advice are subject to the provisions 
of the Linkage Plan and Phlx Rules 1083--1087 respecting Trade-
Throughs.\37\
---------------------------------------------------------------------------

    \37\ Under the Linkage Plan and Exchange Rules, a ``Trade-
Through'' means a transaction in an options series at a price that 
is inferior to the NBBO. The Linkage Plan and Exchange Rules provide 
that, absent reasonable justification and during normal market 
conditions, members should not effect Trade-Throughs. See Phlx Rule 
1085(a)(1). If a Trade-Through occurs, the Linkage Plan and Exchange 
Rules provide certain rights and remedies for aggrieved parties 
whose markets are traded through. A Block Trade (defined in the 
Linkage Plan and Exchange Rules as a trade that involves 500 or more 
contracts and has a premium value of at least $150,000) effected at 
a price outside the NBBO is not deemed to be a Trade-Through for 
purposes of surveillance and enforcement, provided that the 
member(s) that execute such a Block Trade have satisfied all 
aggrieved parties in accordance with the Linkage Plan and Exchange 
Rules. See Phlx Rule 1085(d)(2).

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[[Page 33449]]

Crowd Area
    For purposes of Phlx Rule 1014, Commentary .03, an SQT or non-SQT 
ROT would be deemed to be participating in a crowd if such SQT or non-
SQT ROT is, at the time an order is represented in the crowd, 
physically located in a specific ``Crowd Area.'' A Crowd Area would 
consist of a physical location marked with specific, visible physical 
boundaries on the options floor, as determined by the Options 
Committee.\38\ An SQT or non-SQT ROT who is physically present in such 
Crowd Area may engage in options transactions in assigned issues as a 
crowd participant in such a Crowd Area, provided that such SQT or non-
SQT ROT fulfills the requirements set forth in Phlx Rule 1014. An SQT 
or non-SQT ROT would be deemed to be participating in a single Crowd 
Area, and thus would not be permitted to be a crowd participant in more 
than one particular Crowd Area at any specific time.
---------------------------------------------------------------------------

    \38\ While the proposed rules would grant authority to assign 
trading privileges in Streaming Quote Options to the OAESC (which 
includes three off-floor persons, one public Governor, and one non-
industry governor pursuant to Phlx Rule 500), the proposed rules 
would grant authority to determine the physical location of Crowd 
Areas and SQT Zones to the Options Committee, which is composed of 
specialists, ROTs and Floor Brokers who conduct business on the 
Exchange's Options Floor. The purpose of this provision is to ensure 
that Exchange members who are most familiar with the physical 
configuration and layout of the Exchange's Options Floor (i.e., the 
members of the Options Committee) determine such physical location.
---------------------------------------------------------------------------

SQT Zones
    Proposed Phlx Rule 1014, Commentary .05(b) would provide that an 
SQT may be assigned to (and thus submit quotes electronically in) up to 
all of the options located within a specified physical zone on the 
Exchange Floor (an ``SQT Zone'') provided that such SQT is physically 
present in such SQT Zone. Thus, each member organization must have at 
least one SQT physically present in each SQT Zone in which such member 
organization submits electronic quotations. An SQT Zone could consist 
of multiple Crowd Areas. Each SQT Zone would be identified as including 
specific Crowd Areas (for example, ``SQT Zone 1'' might be identified 
as encompassing Crowd Areas A-D, ``SQT Zone 2'' might be identified as 
encompassing Crowd Areas E-H, etc.).
    Initially, there would be one SQT Zone representing the entire 
options trading floor. This means that an SQT could submit electronic 
quotations in any Streaming Quote Option while such SQT is physically 
on the Exchange floor.
    The number and location of any additional SQT Zones would be 
determined by the Options Committee based on its review of quote and 
trade data during the first six months of the deployment of Phlx XL. 
Proposed Phlx Rule 1014, Commentary .05(c) would require the Exchange 
to file for, and receive, Commission approval in the event the Options 
Committee determines to change the number and/or location of SQT Zones.
ROT Limit Orders
    The proposed rule change would amend the Exchange's rules regarding 
ROT electronic access to the limit order book.\39\ Currently, ROTs are 
permitted by rule to enter electronic price improving limit orders (and 
orders matching such orders entered by the specialist or other ROTs in 
the trading crowd) onto the limit order book via electronic interface 
with AUTOM, and are entitled to receive a special allocation in trades 
stemming from such price improving limit orders.\40\ Under the instant 
proposal, ROTs would be permitted under Phlx Rule 1080(b)(i)(B) and 
Commentary .04 to place certain limit orders on the limit order book 
electronically. The requirement that such limit orders be price-
improving orders, however, would be deleted. ROTs would be permitted to 
place limit orders, including Good Till Cancelled (``GTC'') orders, on 
the limit order book whether such an order improves the then-prevailing 
Exchange market or not. ROTs entering limit orders on the book would be 
required to submit such orders with a size of at least ten contracts in 
both Streaming Quote Options and non-Streaming Quote Options. ``Price-
Improving ROTs'' that place price-improving limit orders would continue 
to be entitled to receive contracts under the aforementioned special 
allocation.
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    \39\ In November, 2002, the Commission approved the Exchange's 
proposal to allow on-floor, in-crowd ROTs to place electronic price-
improving limit orders on the limit order book via electronic 
interface with AUTOM, and to provide a special trade allocation 
algorithm applicable to trades involving such limit orders. See 
Securities Exchange Act Release No. 46763 (November 1, 2002), 67 FR 
68898 (November 13, 2003) (SR-Phlx-2002-04). That proposal was filed 
in response to the Order (see supra note 20) which required, among 
other things, that the respondent exchanges adopt new, or amend 
existing, rules concerning its automated quotation systems which 
substantially enhance incentives to quote competitively and 
substantially reduce disincentives for market participants to act 
competitively. The Commission recently approved Phlx's proposal to 
modify the timetable for the automatic execution of such limit 
orders as such automaton relates to both Streaming Quote Options and 
non-Streaming Quote Options. See Securities Exchange Act Release No. 
49151 (January 29, 2004), 69 FR 6010 (February 9, 2004) (SR-Phlx-
2004-01).
    \40\ Id.
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    The proposed rule would provide that, respecting Streaming Quote 
Options, inbound AUTOM orders or electronic quotations eligible for 
execution against non-SQT ROT orders entered into AUTOM via electronic 
interface would be automatically executed and would be allocated 
automatically pursuant to Exchange rules.\41\
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    \41\ Respecting Streaming Quote Options, non-SQT ROT limit 
orders on the book, entered electronically or manually by the 
specialist that are automatically executed would be allocated 
pursuant to proposed Phlx Rule 1014(g)(vii).
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    The Exchange believes that the instant proposal, which would enable 
SQTs to stream electronic quotes, combined with the size pro rata 
allocation algorithm applicable to automatically executed trades 
resulting from such quotes, rewards market participants for quoting and 
providing liquidity at the best price. The Exchange believes that the 
result would thus be substantially enhanced incentives for market 
participants to quote competitively and substantially reduced 
disincentives to quote competitively. In Streaming Quote Options, non-
SQT ROTs with limit orders on the book at the Exchange's disseminated 
price that are automatically executed would be allocated contracts 
according to proposed new Phlx Rule 1014(g)(vii), which, as stated 
above, would reward non-SQT ROTs who provide liquidity at the best 
price.
Book Match
    Book Match is a feature of AUTOM that currently provides automatic 
executions for inbound AUTOM-delivered customer and off-floor broker-
dealer \42\ orders against customer limit orders on the book. The 
proposed rules would enhance Book

[[Page 33450]]

Match to provide that the contra-side to automatically executed inbound 
eligible orders would be a limit order on the book or specialist and/or 
SQT electronic quotes (``electronic quotes'') at the disseminated price 
where the Exchange's disseminated size includes a limit order on the 
book and/or electronic quotes at the disseminated price. The 
enhancements would involve the automatic execution of inbound market 
and marketable limit orders against contra-side booked limit orders 
and/or quotes that are included in the Exchange's disseminated 
quotation.
---------------------------------------------------------------------------

    \42\ Phlx Rule 1080(b)(i)(C) defines an ``off-floor broker-
dealer'' as a broker-dealer that delivers orders from off the floor 
of the Exchange for the proprietary account(s) of such broker-
dealer, including a market maker located on an exchange or trading 
floor other than the Exchange's trading floor who elects to deliver 
orders via AUTOM for the proprietary account(s) of such market 
maker.
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    Book Match would not be engaged: (i) When the Exchange's 
disseminated price represented by a limit order on the book is not the 
National Best Bid or Offer (``NBBO''); (ii) for pre-opening orders; and 
(iii) during trading rotations. In these situations, incoming orders 
would be subject to manual handling by the specialist.
    The Exchange believes that the proposed enhancements to Book Match 
should provide for a greater number of automatic executions involving 
matching inbound orders against booked limit orders and SQT and 
specialist quotations that are included in the Exchange's disseminated 
quotation, thus providing customers with quicker, more efficient 
executions for a larger number of trades.
Book Sweep
    Similar to Book Match, the Book Sweep function currently matches 
specialist quotations generated by Auto-Quote (or by a proprietary 
quoting system called ``Specialized Quote Feed'' or ``SQF'') against 
booked limit orders representing the Exchange's disseminated bid or 
offer when such quotations lock or cross the booked limit order 
(provided that the disseminated bid or offer is at the NBBO). 
Currently, Phlx Rule 1080(c)(iii) provides that, when the bid or offer 
generated by the Exchange's Auto-Quote system or SQF matches (locks) or 
crosses the Exchange's best bid or offer in a particular series as 
established by an order on the limit order book, orders on the limit 
order book in that series will be automatically executed up to the size 
associated with the quote that locks or crosses the order on the limit 
order book and allocated among crowd participants signed onto the 
Wheel.
    Book Sweep would be enhanced in Phlx XL for Streaming Quote Options 
under the instant proposed rule change to allow SQT quotations, in 
addition to specialist quotations, to initiate the Book Sweep function. 
The SQT Book Sweep feature would function in essentially the same 
manner as the current Auto-Quote or SQF Book Sweep feature, i.e., when 
an SQT submits a quotation that locks or crosses a limit order on the 
book that represents the Exchange's best bid or offer, such limit order 
would be executed automatically up to the size associated with the 
SQT's quotation, and would be automatically allocated in accordance 
with Exchange rules. The specialist or SQT may manually initiate the 
Book Sweep feature by sending a manual quote in situations where the 
specialist or SQT's automatic generation of electronic quotations is 
suspended due to, for example, a system malfunction. Eligible orders on 
the limit order book would be automatically executed up to the size 
associated with the quote that matches or crosses such limit orders. 
Orders on the limit order book would not be eligible for Book Sweep 
when the NBBO is crossed (i.e., 2.10 bid, 2 offer).
    The current functionality of Book Sweep would remain effective for 
non-Streaming Quote Options. The above-described enhancements would 
apply to Streaming Quote Options, and the Exchange proposes to amend 
Phlx Rule 1080(c)(iii) to reflect the Book Sweep functionality for both 
Streaming Quote and non-Streaming Quote Options.
NBBO Step-Up
    The Exchange's current rules relating to the ``NBBO Step-Up'' AUTO-
X function would be deleted for all options, including both Streaming 
Quote Options and non-Streaming Quote Options. The purpose of this 
proposal is to enhance incentives for specialists and SQTs to quote 
competitively at the NBBO, rather than relying on the representation 
that the Exchange would ``step up'' and automatically execute at the 
NBBO as disseminated by another exchange if such other exchange's 
disseminated market falls within a specified ``step-up parameter'' of 
the Exchange's disseminated quote.
Firm Quotations
    The introduction of independent streaming options quotations in 
Phlx XL necessitates various changes to the Exchange's ``Firm Quote'' 
requirements.
    Definition of disseminated size. The Exchange proposes to amend 
Phlx Rule 1082, Firm Quotations, by establishing by rule the Exchange's 
firm quotation size with respect to non-Streaming Quote Options and 
with respect to Streaming Quote Options.\43\
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    \43\ Rule 11Ac1-1(d)(1)(i) under the Act permits an exchange to 
establish by rule, and periodically publish, the quotation size for 
listed options, for which responsible brokers or dealers are 
obligated to execute an order. 17 CFR 240.11Ac1-1(d)(1)(i).
---------------------------------------------------------------------------

    Respecting non-Streaming Quote Options, the Exchange's 
``disseminated size'' would be defined as, with respect to the 
disseminated price, at least the sum of the size associated with: (1) 
Limit orders; and (2) specialists' quotations generated by Auto-Quote 
or Specialized Quote Feed (``SQF'') as described in Phlx Rule 1080, 
Commentary .01 (which represents the collective quotation size of the 
specialist and any ROTs bidding or offering at the disseminated price 
unless an ROT has expressly indicated otherwise in a clear and audible 
manner). The proposed definition of ``disseminated size'' respecting 
non-Streaming Quote Options would provide more specificity to the 
current definition, which includes at least the sum of limit orders and 
allows, but does not require, the specialist and/or crowd to add 
additional size to the Exchange's disseminated size. The Exchange 
believes that the requirement that specialists' quotations generated by 
Auto-Quote or SQF be included in the disseminated size provides a more 
accurate and transparent reflection of the size for which the Exchange 
is firm in quotations for non-Streaming Quote Options.
    The Exchange is proposing to adopt new Phlx Rule 1082(a)(ii)(B) to 
establish by rule the definition of ``disseminated size'' that would 
apply to Streaming Quote Options. Specifically, for Streaming Quote 
Options, ``disseminated size'' would mean, with respect to the 
Exchange's disseminated price, at least the sum of the size associated 
with limit orders, specialists' quotations,\44\ and SQTs' quotations. 
The Exchange would disseminate the aggregate size of these three 
components.
---------------------------------------------------------------------------

    \44\ Because the specialist and SQTs in Streaming Quote Options 
would be quoting independently, the term ``specialist's quotations'' 
with respect to Streaming Quote Options would mean the individual 
specialist's quotation, including, for purposes of the definition of 
``disseminated size,'' the size associated with such a quotation.
---------------------------------------------------------------------------

    Proposed Phlx Rule 1082(a)(ii)(C)(1) would provide that, if an 
SQT's quotation size in a Streaming Quote Option is exhausted, such 
SQT's quotation would be deleted from the Exchange's disseminated 
quotation until the time the SQT revises his/her quotation. Although 
such SQT's quotation size in a given series may be exhausted and thus 
removed from the Exchange's disseminated quotation in that series, such 
an SQT would nonetheless continue to be required to submit continuous 
two-sided quotations in not less than 60% of the series in each 
Streaming Quote Option in which

[[Page 33451]]

such SQT is assigned, in accordance with proposed Phlx Rule 
1014(b)(ii)(B).
    Proposed Phlx Rule 1082(a)(ii)(C)(2) would provide that, if the 
Exchange's disseminated size in a particular series in a Streaming 
Quote Option is exhausted, the Exchange would disseminate the next best 
available quotation.\45\ If no specialist or SQT has revised their 
quotation immediately following the exhaustion of the Exchange's 
disseminated size, the Exchange would automatically disseminate the 
specialist's most recent disseminated price prior to the time of such 
exhaustion with a size of one contract.
---------------------------------------------------------------------------

    \45\ The Exchange would have available the quotations submitted 
by the specialist and SQTs in a particular series, and would 
disseminate only the aggregate size of SQT and specialist quotations 
at the best bid and offer on the Exchange. If the best bid or offer 
is exhausted and not refreshed, the Exchange would disseminate the 
next best bid or offer submitted by the specialist and/or SQTs 
quoting in the series.
---------------------------------------------------------------------------

    This provision is intended to address the situation in which the 
size associated with all SQT quotations in a given series, together 
with the specialist's quotation in such series, are exhausted.\46\ The 
purpose of this proposal is to ensure that the specialist is fulfilling 
the continuous quoting requirement set forth in proposed Phlx Rule 
1014(b)(ii)(B) by disseminating continuous two-sided markets in 
Streaming Quote options in which such specialist is assigned, while 
permitting the specialist to revise its quote. If SQTs continue to 
submit quotations at the disseminated price, inbound AUTOM orders or 
quotes would be eligible for automatic execution against such SQT 
quotations.
---------------------------------------------------------------------------

    \46\ Rule 11Ac1-1(d)(3) under the Act provides that no 
responsible broker or dealer shall be obligated to execute a 
transaction for any listed option if, prior to the presentation of 
an order, the responsible broker or dealer has communicated to its 
exchange, a revised quotation size or a revised bid or offer. 17 CFR 
240.11Ac1-1(d)(3). See also 17 CFR 240.11Ac1-1(c)(3)(i)(A) and 
(c)(3)(ii)(A).
---------------------------------------------------------------------------

    Responsible broker or dealer. Currently, the Exchange's 
disseminated market (whether by Auto-Quote or specialized quote feed) 
is deemed to represent the quotations of all ROTs in that option unless 
an ROT has expressly indicated otherwise.\47\ All ROTs in such an 
option who have not expressly indicated that the disseminated market 
does not represent their quote would collectively be bidding or 
offering at the disseminated price, and thus are the collective 
``responsible brokers or dealers'' for purposes of the Exchange's 
``Firm Quote'' requirement. Phlx Rule 1082(b) currently provides that 
responsible brokers or dealers bidding (or offering) at the 
disseminated price are collectively required to execute orders 
presented to them at such price up to the disseminated size. This would 
remain in effect for non-Streaming Quote Options.
---------------------------------------------------------------------------

    \47\ See Phlx Rule 1080, Commentary .01(c).
---------------------------------------------------------------------------

    Because, however, SQTs and specialists would be quoting 
independently in Streaming Quote Options, each individual SQT and 
specialist would be deemed to be the ``responsible broker or dealer'' 
in Streaming Quote Options. To address this change, proposed new Phlx 
Rule 1082(b)(ii) would provide that, with respect to Streaming Quote 
Options, in the event an SQT or specialist in a Streaming Quote Option 
has electronically communicated on the Exchange bids or offers for a 
Streaming Quote Option, each such SQT or specialist would be considered 
a ``responsible broker or dealer'' for that bid or offer, up to the 
size associated with such responsible broker or dealer's bid or offer. 
There thus would be individual ``responsible brokers or dealers,'' and 
no ``collective'' firm quotation requirement, in Streaming Quote 
Options.\48\
---------------------------------------------------------------------------

    \48\ This is consistent with Rule 11Ac1-1(a)(21)(i) under the 
Act, which provides:
    ``The term responsible broker or dealer shall mean:
    (i) When used with respect to bids or offers communicated on an 
exchange, any member of such exchange who communicates to another 
member on such exchange, at the location (or locations) designated 
by such exchange for trading in a covered security, a bid or offer 
for such covered security, as either principal or agent; provided, 
however, That, in the event two or more members of an exchange have 
communicated on such exchange bids or offers for a covered security 
at the same price, each such member shall be considered a 
'responsible broker or dealer' for that bid or offer, subject to the 
rules of priority and precedence then in effect on that exchange; 
and further provided, That for a bid or offer which is transmitted 
from one member of an exchange to another member who undertakes to 
represent such bid or offer on such exchange as agent, only the last 
member who undertakes to represent such bid or offer as agent shall 
be considered the 'responsible broker or dealer' for that bid or 
offer.'' 17 CFR 240.11Ac1-1(a)(21)(i).
---------------------------------------------------------------------------

    Locked and crossed markets. Two new Commentaries to Phlx Rule 1082 
are proposed, relating to the situation in which a specialist or SQT's 
quotation locks (i.e., 1.00 bid, 1.00 offer) or crosses (i.e., 1.10 
bid, 1.00 offer) another quotation.
    Because the specialist and multiple SQTs would be quoting 
simultaneously, there may be instances where quotes may become locked. 
Under the proposal, the Exchange would disseminate the locked market 
and both quotations (bid and offer) would be deemed ``firm'' 
disseminated market quotations. Once SQT and/or specialists' quotations 
become locked, a one-second ``counting period'' will begin during which 
SQTs and/or specialists whose quotations are locked may eliminate the 
locked market. However, such SQT and/or specialist would be obligated 
to execute orders at their disseminated quotation. During the 
``counting period'' SQTs and specialists located in the Crowd Area in 
which the option that is the subject of the locked market is traded 
will continue to be obligated to respond to floor brokers as set forth 
in Phlx Rule 1014, Commentary .05(c), and would continue to be 
obligated for one contract in open outcry to other SQTs, non-SQT ROTs, 
and specialists.
    If at the end of the counting period the quotations remain locked, 
the locked quotations will automatically execute against each other in 
accordance with the allocation algorithm set forth in Phlx Rule 
1014(g)(vii).
    The Options Committee may shorten the duration of the one-second 
``counting period.'' The quotation that is locked may be executed by 
another order during the one-second ``counting period.''
    Crossed Markets. The Exchange will not disseminate an internally 
crossed market (e.g., $1.10 bid, 1.00 offer). If an SQT or specialist 
submits a quotation in a Streaming Quote Option (``incoming 
quotation'') that would cross an existing quotation (``existing 
quotation''), the Exchange will: (i) Change the incoming quotation such 
that it locks the existing quotation; (ii) send a notice to the SQT or 
specialist that submitted the existing quotation indicating that its 
quotation was crossed; and (iii) send a notice to the specialist or SQT 
that submitted the incoming quotation, indicating that its quotation 
crossed the existing quotation and was changed. Such a locked market 
would be handled in accordance with proposed Commentary .01 concerning 
locked markets. During the one-second counting period, if the existing 
quotation is cancelled subsequent to the time the incoming quotation is 
changed, the incoming quotation will automatically be restored to its 
original terms.
Other Rules and OFPAs
    The Wheel. The Exchange is proposing to amend its OFPA F-24 to 
reflect that the Wheel will apply only to non-Streaming Quote Options. 
Because a new trade allocation algorithm would become effective with 
respect to Streaming Quote Options, taking into account the 
entitlements of the specialist, SQTs, ROTs and off-floor broker-dealers 
based on the size associated with their quotes and/or limit

[[Page 33452]]

orders, the trade allocation algorithm applicable to non-Streaming 
Quote Options would not apply in Streaming Quote Options.\49\
---------------------------------------------------------------------------

    \49\ Currently, and with respect to non-Streaming Quote Options 
under the instant proposal, AUTO-X participation would be assigned 
to Wheel Participants on a rotating basis, beginning at a random 
place on the rotational Wheel each day, from those participants 
signed-on in that listed option at that time. The Wheel rotates and 
assigns contracts depending upon the size of the order executed and 
the number of Wheel participants in a given option. See OFPA F-24.
---------------------------------------------------------------------------

    Auto-X Disengagement. The provisions relating to orders otherwise 
eligible for automatic execution via AUTO-X currently included in Phlx 
Rule 1080(c)(iv) would continue to apply to non-Streaming Quote 
Options; such provisions would not apply to Streaming Quote Options 
because the automatic execution function for Streaming Quote Options is 
Book Match or Book Sweep, not AUTO-X.
    Currently, Phlx Rule 1080(c)(iv)(I) provides that, when the number 
of contracts automatically executed within a 15 second period in an 
option (subject to a pilot program until November 30, 2004) exceeds the 
specified disengagement size, a 30 second period ensues during which 
subsequent orders are handled manually by the specialist. The proposed 
rule change would amend the rule to provide that this provision would 
continue to apply only to non-Streaming Quote Options.
    Automatic executions in Streaming Quote Options would be initiated 
under the Book Match or Book Sweep function and allocated automatically 
in accordance with proposed Phlx Rule 1014(g)(vii), whereas automatic 
executions in non-Streaming Quote Options would be executed via AUTO-X 
and allocated on the Wheel.
    Proposed Phlx Rule 1080(c)(iii) would provide that Book Sweep would 
be engaged when AUTO-X is engaged, and would be disengaged when AUTO-X 
is disengaged. In order to disengage AUTO-X, a specialist is required 
to obtain the approval of two Floor Officials pursuant to OFPA A-13, 
and under extraordinary circumstances, pursuant to Phlx Rule 1080(e). 
Moreover, the specialist would not be able to disengage AUTO-X (and 
thus the Book Sweep function) such that an SQT could not initiate Book 
Sweep manually; an SQT would have the ability to initiate the Book 
Sweep function regardless of whether the specialist has obtained the 
necessary Floor Official approval and disengaged the AUTO-X feature. 
The ``disengagement'' provision is not proposed for Streaming Quote 
Options because when the size associated with an individual specialist 
or SQT's quotation is exhausted, there is no ``disengagement'' of a 
system; such a quotation would be handled in accordance with proposed 
Phlx Rules 1082(a)(ii)(C)(1) and (2), as stated above.
    Removal of Unreliable Quotes. While the Exchange is proposing to 
delete the provisions in Phlx Rule 1080(c)(i) relating to the NBBO 
Feature, certain language contained in that rule describing the 
conditions and procedures under which the Exchange can exclude another 
market's quotes from its calculation of the NBBO would be retained. The 
provisions relating to the removal of unreliable quotes from another 
exchange from the Exchange's calculation of NBBO are intended to apply 
to both Streaming Quote Options and non-Streaming Quote Options.
    Eligible AUTOM order types. Currently, the specialist, when alerted 
by AUTOM, handles the conversion of contingency orders on the limit 
order book into market or marketable limit orders when the respective 
condition applicable to such orders is manifested. The Exchange's 
systems do not currently perform this task electronically. The Exchange 
therefore proposes to amend Phlx Rule 1080(b)(i)(a), Eligible Orders, 
to provide that the following contingency order types would not be 
eligible for delivery via AUTOM: stop, stop limit market close, market 
on opening, limit on opening, and limit close.\50\ Because the 
conversion of these contingency order types is not done electronically 
by AUTOM, such order types would not be eligible for electronic entry 
on the electronic limit order book. Previously, any limit order on the 
book that became due for execution against an inbound electronic order 
delivered via AUTOM was handled manually by the specialist; with the 
development and deployment of Book Match, such contingency orders may 
now be executed electronically, but would not be converted 
electronically. Thus, such orders would not be placed on the electronic 
limit order book. Customers wishing to submit such orders would be 
required to do so by way of representation by a Floor Broker.
---------------------------------------------------------------------------

    \50\ For a complete description of these order types, see Phlx 
Rule 1066.
---------------------------------------------------------------------------

    Eligible order delivery size. In order to allow a greater number of 
orders to be delivered electronically to the Exchange via AUTOM, the 
Exchange proposes to amend Phlx Rules 1080(b)(i)(A), (B), and (C) to 
increase the maximum AUTOM order delivery size from 1,000 contracts to 
5,000 contracts for all eligible order types. This increase would apply 
to both Streaming Quote Options and non-Streaming Quote Options.
2. Statutory Basis
    The Exchange believes that its proposal to adopt Phlx XL is 
consistent with Section 6(b) of the Act \51\ in general, and furthers 
the objectives of Section 6(b)(5) of the Act \52\ in particular, in 
that it is designed to promote just and equitable principles of trade, 
remove impediments to and perfect the mechanisms of a free and open 
market and a national market system, and to protect investors and the 
public interest, by creating an electronic trading platform designed to 
provide Exchange members with substantially enhanced incentives to 
quote competitively, increase the depth and liquidity in the Exchange's 
markets, and to allow the Exchange to remain competitive for order flow 
by providing order flow providers with an electronic trading platform 
that will assist them in fulfilling their duty of best execution on 
behalf of their customers.
---------------------------------------------------------------------------

    \51\ 15 U.S.C. 78f(b).
    \52\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Exchange believes that the obligation for SQTs to quote in 60% 
of the series in all Streaming Quote Options in which they are 
assigned, and the requirement that specialists quote in 100% of the 
series in all Streaming Quote Options in which they are assigned, is 
consistent with the notion that market makers receive certain benefits 
for carrying out their duties because of those obligations. For 
example, with respect to margin treatment, market makers may obtain 
credit from lenders without regard to the restrictions in Regulation T 
of the Board of Governors of the Federal Reserve system if the credit 
is to be used to finance a specialist or market maker's activities on a 
national securities exchange.\53\ The Exchange believes that the 
affirmative obligation in the proposal, that SQTs and specialists hold 
themselves out as willing to buy and sell options for their own account 
on a regular and continuous basis, justifies this favorable treatment.
---------------------------------------------------------------------------

    \53\ See 12 CFR 221.5(c)(6).
---------------------------------------------------------------------------

    Additionally, the Exchange believes that the additional obligations 
of the specialist, such as the obligation to handle limit orders on the 
book; the obligation under the Linkage Plan to handle all inbound 
Linkage Orders and to send Satisfaction Orders on behalf of customer 
limit orders on the specialist's book; and the obligation, under 
certain circumstances, to allocate manually executed trades, justifies 
the proposed enhanced participation rights afforded

[[Page 33453]]

to specialists in Streaming Quote Options.
    The Exchange further believes that the proposed rule change 
regarding Book Match, in which orders and quotes interact directly with 
one another for execution, is consistent with Congress's stated goal in 
Section 11A(a)(1)(C)(v) of the Act \54\ that it is in the public 
interest and appropriate for the protection of investors and the 
maintenance of fair and orderly markets to assure an opportunity for 
investors' orders to be executed without the participation of a dealer.
---------------------------------------------------------------------------

    \54\ 15 U.S.C. 78k-1(a)(1)(C)(v).
---------------------------------------------------------------------------

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

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

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

    No written comments were either solicited or received.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission will:
    A. By order approve the proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. 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-Phlx-2003-59 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-Phlx-2003-59. 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 the Phlx. 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-Phlx-2003-59 and should be submitted on or before July 
6, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\55\
---------------------------------------------------------------------------

    \55\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-13403 Filed 6-9-04; 2:12 pm]
BILLING CODE 8010-01-P